After the death of Mao Zedong in 1976, the more orthodox communism gave way to a pragmatic approach to economic development, and three years later the country opened its doors to foreign investment.
In the following decades, capital inflows grew exponentially, with Chinese GDP expanding at an average rate of more than 9% per year.
But now that long-term trend has begun to reverse.
Foreign investment in China has been plummeting since the beginning of this year, especially since the Russian invasion of Ukraine.
Between January and March alone, foreign investors withdrew about US$150 billion in yuan-denominated financial assets, mostly in bonds.
“Although China recorded (capital) inflows in January, outflows in February and March were so large that they made the first quarter the worst on record. The flight continued into April,” says the May report from the Institute of International Finance. (IIF, its acronym in English).
The Washington-based entity expects an asset outflow from China of $300 billion this year, more than double the $129 billion in 2021.
We analyze what are the four main causes of this trend, if it is here to stay, what consequences it will have and how the Chinese authorities are reacting.
“‘Covid zero’ policies are pushing China into a contraction similar to the first wave of the pandemic,” Spanish economist Juan Ramón Rallo told the BBC.
More than two years after the start of the pandemic, most countries have lifted restrictions due to covid. But in China it is different.
Beijing, which previously always prioritized economic growth above all else, this time put that aside to avoid a possible health crisis, despite the majority of its population being vaccinated.
The government has imposed strict lockdowns on Shanghai — which accounts for 5% of the national GDP. And in other cities, he reinforced anti-covid measures, reducing business activity.
Thus, unemployment in cities exceeded 6%, its economy contracted 0.68% in April and few believe that China will reach the growth target for this year of 5.5%, a figure that is already discreet compared to previous years.
Two-month lockdown comes to an end in Shanghai, China
“Many companies still see China as an important market, but today it is difficult to maintain that optimism while the rest of the world opens up and China remains closed,” says Nick Marro, an analyst at the Economist Intelligence Unit (EIU) in Hong Kong.
Marro believes that the “covid zero” strategy does not encourage investors to bet on China “as the rules can change suddenly, without notice, which makes planning and decisions about future investments even more difficult”.
“The big question is whether foreign investors see ‘Covid Zero’ as a temporary problem they can tolerate. The longer this policy continues, the greater this intolerance.”
Home construction has been one of the growth engines of the Chinese economy in recent decades.
However, the sector has been in crisis since last year due to the heavy indebtedness of local giants such as Evergrande.
While China’s housing crisis dates back to earlier, foreign investors’ fears about its consequences on the country’s economic health in combination with the effects of “covid zero” and other factors are more recent.
“In the last 10 years, China has grown based on cheap credit and the housing bubble”, recalls Professor Rallo.
After that bubble burst, he explains, the country is immersed in a change in the productive model that he describes as “complicated”.
“Digesting a housing bubble of such magnitude is a slow and painful process, even more so if it doesn’t allow for a quick adjustment, as the Chinese Communist Party seems to be doing.”
Aware of this problem, the Chinese authorities took some measures to revitalize the housing market, including several cuts in interest rates on housing finance through a decree from the country’s central bank.
That puts China as one of the few countries that is going against the tide: while the European Central Bank (ECB) and the Federal Reserve announce interest rate hikes to fight inflation, Beijing is turning to stimulus to ease its housing crisis and revitalize its economy — bet that many consider risky in full price escalation on a global level.
3. Russia, geopolitical tensions and human rights
The invasion of Ukraine cost Russia economic isolation from the West with sanctions of a magnitude that no one would have imagined for such an important country.
The war has led many investors to wonder what would happen to their assets in China if Xi Jinping launched a military operation in Taiwan, quells a popular uprising in Hong Kong by force or decides to settle territorial disputes with neighbors by force of arms.
China’s position in the Ukrainian conflict — closer to Russia — doesn’t help either.
“Markets are worried about China’s ties to Russia — this is scaring investors and risk aversion has been in evidence since the start of the invasion,” Stephen Innes, managing partner at investment service SPI Asset Management, said in a statement. to Bloomberg.
“Everyone started selling Chinese bonds, so we’re glad we didn’t buy any.”
Professor Rallo, in turn, highlights the trend towards regionalization of global trade with two major areas of influence: Europe-USA, on the one hand, and China-Russia, on the other.
Thus, for Western companies “having part of their value chain in the other block can be a disadvantage”, so some of them would choose to give up these markets.
Analyst Nick Marro also highlights “the deepening schism between China and the West on issues such as economic and strategic competition, as well as democratic values and human rights.”
A good example of this is Norway’s Norges Bank Investment Management, the world’s largest sovereign wealth fund that manages assets of 1.3 trillion dollars. In March, the fund excluded shares in Chinese sportswear company Li Ning for “unacceptable risk” that “contributes to serious human rights violations”.
4. The offensive against the private sector
Both the Chinese “economic miracle” and the avalanche of capital flows that largely made it possible came along with free-market reforms and the development of private enterprise.
However, notes Nick Marro, “much of the reform agenda that could benefit both foreign and local private companies has stalled.”
The recent trend of protectionism and intervention takes place in many sectors, but especially in technology, “where national security concerns trump everything else”, he says.
The clearest example is the offensive that began in 2021 against big Chinese tech companies, which critics attribute to the state’s desire to control the sector. This has affected the value of world-renowned companies, including Alibaba.
Billionaire Jack Ma’s corporation has been one of the hardest hit by Beijing’s regulatory campaign, which in April last year imposed the largest antitrust fine in the country’s history, worth about $2.8 billion.
According to the analyst, the Chinese government is giving more and more power to state entities, which may go against its objective of reviving economic growth.
In recent weeks, Reuters and Bloomberg have cited industry sources who say Beijing plans to correct its policy on tech companies, although the government has not officially confirmed this.
Does development have a limit?
Chinese stock indices have also not given good returns to investors in recent months.
The Shanghai CSI300 bottomed out in late April and has since recovered slightly, although it is still far from its early-year levels.
The local currency, the yuan, traded at its lowest levels in two years against the dollar in May.
The downward curve of Chinese indices is not much steeper than their counterparts in the US and Europe, which have also depreciated since the beginning of the year after reaching highs in 2021.
China’s trade surplus exceeded $200 billion in the first quarter. Although this is partly because of the fall in imports, the reserve is considerable and helps the country better resist foreign investment withdrawals.
In this context, the IIF describes in its report, capital outflows from China are not jeopardizing the country’s solvency, which does not need foreign currency to meet its external obligations.
The institution also considers that the wave of divestments in China has limits.
“While we see high-profile companies announcing plans to leave the market, we shouldn’t see this as an exodus. Many of these companies have been in China for decades and it won’t be an easy or quick decision for them to leave that market,” he says.
In a recent editorial, The Economist magazine points to the upcoming National Congress of the Communist Party of China (CPC), scheduled for October, as the turning point that could refocus the Chinese economy and present a different perspective to foreign investors. .
“The optimistic view is that this dark period of ideology, political mistakes and slow growth is part of the preparation for the party congress. When that passes, pragmatists will have more control of politics, ‘covid zero’ will end and support will return to economy and technology”.