Foreign Investors Shunning China, Piling Pressure on Yuan

China’s yuan is coming under increasing pressure as foreign investment in the country continues to drop at an alarming rate.

A gentle downtrend in direct investment from abroad gave way to a steep drop last quarter, and inflows to China have plunged to their lowest since records began 25 years ago, raising the prospect that a seismic shift is taking place.

Since China opened to foreign investment in 1978 under Deng Xiaoping, global firms have ploughed in hundreds of billions of dollars to buy and build factories for market access and cheap labour, bolstering the Chinese currency.

But now, corporate leaders and their advisers say a shift is under way and the political concerns behind investment decisions are long term, which leaves the yuan facing pressure from what was long one of its staunchest supports.

Also on AF: China, US, India Face Climate Change Debt-Cost Time Bomb

“FDI has historically not been a huge swing factor in the exchange rate’s value, because you typically had surpluses of $50 to $100 billion a year,” said Logan Wright, director of China Markets Research at analytics firm Rhodium Group.

“But when that swings to a deficit, which is where it is right now … that’s a pretty big adjustment.”

Foreign direct investment (FDI) inflow slowed to less than $4.9 billion for the second quarter, while Chinese companies’ investments abroad sent net direct investment to a record deficit of $34.1 billion, figures published last week by China’s State Administration of Foreign Exchange (SAFE) showed.

Investors and analysts say the decline is the result of firms’ nervousness over the direction of competitive and political friction between China and the West which has already led to trade and investment restrictions and a diplomatic chill.

The Biden administration is likely to adopt new outbound investment restrictions on China in the coming weeks. Japan, the US and Europe have already restricted the sale of high-tech chipmaking tools to Chinese companies while China has hit back by throttling exports of raw materials.

Diplomatic tensions aside, business confidence had already been eroded by three years of Beijing’s strict “zero-Covid” policy of quarantines and lockdowns that disrupted manufacturing and supply chains.

Greenfield Investment Flows Slide

China’s regulatory crackdowns on some industries and raids on US consulting firms have also been unnerving, leading businesses to fret over when and where the next hit was coming.

“I don’t have one client wanting to invest in China. Not a single client,” said John Ramig, shareholder at law firm Buchalter, who specialises in international business deals and structuring of manufacturing.

“Everyone is looking to either sell their Chinese operation, or if they’re sourcing products in China, they’re looking for an alternative place to do that,” he said. “That’s dramatically different from what it was even five years ago.”

Oxford Economics’ analysts say greenfield flows into new production capacities, probably best capture the forward-looking sentiment and have been sliding for years to total just $18 billion in 2022 from running around $100 billion a year in 2010-2011.

The slide in China FDI has been eye-catching because it has for so long been taken for granted as a fact of global trade and its unravelling portends deeper shifts.

‘China Risks Outweigh Benefits’

Pressure on the exchange rate is already being felt. Dollar purchases via Chinese banks for outbound direct investment has consistently exceeded yuan purchases for foreign inbound investment this year, resulting in six consecutive months of outflows, according to latest SAFE data.

That trend was also captured by Ministry of Commerce data, which showed that paid-in FDI fell 5.6% during the first five months of the year, the biggest decline in three years.

The yuan is down about 4% on the dollar this year, even as the US currency has fallen elsewhere, and has only found support as the central bank has guided its trading range off lows and state banks have been buying in the spot market.

The data shows enough firms are taking decisions to either quit or avoid adding to capacity in China that will set the tone for capital flows for years to come.

“The political atmosphere is incentivising western companies away from China … because the benefits of being in China are not outweighing the risks,” said Lee Smith, global trade attorney at Baker Donelson.

“A lot of our clients are worried about their exposure to China as a sole country of supply.”

• Reuters with additional editing by Sean O’Meara

Read more:

US Curbs on Investments in Critical China Tech Likely This Week

China’s Investment Calls Failing to Lure Foreign Investors

Yellen Says China Investment Curbs Will Be ‘Narrow In Scope’

China Will Still Get Big Investments From West, Scholz Says