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China’s foreign investment data distorted by Hong Kong flows

China’s government data show foreign investment into the economy grew by almost a fifth this year, a feat highlighted by officials as evidence global companies are resisting calls from US and European politicians to decouple from the country.

Yet, a look below the headline figure of 17.3 percent expansion in the first seven months of the year shows a less flattering picture. Much of the investment into China actually comes from Hong Kong, and is likely because mainland companies based there are routing funds through the city in a circular journey that’s called “round-tripping.”

The data also show that three-quarters of the new investment into China has gone into services industries, rather than the crucial manufacturing sector, which the government is promoting to transition the economy toward higher-value production.  

The figures help to explain why inbound investment has continued to set new records each year despite an increasing number of foreign firms considering curtailing their presence in China as the economy struggles and tensions with other nations rise. US companies surveyed by the US-China Business Council recently said they planned to slow new investment next year, largely because of China’s strict virus controls. 

“The era of strong FDI inflows seen in the 1990s and the early 2000s is gone,” Raymond Yeung, chief economist for Greater China, Australia & New Zealand Banking Group, wrote in a recent note. “The increase of FDI over the past few years includes a rising presence of Chinese entities based in offshore funding centers, making the expression ‘foreign’ investment somewhat of a misnomer.”

To be sure, some foreign companies are still putting new money into China, although the size and speed of that expansion is not as big as some of Beijing’s officials suggest. In the first three months of this year South Korean firms invested a net $4 billion, according to data from the Export-Import Bank of Korea, while Japanese companies invested a net $3 billion in the first half of the year, according to Ministry of Finance data.

Round trip via HK

Hong Kong was the source of a record 76 percent of all “actually utilized” FDI last year, according to a Bloomberg analysis of government data, and if that ratio holds for this year then 607 billion yuan ($88 billion) of the 798 billion yuan of investment so far this year is from Hong Kong. Researchers at the Chinese Academy of Social Sciences and Nankai University estimate that almost 37 percent of China’s inbound FDI is “round-tripped.”

Flora Zhu, director for corporate ratings at Fitch Ratings in Beijing, said Chinese high-tech service firms have a relatively high share of round-tripped investment since many are listed offshore.  

“Most of their funds raised offshore are repatriated to China and counted as FDI,” with some of that circular movement to take advantage of preferential treatment for foreign funding, she said.

There is no detailed breakdown available yet for the origin of investment flows this year, but in 2021 new investment from everywhere but Hong Kong grew 8 percent to $42 billion, after dropping in 2019 and 2020. Inflows from Taiwan, Canada, Australia and the Cayman Islands shrank last year. 

A similar pattern can be seen in completed cross-border mergers and acquisitions. So far this year, there have been almost $24 billion in completed deals from Hong Kong, 35 percent of the total amount of deals into the mainland. 

The vast majority of the deals from Hong Kong were by mainland companies listed in the city. For instance, Alibaba Group Holding Ltd. and Tencent Holdings Ltd. were part of a consortium that invested $5.2 billion in Ruili Integrated Circuit Co., the biggest inbound deal so far this year.

The plateauing of growth in new funds in recent years and the caution expressed by foreign companies about boosting investment into China due to the Covid Zero lockdowns and geopolitical tensions may be raising concern at senior local levels. Vice Premier Hu Chunhua recently called for the government to work harder to both shore up existing foreign investment and attract new money. 

Services focus

Where the money is going is also of concern. Services industries have received the vast majority of inflows, rather than the manufacturing and high-tech sectors that are the focus of government efforts to boost investment.

However while new foreign funds for manufacturing were well down from the peak in 2011, that dynamic may have started to shift last year and into this year, according to Fitch’s Zhu. 

FDI into manufacturing has grown faster than total FDI since February 2022, she said. She pointed to a 50 percent jump in manufacturing investment into the industrial powerhouse Jiangsu province in the first six months of this year and a rise in money going to Sichuan, which is a center for electric vehicles.

However other provinces haven’t been so fortunate this year, with investment into Shanghai only starting to recover in June after the two-month lockdown was lifted, and flows to Guangdong in the first seven months still below the same time last year. The lockdown of Sichuan’s capital of Chengdu may now affect how investors see that city, especially if it is shut for months as Shanghai was. 

“We’re expecting foreign investment into China to soften in 2022-2026, particularly when benchmarked against a bright FDI outlook for emerging markets in Southeast Asia,” said Nick Marro of the Economist Intelligence Unit in Hong Kong. “This is partly a Covid story, partly a growth story, and partly a geopolitics story, as China’s fraying diplomatic ties generate anxieties around protectionism, but also around overexposure to things like sanctions, tariffs and compliance with export controls.” With assistance from Fran Wang, Yujing Liu, Lin Zhu, Tom Hancock, Fion Li, Sam Kim and Yuko Takeo /Bloomberg

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