Magnetism still there, despite investment falls

But the risks and uncertainties are evident

China has been among the top destinations for foreign direct investment, ranking second after the US since 2009. However, while inward FDI rose to a new record of $116 billion last year, its growth slowed to 9.7 percent, compared with global FDI growth of 16 percent. From January to July, FDI inflows have fallen 3.6 percent, after posting nine consecutive months of year-on-year falls since November, adding to concerns about China's competitiveness and growth prospects.

At first glance, the year-on-year fall should not come as a surprise, given subdued investor sentiment and a slowing global economy. A closer look at FDI points to significant headwinds facing China, given changing domestic and global conditions. While it is not easy to disentangle the cyclical and structural impacts, we think the concerns are warranted.

Domestically, rapid increases in production costs (including labor, land, energy, resources/water), a more expensive currency and high inflation compared with the past have reduced China's competitiveness, especially in the low-end, labor-intensive manufacturing sectors.

In recent years multinationals as well as Chinese firms have relocated some of their production to Southeast Asian countries or to inland China, where overheads are lower. This year's report of the United Nations Conference on Trade and Development indicates that FDI inflows to the Southeast Asian regions rose 26 percent ($117 billion) last year, compared with 9 percent ($219 billion) to the East Asian regions.

This, in combination with a slowdown in China's potential growth (from 10 percent previously to 8 percent now) and the structural challenges to rebalance the Chinese economy, have added to the risks and uncertainties of investing in China. Multinationals have been turning to promising countries such as India, Brazil and Russia for their strategic positioning.

Cyclically, the deflating of the domestic property bubble and slowing industrial activity have also had a visible impact on FDI inflows. FDI in real estate has fallen 9.3 percent year-on-year so far this year, and in manufacturing 6.4 percent, compared with a 3.6 percent fall in total FDI inflows. In contrast, wholesale and retail trade has risen 15.6 percent year-on-year so far this year, and leasing and commercial services rose by 4.8 percent in the first half of the year, based on the latest available data.

Externally, the global financial crisis and slowing potential growth in the developed economies point to greater competition and rising protectionism. Developed countries, such as the US, are adopting new strategies to rejuvenate their economies, such as launching campaigns to encourage businesses and capital back to revitalize domestic sectors such as manufacturing.

Meanwhile, with huge sums of foreign reserves, the Chinese government is more concerned about the quality of FDI, rather than its quantity, and is encouraging outward investment. The new Industry Directory for FDI, effective from Jan 30, follows clear principles to facilitate a change in the growth model.

The key amendments from the 2007 edition pertain to: further liberalizing the domestic market; encouraging industrial upgrading; developing strategic new industries; developing the service sector; and achieving balanced regional development.

Specifically, China will encourage FDI industries such as high-end manufacturing, high-tech, modern services, clean-energy, and modern agriculture sectors. We would expect FDI to service sectors such as finance, logistics, healthcare, tourism and culture to experience faster development.

Meanwhile, investment in labor-intensive industries is also being encouraged in the inland regions, given their richness in land, energy resources and labor.

Looking ahead, we think FDI is likely to fall, or be flat at best, this year. Despite a slowdown, we believe the trend of faster service-sector growth and more balanced regional development will continue. Last year for the first time the share of service FDI (48 percent) surpassed that of manufacturing (45 percent). The contribution of sales and retail, and leasing and commercial combined rose to 7 percent, while real estate's climbed to 23 percent. Meanwhile, the inland has attracted faster FDI inflows than the coastal east, with its total share rising to 40 percent.

In the medium term we expect China, with its diversity and scale, well-placed supply chain and huge domestic market, to remain attractive for multinationals in selective industries.

In this year's UN Conference on Trade and Development World Investment Prospects Survey China is ranked at No 1 for the investment plans of multinationals in the period 2012-14, followed by the US and India.

Jian Chang is director and China economist, Barclays Bank. Yiping Huang is managing director and chief economist, Emerging Asia, Barclays Bank. The views do not necessarily reflect those of China Daily.

(China Daily 08/31/2012 page9)