Pandemic Distorts FDI Trends For China And The US

THE HEADLINE FROM the initial estimates of foreign direct investment (FDI) flows last year by the UN Conference on Trade and Development (UNCTAD) is that China overtook the United States as the primary destination for FDI.

While that is consistent with a long-term trend — that the world’s centre of gravity is shifting eastwards — a peep behind the headlines is warranted.

Last year was exceptional. Global FDI fell by 42% to $859 billion. That was a plunge 30% steeper than followed the global financial crisis in 2008 and took FDI worldwide back to the levels of the 1990s. The pandemic shaped the winners and losers, both by geography and sectors (IT and pharma were among the winners).

Yet so did geopolitics.

With the then Trump administration in the United States pursuing the denial of US capital and technology to Chinese firms, FDI to the United States almost halved to $134 billion in 2020 from $251 billion the previous year, with cross-border mergers and acquisitions particularly hard hit. And 2019 was way below the giddy heights of 2015-16 before Beijing reined in Chinese companies’ exuberant global aspirations, largely focused on US assets.

At the same time, FDI into China, the only large economy to grow last year, rose to $163 billion in 2020 from USD140 billion the previous year, a rise of 16%.

China will likely continue to attract more FDI than the United States during the recovery, which the new mutations of Covid-19 may well extend. US plans to use infrastructure investment, including in digital infrastructure, and the development of renewable energy as the backbone of economic recovery will likely cause FDI in the United States to snap back. However, this will take time and FDI worldwide this year is likely to remain weak.

In contrast, China’s needs to move its economy up the value chain and drive for technological self-sufficiency will sustain its inward FDI on a steady but more modest growth path.

The combination of the two will put FDI patterns back on their historical paths.

China And US Increase Financial Distancing

DECOUPLING THE ECONOMIES of China and the United States would be a Herculean task after three decades of globalisation. US Trade Representative Robert Lighthizer told a US Congressional Committee as much this week before he was tweeted down by his president, who said complete decoupling remains a policy option for his administration.

The president has taken policy measures aplenty to discourage Chinese trade and investment in the United States, with the intent particularly of keeping US technology out of Chinese hands. This is small-scale decoupling on the ground.

One example is the increased use of national-security reviews by the Committee on Foreign Investment in the United States, commonly known by its acronym CFIUS. It has had its mandate expanded and new scope to investigate property deals near critical infrastructure and military installations is also being added.

The committee’s latest report to Congress, from which the chart below is taken, makes clear both how much broader is the swathe of inbound foreign investments CFIUS is taking an interest in since President Donald Trump took office in 2017 and how increasingly effective a CFIUS investigation is in prompting would-be acquirers to back off.

Roughly one-quarter of CFIUS reviews involve Chinese acquirers, the largest share of any individual country.

Another is the administration’s threat to promote legislation that could force Chinese companies from US stock exchanges by requiring them to report to US accounting standards.

Bloomberg reported recently that 58.com, an online classifieds firm, was going to go private and thus delist its shares from a US exchange. That would make it the fourth US-listed Chinese company to do so this year, an aggregate removal of $8 billion in market capitalisation, the fastest pace of withdrawal since 2015.

Bloomberg reports a similar trend with initial public offerings, with global banks walking away from deals to list Chinese companies in the United States.

Nothing like full decoupling, to be sure, but a step in the direction of increased financial distancing.

China’s New Foreign Investment Law: Many A Slip…

THE NEW FOREIGN Investment Law passed in March 2019 comes into effect on January 1, 2020. It will replace 1979-90-era laws on foreign-owned enterprises and joint ventures. These are no longer fit for purpose given the rebalancing of the economy from low-tech export manufacturing to high-tech sectors and domestic consumption, and the growing need to compete for foreign business investment with other countries in the region.

The new law also carries the high hopes of foreign firms for the protection of their intellectual property rights — copyrights, patents, trademarks, trade names, technical process, business secrets and goodwill — which it cannot bear.

Beijing needed to signal that China was improving its opaque and often closed business climate for foreign investors by putting them on the same footing as domestic investors and that it was listening to the grievances of trade partners, particularly the United States. Such complaints ranged from the forced transfer of intellectual property as the price of access to the Chinese market to exclusion from government procurement and patchwork implementation of existing legislation at the provincial and municipal level.

At the heart of the new Foreign Investment Law is the principle that foreign investors will be treated the same as domestic ones. That may have side benefits for company formation and flexibility in corporate governance; for example, the Byzantine process for foreign investors to form a corporate entity should become as quick and straightforward as it is for Chinese. Equal treatment in government procurement and standards-setting is also promised.

Redressing the issues around intellectual property will likely prove a different matter.

On the face of it, the new law and its implementing regulation published on December 31, appears to take steps in the right direction as it:

• explicitly bans forced technology transfers, i.e., expropriation;
• heralds an intellectual property rights regime closer to international practices; and
• imposes an obligation on local governments to standardise administrative actions on foreign investment and ensure local officials act lawfully — no more passing onto favoured local businesses information reported by foreign investors. At least in theory. This Bystander fears old habits will die hard, regardless of the tightening of central control.

Inconsistent interpretation of national law by local governments points to an eternal truth of Chinese laws. They are an overarching statement of intent but otherwise mostly a blank slate until the detailed rules and regulations are published and then implemented, frequently on an as-needed basis. We have little to guide us until then.

China has improved its intellectual property protections in line with its companies having more intellectual property of their own to protect and has signed onto most relevant multilateral treaties, but the need and desire to advantage domestic companies remain.

The new law provides at least a couple of loopholes to allow this.

First, the ‘negative list’ that sets out the industries in which foreign investment is proscribed or restricted remains. Beyond that is a web of licensing requirements that hamper foreign investment in critical areas.

Second, the exceptions to the explicit ban on expropriation of foreign investments are broad and vaguely defined: ‘special circumstances’ and ‘in the public interest’. Foreign investment will also remain subject to ‘national security’ reviews.

The greatest unknown for foreign investors will be the effectiveness of the process for seeking and enforcing redress. There are many cracks through which to fall. The new Foreign Investment Law becomes one of three co-existent spheres of intellectual property protections in China. The other two are those provided through bilateral investment treaties between China and other countries, and those that are provided by the World Trade Organization’s Trade-Related Aspects of Intellectual Property Rights (TRIPS), which mainly apply to patents.

There are indications if not confirmations that in the event of a dispute, whichever of the three spheres that provides the greatest intellectual property protections will take precedence. However, our learned friends advise, the runes offer no reading of whether foreign investors must exhaust the remedies provided by domestic law —and thus take their chances in China’s newish commercial courts — before turning to international law, or whether they can take a short cut to international arbitration.

The other question is how much meat the new law provides for the United States. Intellectual property protection and market-opening is the kernel of US firms’ trade beef with China, even though it is the politically sellable trade numbers that US President Donald Trump focuses on. Trump’s announcement that he will sign a ‘Phase One’ deal on January 15, suggests Beijing has provided a big-enough headline victory with its new law for Trump to claim as his own, regardless of the devilishness in the details.

 

Anbang Nationalisation Underlines China’s Financial Stability Priority

WU XIAOHUI, THE politically well-connected chairman of the giant insurance group Anbang (his wife is Deng Xiaoping’s grand-daughter), has been in detention by authorities since last June. Now he is to stand trial for economic crimes, code for fraud and embezzlement, and the company run by personnel from the China Insurance Regulatory Commission for a year or two, an extraordinary move. The state assuming control of a private-sector business, and particularly one of this size and prominence, is unusual.

Anbang has been on an aggressive international acquisitions drive, buying such foreign trophy investments as the Waldorf Astoria in New York and a string of other luxury US hotels. Chinese firms, with official encouragement, have ‘gone global’ in recent years, rapidly expanding their international mergers and acquisitions activity.

In 2016, China overtook Japan to become the world’s second-largest overseas investor. Non-financial outward direct investment that year exceeded $170 billion, a 44% increase from the previous year, according to the Ministry of Commerce. However, such activity entails tremendous financial risk from the leverage taken on, a risk exacerbated by Chinese firms’ lack of experience with the integration and management challenges that M&A brings, especial in deals that cross national and cultural borders.

Anbang appears to fall squarely in this camp. On some estimates (its finances are notoriously opaque), it has encumbered itself with debt to the point that it is fast approaching technical bankruptcy despite having more than $300 billion of assets.

That also makes it ‘too big to fail’. State administration will provide the funding to keep its core life and non-life insurance business operationally solvent. The insurance regulator says the company’s current operations remain stable but that its solvency is seriously endangered by its ‘illegal operations’ unspecified but which presumably include its investments in prestige prime US real estate.

Last August, authorities announced a list of sectors hat should be off-limits for Chinese firms as the foreign investment spree into things like European football clubs and Hollywood entertainment businesses was exacerbating debt concerns.

More broadly, in the drive for financial stability and to forestall any systemic financial shocks, President Xi Jinping has been asserting greater control over state enterprises and reining in sprawling private conglomerates, notably the ‘big four’ — Angbang plus Dalian Wanda, Fosun International and HNA Group — that have expanded rapidly via debt-fuelled foreign acquisitions.

That quartet that accounted for 20% of Chinese foreign acquisitions in 2016. Also, there has always been a nagging suspicion that, given the quartet’s political connections, some of this M&A acted as a conduit for senior officials to get their money out of the country.

All have been ‘urged’ to sell assets and pay down their debt while state banks were told to rein in their lending to them. In January, the chairman of the Banking Regulatory Commission, Guo Shuqing, warned that ‘massive, illegal financial groups’ posed a grave threat to financial reforms and the stability of the banking system and that China would address the issue ‘ in line with the law’.

Taking Anbang into state control may be the prelude to a series of moves against the layer of private conglomerates below the ‘big four’, a group of some 25-30 companies said to be in the regulators’ sights. Despite or perhaps because of his connections, Wu’s treatment, in particular, is intended to show that no tycoon is immune from being ‘deterred’ from risky borrowing and investment overseas, or from being reminded that private M&A strategies should be integrated with national investment priorities.

China Invests Abroad

CHINA IS NOW the second largest investing economy. This reflects Beijing’s ‘Go Global’ policy that delivered a surge of cross-border M&A purchases in manufacturing and services by Chinese firms last year while individuals stepped up their purchases of real estate in developed countries. Chinese firms accounted for 8% of inbound cross-border M&A in the United States last year, worth a record $29 billion.

But China is also the world’s third favourite destination for foreign direct investment (FDI) after the United States and the United Kingdom. According to the UN Conference on Trade and Development (Unctad)’s newly released World Investment Report, 2017, China had FDI inflows of $134 billion last year. That was 1% down on the previous year, mostly because of lower inflows into the financial sector.

However, Unctad notes that:

In non-financial sectors, [China] recorded 27,900 new foreign-invested enterprises (FIEs) in 2016, including 840 with investments above $100 million. In addition, 450 existing FIEs significantly expanded their businesses, undertaking additional investment above $100 million. Non-financial services continued to underpin new FDI, with inflows in the sector growing by 8% while foreign investment into manufacturing continued to shift to higher value added production. In March 2017, for example, Boeing started to build an assembly facility in China, the first such project outside the United States.

Inflows via Hong Kong fell much more sharply, from $174 billion to $108 billion over the same period, though 2015 was an exceptional year and 2016 represented something of a return to trend.

China’s outflows increased to $183 billion in last year from $128 billion in 2015. Those via Hong Kong slowed slightly, from $72 billion to $68 billion.

The Unctad report identifies state-owned multinationals as major players in global FDI. China is home to the most — 257 or 18% of the total, way ahead of second-ranked Malaysia (5%). In 2016, the report notes, greenfield investments announced by state-owned multinationals accounted for 11% of the global total, up from 8% in 2010.

The investments of China’s state-owned multinationals “are instrumental in the country’s outward FDI expansion strategy”, Unctad says. It notes that generally the investments of state-owned multinationals tend to be weighted more heavily in financial services and natural resources than those of multinationals as a whole.

Seven of the 10 largest financial state-owned multinationals are headquartered in China, as are four of the 25 largest non-financial ones — China National Offshore Oil Corp. (CNOOC), China COSCO Shipping Corp., China MinMetals Corp. and China State Construction Engineering Corp. (CSCSC).

China remained the largest investor economy in the least developed economies, far ahead of France and the United States, and showed more interest than most in investing in transition economies, and particularly landlocked ones like Kazakhstan and Ethiopia, though the sums remain relatively small. However, state-owned oil firm Sinopec acquired the local assets of Russian oil company Lukoil for $1.1 billion.

A future focus of China’s investment will be via its One Belt One Road (OBOR) initiative. Beijing has already signed around 50 OBOR-related agreements with other nations, covering six international economic corridors. FDI to Pakistan, for example, rose by 56% year-on-year last year, pulled by China’s rising investment in infrastructure related to the China-Pakistan Economic Corridor, one of the most advanced OBOR initiatives.

Unctad notes:

Stretching from China to Europe, One Belt One Road is by no means a homogenous investment destination. However, investment dynamism has built up rapidly over the past two years, as more and more financial resources are mobilized, including FDI.

A number of countries located along the major economic corridors have started to attract a significant amount of FDI flows from China as a result of their active participation in the initiative.

Central Asia, unsurprisingly, is at the leading edge of this. The implementation of OBOR is generating more FDI from China in industries other than natural resources and diversifying the economies of various host countries.

Chinese companies already own a large part of the FDI stock in extractive industries in countries such as Kazakhstan and Turkmenistan. The ongoing planning of new Chinese investments in the region, however, has focused on building infrastructure facilities and enhancing industrial capacities. In addition, agriculture and related businesses are targeted. For example, Chinese companies are in negotiation with local partners to invest $1.9 billion in Kazakh agriculture, including one project that would relocate tomato processing plants from China.

South Asia benefits from the development of the China-Pakistan Economic Corridor.

This has resulted in a large amount of foreign investment in infrastructure industries, especially electricity generation and transport. For instance, Power Construction Corporation (China) and Al-Mirqab Capital (Qatar) have started to jointly invest in a power plant at Port Qasim, the second largest port in Pakistan. In addition, the State Power Investment Corporation (China) and the local Hub Power Company have initiated the construction of a $2 billion coal-fired plant.

OBOR also stretches to North Africa. Indeed, it seems decreasingly to recognise any geographic limits to its ambition and scope.

Egypt has signed a memorandum of understanding with China, which includes $15 billion in Chinese investment, related to Egypt’s involvement in the initiative. It is undertaking a number of cooperative projects under the One Belt One Road framework, including the establishment of an economic area in the Suez Canal Zone and investments in maritime and land transport facilities.

China’s Cautious $60 Billion For Africa

The Africa growth story may be overhyped — rising worries about debt and public finances in many African countries in the face of low global prices for natural resources are making the continent’s growth prospects less rosy — but that is not stopping Beijing pledging billions more dollars in development aid.

President Xi Jinping announced at the triennial Forum on China-Africa Cooperation (Focac) in South Africa that a larger-than-expected $60 billion worth of assistance and loans would be made available to Sub-Saharan African nations over an unspecified period. We shall return later to whether that is a lot or a little.

The newly pledged money is a mix of:

• free aid and interest-free loans ($5 billion),
• preferential loans and export credits ($35 billion);
• additional capital for the China-Africa Development Fund ($5 billion);
• additional capital for the Special Loan for the Development of African Small- and Medium-sized Enterprises ($5 billion); and
• initial capital for a China-Africa production capacity cooperation fund ($10 billion).

The funding is probably a mix of old and new promises. Some will underwrite expanding trade. As of October, Africa’s exports to China, dominated by oil and minerals (85%), had slumped in value by 32% year-on-year, though they are virtually unchanged in volume.

Angola, South Africa, the Democratic Republic of Congo, Equatorial Guinea and Zambia — natural resources-rich all — are China’s main trading partners in Africa. Together, they account for more than 70% of all that China buys from Africa.

The slump in export values together with the steady rise in exports from China to Africa has turned Africa’s overall trade surplus with China into deficit for the first time since the early 2000s.

The inflow of Chinese direct foreign investment to Africa fell by 40% in the first half of the year from the same period a year earlier, after having shrunk 5% last year over 2013.  Nonetheless, much of the newly pledged money will end up funding much-needed infrastructure projects that will also provide lucrative contracts for China’s road, rail, port, power-station and dam builders.

China’s investment in Africa has hitherto focused on natural resources and to a lesser extent farmland. The global slump in commodity prices, driven in part by China’s own slumping demand as its  economy slows, means that Chinese investors are looking to put their money elsewhere, at least for as long as it takes for this turn of the commodity cycle to pass.

Contrary to popular perception, most of the more than 2,300 Chinese companies doing business in Africa are privately owned, though the big state-owned ones dominate the big-ticket investment flows. China is still the largest lending country to infrastructure projects in Africa but in 2014 it accounted for only 4% of total commitments, compared with about 50% the previous year, a reflection of both the slowing economy at home and a more realistic eye being taken to the potential return on investments being made, as Chinese investors are also doing in Latin America.

All of which provides some background to whether $60 billion is a lot or a little — to which the answer is it is difficult to say.

Untangling the true level of Chinese investment in Africa is tricky. Official statistics put the stock of Chinese foreign direct investment in Africa at $32.4 billion as of last year (up from $1.6 billion in 2005). If all of the Xi’s pledged $60 billion went into FDI, it would triple the stock, which sounds impressive, but if that took, say, five years to happen, the rate of annual growth would decline by a quarter.

However, as noted above, not all the $60 billion will take the form of FDI — and FDI is a rough and ready reckoner of true investment levels anyway (for any country, not particularly China, which uses the standard OECD/IMF definitions of FDI). The numbers won’t include loan financing of capital investments, any investment that comes via third countries, usually tax havens and acquisitions of non-African companies that have assets in Africa. They will also undercount smaller investments, which tends to mean mom-and-pop scale retailing and manufacturing businesses (who also tend to get missed from the count of Chinese businesses in Africa).

Independent tracking under the aegis of the American Enterprise Institute and the Heritage Foundation that aims to get round this undercounting puts the flow of new Chinese FDI into Sub-Saharan Africa in 2013 at $15.25 billion against the official number of $3.37 billion, although we caution that that is commitments rather than actual flows. Between 2005 and now, the AEI estimates, Chinese firms have signed $197.2 billion in investments and contracts since 2005.

Sixty billion dollars would be a substantial but not transformative addition to that. We also note that Xi’s figure includes aid, about which China is far more secretive than FDI.

China is clearly not backing off its interest in Africa; a first military base on the continent, in Djibouti, is in prospect as sign of the magnitude of both of its national interests and assets in the content. But Xi’s latest assistance package indicates that Beijing is also maintaining a realistic view of what it can get for its money.

Update: According to a Foreign Ministry spokeswoman, China has helped Africa build 5,675 kilometers of railway, 4,507 kilometers of highway, 18 bridges, 12 ports, 14 airports and terminals, 64 power stations, 76 sports facilities, 68 hospitals, over 200 schools and 23 agricultural demonstration centers.

Will Unravelling China’s VIEs Pull The Rug Out From Under Alibaba?

IS THE LAW of unintended consequences — or intended ones — in play with the new draft revisions to China’s foreign investment law? And if the later, whose intentions need to be examined?

What may be at stake is control of three of the fastest growing sectors of the Chinese economy — the internet, e-commerce, and cloud computing. Privately owned companies, not state-owned enterprises dominate all three. More to the point, these are about the only sectors of the economy to create large privately owned Chinese companies and from which state-owned behemoths are absent.

As Steve Dickinson of the China Law Blog points out, Baidu, Sina, and Alibaba are at risk of getting their wings clipped. To be fair, that is not the wording he uses. However, this Bystander sees it as a consequence of the significant implication he does note will result from the draft foreign investment law newly published by the commerce ministry: it will end a corporate governance structure known as the Variable Interest Entity (VIE).

All three companies and hundreds of others, particularly technology and telecoms firms, use VIEs to get round the investment regulatory rigidities of sectors of the economy the government deems strategically important and so proscribes or limits foreign investors.

The new draft revisions specifically set out to end VIEs. The revisions’ other main goals are:

• to lessen the red tape for foreign direct investors wanting to own businesses in China;
• to switch to a system of monitoring foreign investors via annual reports from pre-approvals for new foreign investments, save for in sectors of national significance; and
• to put Chinese companies with foreign investors under the same legal regime as domestic companies.

China’s foreign investment law is outdated, so modernisation is to be welcomed — even if the draft law runs to a weighty 179 articles across eleven chapters.

VIEs are a loophole that has let foreigners operate businesses in the country through Chinese front companies. They are a corporate sleight of hand by which an investor controls a company through contractual legal agreements rather than through share ownership.

In short, VIEs say to authorities in country A ownership resides in country A while at the same time telling investors in country B that ownership resides in country B. This Bystander doesn’t need to be a lawyer to see that doesn’t pass many smell tests for good corporate governance.

There have been a number of VIE-related scandals, including involving Alibaba, Sina.com, and New Oriental Education, as VIEs open too many creases along which any or all of regulatory, ownership and operational risk can spread.

Nevertheless, VIEs have become widely used. At first, they were a way for inward foreign investors to enter parts of the Chinese market otherwise closed to them. Increasingly they have been used by privately-owned Chinese companies that list overseas, especially those from industries in which having any foreign shareholders is forbidden or restricted, such as tech and telecoms.

They circumnavigate regulatory rigidities: the constraints on Chinese firms raising capital domestically and the need for private firms to get permission to invest overseas, and restrictions on foreign investors and firms having ownership of Chinese enterprises in certain sectors of the Chinese economy. But given those restrictions on foreign investment exist, VIEs aid and abet in breaking the spirit of the law, if not its letter.

The straightforward solution would be to remove the regulatory rigidities. However, Beijing is not going to abandon keeping sectors of the economy ‘off-limits’ to foreign investors. Its new draft foreign investment regulations use where ‘effective control’ of a company resides to determine ownership.

At a stroke of the legal drafting pen, VIEs becomes irrelevant. Any business that authorities determine to be effectively foreign controlled will be breaking the law if it operates in a restricted or prohibited industry.

All of which would leave the likes of Baidu, Sina and Alibaba and all the other internet businesses that operate as VIEs in China, in a pickle. So, too, foreign investors who bought into the initial public offerings with such gusto and who could end up holding the paper of a company that is illegal.

Now, we don’t doubt that between drafting and final promulgation of a new foreign investment law, accommodations will be made to resolve any such discomforts. While the regulators appear to have rejected lobbing from the companies to, in effect, grandfather them into legality, the draft regulations would let a VIE that is controlled by Chinese to be considered a Chinese company. That determination would be made by authorities on a case by case basis. It would be incumbent on the VIE to show it should be exempted from being put out of business like every other VIE.

Beijing has to walk a fine line if it is not to discourage the development of those industries in which Baidu, Sina and Alibaba operate. All of them could play critical roles in encouraging domestic consumption and thus help meet the government’s goal of rebalancing the economy away from infrastructure investment- and export-led growth. On the other hand, it can’t be too blatant in showing that there is one rule for the powerful and well connected and another for all the rest.

Such companies could also switch their governance to a two-share-class model, and keep the relationship between investors and owners as effectively separated as they are with a VIE. (We don’t approve of companies having A and B shares as a matter of good governance, but that is a topic for another day.)

However, the cost of that will be greater government regulation over them and possibly the promotion of state-owned enterprises to rival them, though perversely it may also give the big, established players some protection from new entrants who won’t be allowed to go the VIE route or anything that looks like it (though opening the capital account would mitigate the need to).

There are several parts of the political establishment, from the security and propaganda arms to the state-owned enterprises themselves, who would welcome reining in the big private Internet groups. Abolishing VIE’s might be intended primarily to kill a lot of flies, but, intentionally or not, there are some endangered tigers, too.

China Becoming A Net Capital Exporter Could Boost Domestic Bond Market

WHAT DOES IT mean that China is set to become a net exporter of direct investment capital for the first time?

Outbound foreign direct investment (FDI) reached $75 billion in the first nine months of the year, up 21.6% on the same period a year earlier. Zhang Xiangchen, a senior official at the commerce ministry, said last week that it looks as if outbound FDI will exceed inbound FDI over the full year, and if not this year then certainly next.

Inbound foreign investment at $87.4 billion between January and September was down 1.4% from the same period of 2013, itself a record year at $118 billion.

A degree of caution is in order when considering these numbers. Most inbound FDI comes from Hong Kong, Taiwan and Japan. Influences on flows from three places are different to the considerations weighing on the minds of European and American executives pondering investments in operations in China.

Passing the net-capital-exporter milestone was already a matter of if not when. China has $4 trillion in foreign-exchange reserves, an official policy to push Chinese companies out into the world, and an easing back from encouraging inward investment to acquire technology and know-how. The Chinese economy is suffering from chronic domestic over-investment, so the rate of outbound FDI is only likely to increase as Chinese companies hunt for acquisitions abroad.

One question is whether they will avoid the excess of the Japanese companies before them who trod a similar path in the 1980s and ended up paying pretty fancy prices for some assets. Another is the extent to which portfolio investment will become the swing factor in overall capital flows.

The conditions are there for it to do so. Net FDI flows are turning negative. Inbound FDI accounts for less than 3% of fixed-capital formation, down from 6.8% before the 2008 global financial crisis. Exports account for a diminishing share of the economy — at 1% of GDP they are one-tenth as important as in 2007.

Portfolio investment inflows can be a challenge for any economy as they are fickle. If they are to become more important to China’s capital account, then development of domestic financial markets, and particularly the domestic bond market, becomes even more urgent.

Nexen a world away from Unocal for CNOOC

CNOOC’s $18 billion bid for Canadian oil and gas producer Nexen is the third China-related deal in recent months to have cleared the Committee on Foreign Investment in the U.S. (CFIUS), the regulatory agency that reviews mergers and acquisitions that could have implications for U.S. national security. BGI-Shenzhen’s bid for Complete Genomics and Wanxiang Group’s for battery maker A123 Systems also got a green light from CFIUS.

Its approval to buy Nexen was the final regulatory hurdle CNOOC needed to clear to close what will be the largest Chinese foreign investment to date. It must seem a far cry from its 2005 effort to buy California’s Unocal. That deal, with fewer security implications for the U.S. than the Nexen deal (the Canadian company has oil rigs in the Gulf of Mexico near U.S. military installations), was shot down by fevered political opposition in Washington, stoked by rival bidder Chevron, without ever even getting as far as a CFIUS review. Lessons learned.

Japanese Companies Rethink Their China FDI

September’s Japanese trade figures underlined the economic impact of the maritime territorial dispute in the East China Sea that Tokyo is embroiled in with Beijing. Exports of Japanese cars to China and imports of Chinese tourists in particular were sharply reduced, compounding the difficulties Japan’s exporters, like their Chinese counterparts, are suffering in the sluggish global markets for their goods.

The trade effects of the dispute may be transitory, but a new Reuters survey points to a more permanent breaking of some of the many ties between the two economies. One in four Japanese companies, the survey finds, are rethinking their investment plans in China, either delaying or scaling back new investment; one in six said they were considering switching investment to other countries. The more than 250 Japanese companies surveyed were from both manufacturing and non-manufacturing industries, from electronics to apparel and retailing.

Japan is the leading source of foreign direct investment in China (excluding that from Hong Kong and Taiwan). The Japanese government reckons that some 20,000 of its country’s firms have invested a combined $1 trillion in China over the past two decades.

Some of what these Japanese companies are now thinking may be a political convenience for economic necessity. China’s cost advantages in low-end manufacturing are eroding. Supply chain and worker efficiency advantages decreasingly offset that. That would suggest that low-margin businesses like apparel and low-end consumer electronics, already being produced mainly for export, will move off- off-shore first, to places like Vietnam, Myanmar and Malaysia. Japanese companies that are counting on domestic Chinese sales, like the carmakers and retailers, have little choice but to ride it out, hoping that the diplomatic tensions will ease, and along with them this latest bout of anti-Japanese consumer sentiment in China.

This Bystander recalls that in 2005, when Sino-Japanese relations were going through one of their periodic low-points, Japanese executives started to consider the need to put some of their regional manufacturing capacity elsewhere than in China. By last year, they were putting three yen of new investment in Southeast  Asia for every two they put in China. Now they have double cause to step up that trend.