Analysis: China’s Utilization of Foreign Capital in 2012

Main factors affecting China’s FDI

From the perspective of domestic factors:

First, the national economy has ushered in a new stage for development and thus requires more stringent standard for foreign investments.

In recent years, the national economy has experienced rapid development with remarkable achievements. As early as 2011, China’s aggregate GDP totaled USD 7.3 trillion, which consolidated China’s status as the world’s second largest economy; with a per capita GDP over USD 5,400 in 2011, China was in the course of entering the high-income country rank from the medium-income countries; China’s foreign exchange reserve exceeded USD 3.18 trillion; the FDI utilized by China rose by nearly 2.5 times to USD 116 billion from USD 46.9 billion in 2001. Undoubtedly, FDI has made great contribution to the domestic economic development, industrial structure upgrading and industrial system construction. However, as China has become stronger in economic power, the “dual gap” at the beginning of the implementation of the reform and opening up policy has changed to “dual surplus” and therefore China has naturally unveiled stricter standards for foreign investments. Attracting foreign investments is not mainly for making up the “dual gap”, but for competing for the highly competitive carriers defining by advanced technologies, management expertise and sound corporate governance system in a bid to serve promotion of technological progress, structural upgrading and institution transition.

Second, “mode transformation and structure adjustment” has become a significant topic for domestic economic development, which requires a structural transformation of foreign investments.

To adapt to the requirements for transforming economic growth mode and adjusting economic structure, China will continue to encourage foreign investments to go into such industries as high-end manufacturing, new and high technological industry, modern service, new energy as well as energy saving and environmental preservation, and China will still have strict threshold for the high-energy-consumption, high-pollution and high-resource-consumption projects. Besides, China will encourage the foreign-funded enterprises to set up in China such functional headquarters as regional headquarters, R&D center, purchasing center, financial management center, settlement center as well as cost & profit settlement center and more cooperation in terms of R&D between the domestic en-terprises and their foreign counterparts will be encouraged. In the revision of“advantageous industry catalog for foreign investments in Central and West China”, more entries will be added for the labor-intensive projects; the foreignfunded enterprises will be encouraged to develop in the central and western areas the labor-intensive industries in line with requirements for environmental protection, and both the domestic enterprises and the foreign counterparts in the western areas will continue to enjoy the preferential policies for corporate income tax; more preferential policies as well as technical and capital support will be in place for the foreignfunded enterprises in the eastern regions to shift to the central and western regions. All of these will impact the industrial structure and regional structure of foreign investments.

Third, under such circumstance as stabilizing price and controlling housing price, economic growth has slowed down and investment cost faces upward pressure, which dents the influx of foreign investments

With tight corporate capital chain and increasing risk for economic downside, although the domestic monetary policy has got looser this year, the national economic growth will slow down due to under high pressure for inflation no fast growth in money supply, persistent policy for housing price control and slower investment growth in real estate and related industries. As a result, the time that a couple of years ago foreign investors capitalized on the high housing price to massively nudge into the domestic housing sector has gone. In the mean time, China’s rising labor cost, high raw material price and RMB appreciation will push up investment cost, which will inevitably deter the growth of foreign investments.

From the perspective of international factors:

First, the world economy is gloomy for recovery and great uncertainties exist for economic growth, therefore, foreign investors now become cautious.

In the wake of the financial crisis, the world economy has been struggling out of the slump, but sluggish. The unpredictable international political environment, turbulent situation in the Middle East and North Africa, chaotic South Asia and South China Sea areas, as well as intense battle among big nations across the world have made things worse for the world economy to step out of the crisis. According to the IMF’s analysis, the world economic growth in 2011 did not live up to the prediction at the beginning of the year, declining to around 4% from above 5% in 2010; the real GDP in the economic powers remains grim — the real GDP growth was as low as around 2% in 2011 and this year the real GDP is forecasted to rise 2%. The depressed world economy will necessarily lead to lower enthusiasm and input for the foreign countries to invest in china, which will be a major constraint for attracting inbound FDI.

Second, the US economy is in a downturn and its “re-industrialization”strategy impact its investments in China.

As the world’s largest economic power, the US was heavily hit by the 2008 financial tsunami with high unemployment rate and fiscal deficit as well as slowing economic growth. The IMF forecasted that this year the US would still have a high fiscal deficit, accounting for as high as 6.1% in its GDP. The debt problem will be a mediumand long-term constraint for the US economic recovery. On the one hand, the cap for issuing national bonds needs to be raised so as to avoid debt defaults and then debt crisis; on the other hand, at the time for presidential election, economic decline should be avoided, and a loose fiscal policy with higher corporate tax cannot be implemented. Consequently, the debt problem will be a longterm bottleneck for the US and thus economic recovery will be very slow.

Unemployment is the biggest challenge confronting the US. The IMF’s prediction revealed that in 2011 the US unemployment rate was 8.8%-9.1% and it would remain as high as 8.3%-9% in 2012. In spite of a string of pro-employment acts that the Obama administration has raised, the effects of these acts are not satisfactory enough. As a result, unemployment will become the biggest obstacle for the US economy to recover.

Confronted with so many difficulties, the US economy has seen some growth, but it is still in the downturn. The IMF predicted that in 2011 the US GDP growth rate was 1.7%-2.1% and in 2012 it would probably rise to 2.6%-3.3%. Against the backdrop of the US“re-industrialization” strategy to rejuvenate economy, China’s inbound foreign investments will necessarily sink and even backflow of some foreign investments will resulted.

All in all, the US economic trend and its internal policies will become a key factor affecting its investments in China this year.

Third, as the European sovereign debt crisis escalates, it will be difficult for the EU economy to recover in a short period and the EU will be weaker to invest abroad.

In 2011, the European sovereign debt crisis kept spreading, which meant that the crisis passed on from the periphery countries including Ireland and Greece to the core EU member countries such as Italy, Spain and Portugal. Three international credit rating agencies have kept downgrading the credit grade of the EU member countries and even France, the core member in the EU has no way to be not involved.

As the bailout mechanism the EU formulated can only solve the liquidity problem for the countries trapped by the crisis in the short run, but cannot improve their solvency in the real sense, the default risk for these countries is mounting; the EU debt crisis may transmit to medium- and large-sized economic entities from small-sized ones. In particular, Italy’s debt problem has tremendous potential risk; the European banking sector, with a 53% asset in the global banking sector, holds a huge amount of bonds worth more than EUR 500 billion in the PIIGS(Portugal, Italy, Ireland, Greece and Spain), so there exist risks for the debt crisis to evolve into a banking crisis. In 2012, the EU is very likely to face a difficult year for addressing the sovereign debt crisis.

The EU is deeply hit by the crisis and has no way to step out of the crisis by itself. The escalation of the European sovereign debt crisis this year will impose persistent impact on the EU economy, making it hard to recover in a short time; even if the EU sovereign debt crisis will not escalate, the EU’s countermeasure — tight fiscal policy will decrease the public fiscal expense in the EU, cut social welfare, deter growth in public investments and consumption and even result in frequent individual strikes, which will impact the social economic growth. All of these will slash the EU’s investments in China.

Outlook on China’s Inbound FDI

Due to the changes and impact of both the domestic and international economic framework, it will not be optimistic for China to attract FDI in 2012.

First, the foreign investment scale is projected to decline a bit on an overall stable basis.

In 2011, China’s actually utilized FDI showed negative growth during the last two months, suggesting that the financial crisis and the European sovereign debt have imposed obvious impact on China’s attracting FDI. In 2012, as the world economy will remain gloomy and it will be hard for such developed countries as the US and Europe to rejuvenate economy in a short time, China’s inbound investments will continue to slow down; heavily affected by the US and European economic situation, the 10 Asian countries and regions that accounting for over 80% of China’s FDI will also have a slowing economic growth and weaker power to invest abroad; besides, China has stricter requirements for FDI, but its own economic growth slows down and investment cost rises, therefore, we make such a prediction: in 2012 China’s actually utilized FID will show a stable trend with a little decline, but if the world economy and political environment worsen, foreign investments will drop dramatically.

Second, the industrial structure for FDI will be further adjusted.

Since January 30, 2012, China began to implement the new Industry Directory for Foreign Investments, which will develop modern industrial mechanism by channeling inbound investments to such domains as modern agriculture, new and high technological industry, advanced manufacturing, new energy and modern service. The foreign-invested companies are encouraged to cooperate on R&D with the domestic counterparts, and when utilizing foreign investments, China may enhance its independent innovation capability. At the same time, China will strive for energy saving and emission reduction and will strictly constrain or forbidden the high-energy-consumption, high-pollution and high-resourceconsumption foreign investment projects. Under the guidance of the national industrial policy, more foreign investments are projected to go into agriculture, forestry, husbandry and fishing in 2012, but the ratio in these industries are still very low; constrained by its own development level and affected by the “re-industrialization” strategy in the US and Europe, growth in foreign investments for manufacturing will slow down with a lower ratio; as such domestic service sectors as finance, logistics, tourism, medical service and cultural industry become more open and experience faster development, the service sector will utilize much more foreign investments than manufacturing to account for half of the total FDI China has attracted and thus it claims as the major player for FDI.

Third, the regional structure of FDI will be changed faster.

The domestic regions attracting FDI are obviously out of balance. The majority of FDI concentrates in East China, while the central and western regions account for a smaller ratio. However, with improving investment environment, the central and western regions will attract foreign investments at a faster rate. Particularly, the revised Industry Directory for Foreign Investments points out to bring the superiority of the central and western regions in terms of land, energy resources and labor force into full play, and it encourages the foreign investors to develop labor-intensive industries in line with environmental protection in the central and western regions. In 2012, it is projected that the central and western regions will continue as last year to have greater attractiveness for FDI and more foreign investments will go to the core economic zones of the central and western regions, and the regional structure of FDI will be further optimized.

Fourth, risks are increasing for foreign investors to withdraw investments from the labor-intensive sectors in the coastal regions.

Due to rising labor cost, high prices of raw materials and energy as well as RMB appreciation, the foreigninvested enterprises concentrated in the coastal regions are under more pressure with rising cost yet lower return on investment. It’s more likely for the foreign investments settling in the coastal areas to exit China. Besides, the depressed and unbalanced world economy confronts some foreign-invested enterprises with capital shortage, which poses more risks that these enterprises will exit the Chinese market.

Under complicated internal and external economic circumstances, China needs to further promote investment liberalization and facilitation, keep attractiveness for foreign investments and to strive for steady growth in foreign investments; the combination of economic structure upgrading with utilization of foreign investments will be helpful for the optimization of foreign investment industrial structure and regional structure; the local governments in the eastern and western regions are encouraged to become “twin governments” in a bid to help the labor-intensive foreigninvested enterprises in the coastal areas shift to the central and western regions especially the core economic zones in the central and western regions. In this way, synergy effect will be achieved in these core economic zones, promoting industrialization in the mainland.