House View: FDI matters, but not exclusively


House View: FDI matters, but not exclusively

Empty seats: As FDI shifts to services, China's factories lose their hustle and bustle

China’s foreign direct investment (FDI) for the year to date fell for the third consecutive month this September. While up year-on-year from a drop in August, when FDI hit a low of US$7.2 billion, September’s influx of US$9 billion – making for US$87.4 billion of total FDI for the first three quarters of the year – was taken popularly as a sign of wary international investors unsettled by a slowdown in China’s economy.

This in turn prompted more hand-wringing and fretting that China was poised on the precipice of investor confidence, ready to lunge over at any moment into the abyss. However, we might suggest speculators take a few steps back to appreciate the broader context of the situation.

Economists often caution against taking cues from a single month of data on foreign capital inflows, since each on its own can vary, sometimes wildly, with investor zeitgeist. Certainly there has been plenty of activity in China lately that might weigh on the minds of international CEOs with a presence here: More foreign companies have been prosecuted by regulators this year, and with heavier penalties, than any in recent memory. Japanese companies in particular are now feeling the squeeze thanks to a declining yen and rising labor costs, the latter of which has some pointing to FDI growth in ASEAN economies such as Indonesia and the Philippines as evidence that China is workshop of the world no longer.

Thus has a correlative dip in FDI been widely, if not explicitly, connected to a more hostile environment for major international corporations whose now-large presence on the mainland has made them juicy targets for regulators armed with a 2008 anti-monopoly law that, until quite recently, had been gathering dust. The focus on headline FDI as an indicator of international investor sentiment might be tracked back, at least in part, to China’s passing of the US in 2012 as the largest single recipient of international direct investment. Looking at those figures side-by-side does indeed say something at the macro level about scale and economic influence, but it does not say much in terms of where the money in question is going once it clears customs.

This is where a closer look at FDI composition comes in handy. As Ryan Rutkowski of the Peterson Institute for International Economics pointed out in September, while foreign investment inflows into manufacturing are indeed slowing, those pouring into China services sector not only remain strong, they have dominated FDI since passing manufacturing as a contributor since in 2010, and now account for three-fifths of all FDI flows. While FDI may serve as an indicator of the external economy, it requires another leap to reach the conclusion that a dip indicates a loss of faith in China as a destination for profitable investment. Far from it: Growth in services is currently helping China weather the current storm as it sails into the admittedly choppy waters of the fourth quarter.

A loss of US$4.2 billion in manufacturing FDI for the year to date looks far less worrisome in light of the gains to the tune of about US$4 billion in services FDI and, when considering the broad economic goal of China’s leaders to refocus its economy on services and domestic consumption, is about what one would expect. All this said, it is worth noting – as is always necessary when discussing China’s FDI – that the figure is not in and of itself a major contributor to China’s bottom line: At about US$117 billion, FDI only accounted for roughly 1.31% of GDP in 2013 based on official numbers. Even if the country’s books are lightly cooked in regards to total annual growth – as even Xinhua has suggested – the ultimate importance of foreign direct investment in China should not be overstated.