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Enduring slump in FDI flows beckons changes

By Shi Chenyu (China Daily)
Updated: 2009-02-25 07:48

[The author Shi Chenyu is a senior researcher with China Industrial and Commercial Bank. The article was originally published in Beijing News.]

Recent statistics released by the Ministry of Commerce show that actual foreign direct investment (FDI) in the Chinese mainland dropped significantly in January, down 32.67 year on year. It was the fourth straight monthly decline.

Related readings:  FDI down but not out  FDI sees 4th monthly dive in row  FDI decline to pressure emerging nations  FDI growth falls for third month

In context of the ongoing global financial crisis, and given last January's drastic FDI growth rate and this year's seven-day Spring Festival holiday, the 32.67 percent FDI slump is by no means a source of pessimism.

However, some emerging trends in the country's FDI development deserve special attention.

According to the ministry statistics, just 1,496 new foreign-funded enterprises acquired the green light from authorities in the Chinese mainland in January, down 48.73 percent from the same period last year. This is a clear indication that the volume of FDI flowing to industrial development is declining drastically.

Such trends actually began emerging in 2006 when some China-based FDI was allocated to other developing nations, especially Association of Southeast Asian nations (ASEAN) members. A continuing FDI slump has not stopped the flow of vast amounts of international hot money to China via FDI.

It is known that China's high-pace economic growth in the past decades has been closely related to FDI. However, a rapid FDI flow has also caused some problems for the fast-growing economy.

Closely related to international trade, FDI has long centered on the country's export-bound processing trade, which has for many years accounted for the lion's share of foreign trade volumes. Such a model is key to China's ever-expanding trade surplus. Statistics show that the export of foreign-funded enterprises has long accounted for about 60 percent of the country's total trade value, with the ratio on the increase. As the result, the country's economy has been under-growing certain factors, stemming from its frictions with major trading partners and fluidity excess to a looming risk for inflation.

Considering domestic deposit volumes have exceeded investment, the country's growing demand for FDI fully demonstrates some systemic defects existing in its capital market and banking and interest rate arrangements. Due to these problems, the enormous total of domestic deposits cannot be freely converted into much-needed domestic investment. As a result, investment excess occurred in some certain fields while foreign funds are badly needed to make up for their investment insufficiency.

Under continued expectations for an appreciated yuan, international hot money has chosen to move to China via FDI. China's labor and environmental costs have increased drastically in recent years while its exports have been on the decline.

This should have prompted China-bound FDI to drop accordingly. However, the country's FDI witnessed a big rise in 2007 after experiencing a steady increase in the previous two years. It even achieved a drastic 45.55 percent growth in the first half of last year. The astonishing FDI growth in China since 2007 ran contrary to economic logic.

The FDI-driven economic model has increasingly brought potential risks to the country's economy. Such a low value-added economic development path will contribute to the final exhaustion of the country's natural resources and labor.

China's economy is currently entering a new historical stage, in which structural adjustments obviously outweigh originally planned economic growth target. There is no doubt that the country's economic and industrial structural adjustments are to be accelerated in the following five to 10 years. With such adjustments, a change to the established FID structure is also needed.

As population plays a declining role in increasingly harsh international competition, it has become inevitable for a country to change its labor-intensive industrial development model. This makes it particularly necessary for China to strengthen capital and technology investment to grow non-agricultural populations.

Along with efforts to absorb foreign funds, the country should also take any possible measure to increase domestic enterprises' participation in the global production system and promote the homeland development of foreign-funded enterprises. This is also a common practice widely used by many other countries in their adoption of third-generation foreign-funds policies.

For instance, great efforts are taken in these countries to promote common development between transnational companies and indigenous ones and offer relentless support to the former's suppliers in host countries through information and fund support, technological upgrading and talent training.