Curbs on foreigners based on flawed analysis of cash inflows

PUBLISHED : Tuesday, 14 September, 2010, 12:00am
UPDATED : Tuesday, 14 September, 2010, 12:00am

Foreign direct investment on the mainland is expected to hit a record US$100 billion this year, defying concern that the environment for international investors is deteriorating.

SCMP, September 7

Let's put some things in perspective here. It is entirely possible that net direct investment inflows to China will reach US$100 billion this year. But this is no record. In 2007, the official figure was US$121 billion.

Note, however, that I speak here of net direct investment, not specifically foreign direct investment. I do not think it really possible to distinguish what is foreign and what is not in these capital flows. My guess is that most of them represent Chinese nationals or Hong Kong residents dressing themselves up to look international so they don't have to go to the back of the queue when they want to take their money out of yuan and into dollars again.

Somehow, in some way, there is something that does not quite ring true in the picture of foreigners, native-born Europeans and Americans let's say, falling over themselves to put dollars into railway infrastructure projects or high-rises in Chengdu and complaining that they cannot do it.

These kinds of foreigners are much more likely to want only investment in manufacturing plants for light industrial goods that they can sell in their home markets.

And the point about such light industrial goods plants is that they are labour intensive. The foreign investors in them need to put in some machinery, true, but they are unlikely to need US$100 billion a year for this purpose.

I know that foreigners indeed complain of their difficulties in doing business on the mainland but let's identify what business they do. Most of them are trying to sell foreign-made goods and services in the mainland market. They are sales representatives, not manufacturers.

This makes their activities part of the current account, not the capital account. They are encouraging China to make more imports, which has nothing to do with foreign direct investment. In short it is not really FDI we are talking about here. It is DFI - Disguised as Foreign Inflow, Chinese investors pretending to be foreigners in order to improve their prospects of taking their investment proceeds back abroad.

But now let's talk about a big number, China's balance of payments surplus, which was US$398.5 billion last year, or the equivalent of 8 per cent of gross domestic product.

This is the hard evidence that foreigners have some justification in complaining of a closed Chinese economy.

In any developing economy - and China's is one still - the normal pattern shows a current account in deficit because of all the imports of capital goods needed to build industry. On the other side of the balance of payments, the capital account is in surplus as foreigners contribute much of the money to pay for these capital goods. In consequence the overall balance, either positive or negative, is slight.

In China's case, however, the current account is hugely in surplus because its export industries are labour intensive rather than capital intensive. Meanwhile, the capital account is also in surplus because that's how China invests in its own economy and because there is always a speculative element hoping for a foreign exchange profit in a rising yuan.

They are right, too. It is the sort of pressure that anywhere else would propel a currency straight up.

In this case it has not done so. As the second chart shows, the latest decision in Beijing to loosen the reins on the yuan resulted in a move of only a few cents and this was quickly taken back again.

I would call this a deteriorating environment, and not for international investors but for China itself. A huge balance of payments surplus that has produced gargantuan foreign reserves, which do nothing for the country, is to continue growing because the authorities regard investment inflows mistakenly labelled as foreign to be proof that foreign complaints of being shut out are groundless.

What a mess.