China's foreign direct investment, or FDI, has reported its first-ever quarterly deficit, highlighting its struggles to attract foreign businesses amid Western governments' efforts to reduce their exposure to China.
The State Administration of Foreign Exchange (SAFE) released data on China's balance of payments on Friday. They showed that foreign direct investment (FDI) liabilities, a measure of foreign investment in China, were in deficit by $11.8 billion in the third quarter of 2023. Compared to Q3 2022, the direct investment liabilities stood at $14.1 billion.
This deficit is the first since China's foreign exchange regulator began tracking in 1998. This is likely due to Western countries' de-risking amid geopolitical tensions and the interest rate differences between China and developed nations.
According to Goldman Sachs, this 25-year first suggests more foreign companies withdraw their funds rather than reinvest in China.
Vanguard, the world's second-largest asset management firm, announced Monday that it would close its Shanghai office after December 2023, becoming the latest foreign company to exit China. The company had previously sold its stake in a joint venture with Ant Group after signing severance agreements with its remaining staff in Shanghai.
"With interest rates in China 'lower for longer' while interest rates outside of China 'higher for longer,' capital outflow pressures are likely to persist," wrote Goldman Sachs. Despite lower interest rates in China, capital outflow pressures have persisted, as evidenced by the country's widening basic balance deficit and record-high foreign exchange outflows in September.
China's basic balance, which combines the current account and direct investment balances and is more stable than volatile portfolio investments, fell to a deficit of $3.2 billion.
Yuan under pressure
Tommy Xie, head of Greater China Research at OCBC, expects the Chinese authorities to respond to the unfolding dynamics poised to put pressure on the yuan with a sustained strategic response. This includes implementing a strong daily yuan fixing and managing offshore yuan liquidity.
Recent data show that onshore yuan trading volume against the dollar plummeted to a record low of 1.85 trillion yuan ($254.05 billion) in October, down 73 percent from August.
The authorities' tight control over the yuan's daily reference rate has reached a level not seen in over a decade, increasing the risk of currency pressure that may need to be released at some point. The People's Bank of China (PBOC) has so tightly managed the yuan's daily reference rate that its volatility gauge has plummeted to levels unseen since 2010.
"If the PBOC were to loosen its guidance on the yuan, short-sellers would see it as another window to do the trades," said Zhou Hao, chief economist at Guotai Junan International, Hong Kong. However, Hao believes Beijing may maintain its tight grip on the yuan until it surpasses 7.15 per U.S. dollar.
The yuan has lost about five percent against the dollar year-to-date, making it the third-worst performing currency in Asia, after the Japanese yen and Malaysian ringgit. Société Générale predicts the yuan to reach 7.45 per dollar by year-end. As of writing, the yuan is trading at 7.2697, down 0.42 percent from its previous close of 7.3005.
While a weaker yuan could offer some economic benefits, Beijing is cautious about signaling approval for depreciation, as this could lead to even steeper declines and aggravate capital outflows.
Data from Goldman Sachs also show foreign exchange outflows from China surged to $75 billion in September, the highest monthly figure since 2016.
Beijing has intensified efforts to attract foreign investment this year, but analysts say global investors remain cautious due to China's increasing scrutiny of Western companies and its structural slowdown.
A September survey by the American Chamber of Commerce in Shanghai shows optimism about China's five-year business outlook at a record low of 52 percent. It is lower than 55 percent in 2022 and 78 percent in 2021.