Foreign investment in China is declining as sources of capital change

US FDI may be declining, but Beijing has substitutes from the Middle East

By Chris Devonshire-Ellis

Foreign investment in China has declined significantly since May this year, with four consecutive months showing double-digit declines. FDI in September fell by 34 percent compared to the same month last year, with the falling numbers marking the biggest drop in FDI since monthly data became available in 2014. September recorded inward FDI of US$10 billion.

However, the reasons for this have less to do with China becoming unattractive – its consumer market fundamentals remain positive – but the declines are more to do with geopolitical changes making their way into investment sentiment in China, mostly from United States. Washington’s sustained political pressure on domestic US investors to back away from China is paying off, with these latest numbers showing the effects of a disappearing tail of US private equity and corporate M&A deals drying up.

Historical US FDI in China ($ billion)

Source: Statistics

It also comes after the Biden administration issued an executive order directing the U.S. Treasury Department to create a new regulatory program to ban or require notification of outbound U.S. investment in China in certain sensitive sectors. It was issued on August 9 this year and is a targeted order designed to slow down investment in China. The biggest impact is on US private equity and venture capital investment in China. What we are seeing now are the results.

So where does China go from here? Beijing needs about US$100-200 billion in inward foreign direct investment to sustain and develop its growth plans, and as can be seen from the past, it has been able to rely on the United States for much of this. As Washington wants to pull the plug and limit investment in key strategic Chinese industrial development—new technologies and AI in particular—Beijing needs to find alternative sources of FDI.

Domestically, it has already undertaken a large-scale state development plan in the period 2005-2020; China’s own infrastructure is relatively good, well connected and not yet in need of expensive maintenance costs, although this will change over time. However, China is spending significant amounts of money on technical development as well as securing global supply chains. The amount spent on Belt and Road Initiative projects exceeds US$1 trillion – roughly equivalent to a decade of its inward FDI in the US. On the positive side, many are now entering, after some delay (like Covid), cash flow generating stages. Some of these projects would later be IPOs, with Chinese investors receiving a welcome and marginal return on their investment. However, since China also does not have to spend as much on BRI projects as it has in the past, many of these investments will settle and be realized as annual dividends from Chinese equity holdings.

But even these dividends from the Belt and Road Initiative will not exceed previous US FDI spending in China. Instead, this capital is likely to come from the Middle East, and specifically from the Gulf Cooperation Council countries. These six nations – Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, Bahrain and Oman – have collective sovereign wealth funds worth about US$4 trillion in available investment capital. Only a small fraction of these – roughly 1-2 percent – ​​are invested in Asia, particularly China at the moment. But that will change.

This investment capital is expected to grow to about US$10 trillion by the end of this decade. China’s allocation of FDI from the GCC region is expected to reach around 10-20 percent – ​​more than adequately covering the US shortfall.

This view was also supported by the CEO of the Hong Kong Stock Exchange, Nicolas Aguzin, who stated: “Think about what this means. That’s about 1-2 trillion US dollars which will be redistributed into investments.’

FDI in the Middle East is also on the rise, a topic we discussed in detail in our October 2023 issue of Asia Investment Research “Trends in Foreign Investment in the Middle East” and which contains data on the inflow of FDI in the region.

This adds another level of complexity to China’s foreign direct investment – ​​with future investment potentially originating in the United States, repackaged in financial centers such as the UAE and then sent to Asia – and China.

There are already signs of growing engagement between the GCC and China. For example, in May 2023, the UAE signed three agreements with Chinese nuclear energy organizations, which is just the beginning of nuclear energy goals for the country and the region. ENEC, which is developing the UAE’s nuclear power sector, has signed memorandums of understanding with the China Nuclear Power Operations Research Institute, the China National Overseas Nuclear Corporation and the China Nuclear Energy Corporation. The meetings came six months before the United Arab Emirates hosts the upcoming COP28 global climate summit, amid its strategy to shift 6 percent of its energy needs to nuclear power to meet its net-zero goal by 2050. These nuclear agreements are an entry point into the region for China, which operates more than 53 nuclear power projects and has about 20 more under construction.

This shift to the Middle East also led to a boom in regional IPOs from 2022, which continued into 2023. In the first quarter of 2023, the UAE attracted US$3 billion in investment capital, placing it third in the world (14 percent globally).

Other examples of GCC financing in China in Q3 of this year (2023) are discussed below.

Saudi Arabia

Five agreements were signed, including one with the largest disclosed value in Q1.

Saudi Aramco has signed agreements with Hangzhou-based Rongsheng Petrochemical to acquire a 10% stake in Rongsheng Petrochemical for US$3.6 billion.

Saudi Aramco has announced a partnership with NORINCO Group and Panjin Xincheng Industrial Group to build an integrated refinery and petrochemical complex in Liaoning Province. The complex will be developed by the joint venture set up by the three companies, with NORINCO holding 51 percent and Saudi Aramco taking 30 percent.

Saudi Aramco has agreed to become a 20 percent shareholder in a joint venture for lower emission engine technology with Geely and Renault (the first major oil producer to invest in the automotive business).

Saudi Aramco also signed a memorandum of understanding with the Guangdong provincial government to enter into cooperation in energy, research and development, industrial projects, finance and talent exchange.

VSPN announced a US$265 million investment from Savvy Games Group, (PIF), becoming the largest shareholder. VSPN has become a leading global eSports broadcaster and has hosted a series of eSports tournaments.

UAE

Emirates Airlines has agreed to increase its operations in China in response to strong travel demand, boosting connectivity to its gateways: Guangzhou, Shanghai and Beijing.

Qatar

Oricell Therapeutics, a China-based innovative pharmaceutical company engaged in the development of tumor cell immunotherapeutics, announced the closing of a US$45 million Series B1 investment round, following the close of a US$125 million Series B fundraising in July 2022 This round was led by global investors RTW Investments and QIA, with participation from existing investors including Qiming Venture Partners and C&D Emerging Industry Equity Investment.

Summary

China needs around US$2 trillion in funding over the next decade to fuel its own investment and national development – ​​the GCC appears to be the answer. To some extent, the GCC is also benefiting from the current geopolitical instability as oil prices are rising. A barrel of crude oil is currently selling for around US$100 – a growing number of analysts believe this has the potential to rise to US$150 in the coming months, providing additional financing for the Gulf countries and making it easier for them to allocate investment to Asia.

While China forecasters will make much use of the latest data on FDI inflows, they miss the point – an era of US-funded FDI in China is coming to an end. However, this is a transitional phase, not a final dead end. Another source of FDI in China is starting – with the Middle East to be the main source of foreign investment in China – and Asia.

A secondary element will also come into play – the loss of opportunities for US investors as they are squeezed out of China from alternative sources of capital. In this regard, China is already ahead of global investment trends.