Now as the year draws to an end, more foreign investors may be pondering a similar question as they look into the years ahead: is China uninvestable or irreplaceable?

While the answer differs from industry to industry and company to company, a general trend is that foreign enterprises are divesting their China operations.

But it is at a pace that may take a long time to meaningfully erode investment in the world’s second-largest economy, according to business executives and observers.

China’s large economic size, mature industrial ecosystem and rising middle class mean it is a market hard to give up, but a combination of factors including the ongoing weakness of the economy and geopolitical uncertainty are driving a wave of strategic reshoring and nearshoring.

Beijing has continually pushed for foreign investment to be stabilised, which brings international best practice and market discipline.

But how to retain China’s appeal to investors has been a tricky issue, as it vows to open up further on one hand, while making national security a central focus on the other.

Uninvestable with rising risks

To many, a likely prolonged period of slower growth for China after over four decades of rapid expansion is a fundamental issue to consider when making long-term investment decisions.

“When the Chinese economy was growing 7, 8, 9 per cent a year, there was something in it pretty much for everyone,” said Jens Eskelund, president of the European Union Chamber of Commerce in China.

“But if the economy grows at 3 or 5 per cent, then it means that there are not necessarily great opportunities for everyone.”

Instead of an explosive rebound widely anticipated in the beginning of its reopening, China’s economy has endured a bumpy ride, dragged down largely by insufficient demand and an ailing property market.

Notably, China has averaged a growth rate of about 9 per cent since its reform and opening up in 1978, but economic expansion appears no longer to be the sole priority as Beijing continues to place a focus on security and the quality of its development.

Another reason for foreign firms de-risking is the tightening regulatory environment in China, Eskelund said, exemplified by Beijing’s move to amend its state secrets law and enforcement of a revised law expanding its definition of espionage in July.

“We’re not sure exactly what constitutes a state secret. What types of information we cannot share … we feel that there is a bit of ambiguity in these kinds of things,” he said, adding that this has made the market unpredictable.

The persisting issue of an unfair playing field and the increasing labour costs are also impacting businesses’ long-term commitment to China, according to Michael Hart, president of American Chamber of Commerce in China (AmCham).

“Companies are hesitant to invest if they don’t believe they will be given equal access to the market, if, for example, state-owned enterprises will prefer to buy from local companies or if foreign healthcare companies cannot sell to public hospitals,” he said.

China also still has some of the best manufacturing and sourcing, but “the workforce is less interested in these jobs and labour costs have risen significantly,” he said, adding that this has forced companies to look at diversifying their supply chains.

“These changes won’t be very obvious today or tomorrow, but a decade from now, they will have already happened,” he added.

03:47

‘Door to China-US relations will not be closed again’: Xi Jinping offers assurances to US businesses

‘Door to China-US relations will not be closed again’: Xi Jinping offers assurances to US businesses

In the meantime, geopolitical tensions between China and the United States and its Western allies are unlikely to subside, with both sides having hollowed out any real level of collaboration, said James Zimmerman, a partner in the Beijing office of international law firm Perkins Coie LLP.

“This is very concerning to the business community,” said Zimmerman, who is also a former chairman of AmCham China.

“Foreign businesses have lost faith in Beijing’s ability to manage the business environment and economy,” he said, pointing to China’s unreasonable coronavirus pandemic restrictions that adversely affected supply chains and its inability to tackle the property meltdown.

Irreplaceable as rewards remain

But despite the increasingly challenging operating environment in China, many large businesses still see potential rewards from the market of 1.4 billion people.

Most multinationals are still committed as they expect demand to remain above the global average five years from now, said Alfredo Montufar-Helu, head of the China Centre for Economics and Business at The Conference Board.

Instead of leaving China, more business leaders are talking about the need to defend their China operations, he said.

“[That is], not only because of the significance of China as an end market for their products and services, but also because of its importance as a key node of their global supply chains thanks to its highly cost-efficient industrial ecosystem,” he added.

China’s middle class, which represents its huge purchasing power, would rise to nearly 40 per cent of the total population by 2030, providing longer-term resilience for the economy, according to a report by Boston Consulting in June.

Kristian Odebjer, chairman of Swedish Chamber of Commerce in Hong Kong, said the rise of the middle class means there would be “attractive opportunities in offering them a broad range of products and services”.

“I think for those foreign investors bold enough to stay the course, the rewards may end up being substantial,” he added, despite the combination of challenges in doing business in China over the past years.

India, the other demographic giant in Asia, is unlikely to replace China despite many new investments heading for the South Asian nation of also around 1.4 billion people, according to Jeffrey Kleintop, managing director and chief global investment strategist at Charles Schwab.

China to suffer US$65 billion capital outflow in 2024 as risks, sentiment drag

It has attracted increased foreign investment via its “Make in India” campaign, but China’s FDI was four times larger in 2022.

“India is investing in infrastructure such as roads and railways, to cut logistic costs and improve productivity, but lacks the same government support and ability to increase debt as China did at the same level of development,” Kleintop said.

Low education levels and labour force participation rates, particularly for women, have also created difficulties for it to duplicate China’s large factories, he added.

When compared with developed economies, China also has a much bigger potential in terms of gross domestic product (GDP) per capita, said prominent Chinese political economist Zheng Yongnian.

“All they can do is to cross the river by feeling for the stones, but our goal is clear – to move upwards,” he said, using the saying coined by late paramount leader Deng Xiaoping to describe China’s reform and opening up. It means to take one step and look around before taking another.

China’s GDP per capita was less than US$13,000 last year, compared with over US$70,000 in the US and over US$80,000 in Singapore.

Some industries are expected to be particularly appealing for foreign investors as China pursues high-quality development through technology and innovation.

AmCham China’s Hart pointed out that healthcare, electric vehicles and new energy are likely to lure big investments due to increased innovation.

“High-end manufacturing and supply chain sourcing across a broad spectrum of industries are likely to continue, but the concern is this sector is maturing and there is a lack of new investment,” he added.

01:15

A closer look at China’s C919 jet Victoria Harbour flyover

A closer look at China’s C919 jet Victoria Harbour flyover

Foreign suppliers have continued to invest in the aviation industry, where China has sought to attract more foreign investment to boost its own capabilities, including Germany’s Liebherr-Aerospace, which has a joint venture with the Commercial Aircraft Corporation of China (Comac).

Vlielander added that the company is monitoring geopolitical developments and their effects on its business.

Recalibrating China strategies

Chinese authorities have repeatedly vowed to improve the business environment for foreign firms in the past year, with the latest pledges made at last week’s central economic work conference to solve issues including cross-border data flow and equal opportunity in government procurement.

Against such a backdrop, China’s operating environment would improve slightly in the coming year, and capital inflows would rebound, The Economist Intelligence Unit said in a report late last month.

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But the capital flows would “largely be concentrated in short-term portfolio capital,” and long-term investors “will need some convincing” due to a lack of meaningful improvement in US-China relations and China’s continued obsession with national security, the report said.

Reduction of involvement in China mainly involves companies from North America and Northeast Asia, in many areas by 30 per cent, according to Robert Herzner, chief representative of Germany Trade and Invest in Hong Kong.

Companies are now developing “in China for China”, partly due to the regulations that make it difficult to transfer data, he said.

“The upstream IT industry (chips) is being relocated to Japan, the EU and the US, with companies focusing on security rather than cost,” added Herzner.

“With localisation, the trend is towards China plus X, with production moving to Southeast Asia and Eastern Europe, including downstream IT (hardware such as phones and PCs).”

Foreign businesses are also seen to be facing localisation pressure from new consumption behaviours and spending trends in China.

“Indeed, already, along with the softening of demand and the downgrading of consumption, Chinese have become pickier consumers and more focused on value-for-money spending,” said Montufar-Helu from the China Centre for Economics and Business.

“The competition to win the Chinese consumer will increasingly happen at lower price points where Chinese brands are highly competitive.”

‘The next China is still China’: Xi pledges to tear down investment barriers

To adapt to the new reality, multinational companies would need to recalibrate their China strategies, he added.

Companies of varying sizes are also responding differently, and while China remains a “must win battle” for large global corporations, it is seen as not a must for many smaller players.

“China is no longer a priority market for foreign small and medium enterprises. The inherent risks, and the large costs associated with a China-for-China approach means that China is rapidly losing its attraction for smaller companies,” said Peter Bøgh Hansen, China policy director with the Confederation of Danish Industries.

Robert Gwynne, founder of Aramingo Footwear, agreed that compared with bigger firms which are in a better position to diversify, there are limitations for smaller companies.

“We believe the geopolitical issues to be hyper sensitive and causing overreaction, but believe it will pass, albeit painful to experience. At least how it pertains to our sector,” Gwynne said, adding that he plans to invest in China in the next five to 10 years.

Gwynne believes the efforts of so-called de-risking from China in manufacturing are likely to drive away minor assembly and completion processes to other countries, although most raw material and component sourcing would still come from China.

“I would move anywhere and invest should I believe it to be fruitful, but it’s simply not, and we play with our own money, so we are more careful,” he said.

Additional reporting by He Huifeng