As Foreign Direct Investment Plunges in China, Chinese Companies Go Abroad

While the People’s Bank of China (PBOC) has been cutting interest rates to stimulate the domestic economy, investors can earn about 5 percent just by purchasing U.S. Treasurys, avoiding the risks of China’s struggling economy. So far, it appears unlikely that the Chinese economy will reach its 5 percent growth target this year, with GDP growth in the second quarter falling short at 4.7 percent.

The Chinese economy has struggled since the end of COVID-19 lockdowns and has yet to recover. Over the past three years, Chinese stocks have steadily declined, losing just over $6 trillion in value. Exports contracted in May, saw a partial recovery in June, and grew at a slower pace in July, missing forecasts by 2.7 percentage points.

Chinese manufacturers are feeling the strain, with many beginning to close and lay off workers.

While China’s exports to Russia are growing, particularly in the automotive sector, the share of exports to the rest of the world has decreased by an even larger margin. Additionally, much of China’s exports are driven by foreign-invested firms, many of which are now leaving, along with domestic firms.

Both foreign and Chinese automakers once saw China as a great market, but with demand slipping, even Chinese automakers are seeking better opportunities abroad. Beyond economic pressures, the trade war with the United States and the potential for one with the EU push these companies to look elsewhere, avoiding tariff impacts. The automobile sector, heavily dependent on chips, is also concerned about the availability of these components in China as U.S. restrictions tighten. Toyota, Mitsubishi, Honda, Nissan, and Hyundai are all scaling back their operations in China.

The same factors discouraging foreign investors from investing in China drive Chinese firms to invest abroad. In the second quarter, Chinese firms set a record with $71 billion in outbound investment. This increase in overseas investment means jobs are going abroad rather than staying in China. Just as China once benefited from global outsourcing, other countries will now benefit from Chinese factories moving overseas, which will, in turn, slow job growth in China.

The outlook for China’s exports is expected to worsen. Currently, Chinese electric vehicles (EVs) face up to 37 percent tariffs in the EU. In response, China filed a case with the World Trade Organization, but Brussels argued that the tariffs were justified due to Beijing’s unfair subsidies to its EV manufacturers.

The U.S. trade war has continued since 2016 under the Trump administration, and the Biden administration continued and intensified the tariffs. As well, presidential candidate and Vice President Kamala Harris may continue President Joe Biden’s trade policies. Trump has stated that he would impose tariffs as high as 60 percent to 100 percent on most products and 100 percent to 200 percent on Chinese EV imports. UBS has determined that a 60 percent tariff would halve China’s growth. Given the size difference between the two economies and the U.S. growth rate, halving China’s growth would prevent it from ever surpassing the United States.

As for China’s domestic economy, the ongoing structural weaknesses driving away investment and causing exports to decline remain unresolved. The real estate debt bubble threatening the economy is well-known, but another ticking time bomb that receives less attention is local governments teetering on the brink of insolvency.

Local government debt in China is estimated to be as much as $11 trillion, with $800 billion at risk of default. Much of this debt stems from infrastructure projects, transportation, and housing developments that were never completed, sold, or materialized. Desperate for cash, local governments falling behind on payments are now hounding private companies, demanding millions in back taxes, sometimes based on decades-old assessments. This, along with the PBOC rate cuts, signals an economy in crisis and a regime running out of solutions.

At each Plenum and with every five-year plan or Xi’s economic proclamation, the CCP claims to recognize the need to reform the economy and shift to a more sustainable model, less dependent on infrastructure investment and exports. However, no major changes have materialized. It seems that even the most optimistic foreign companies and investors are done waiting and are finally pulling their money out of China—and many Chinese companies are doing the same.