What is China Considering by Re-emphasizing the Attraction of Foreign Investments?


At this year’s Third Plenum, much attention was drawn to the frequent mention of “security” in the post-meeting communiqué, leading some to believe that the government is shifting its focus from economic growth to national security. However, the words “reform” and “opening up” appeared far more frequently than “security.” Additionally, the communiqué revived a long-absent term—”foreign investment.” The 18th and 19th Third Plenums did not mention foreign investment, so its re-emergence is a noteworthy signal for investors.

Over the past year, the central government has introduced a series of measures aimed at re-attracting foreign investment. In August 2023, the State Council issued “Opinions on Further Optimizing the Environment for Foreign Investment and Increasing Efforts to Attract Foreign Investment,” outlining multiple approaches to make it easier for foreign investors to do business and invest in China. In October 2023, at the Third Belt and Road Forum, the government also announced the removal of restrictions on foreign investment in manufacturing, effectively opening all sectors to foreign investors (previously, there were still significant restrictions in areas such as publishing and traditional Chinese medicine). Furthermore, to make it easier for foreign businesspeople to enter the country, the Ministry of Foreign Affairs announced visa-free entry for citizens of six countries, including France, Germany, and Italy, in November last year, along with a general relaxation of visa application and transit visa policies for other passport holders. It is clear that the re-emphasis on foreign investment at this year’s Third Plenum is not an isolated event; the government had laid considerable groundwork beforehand. Against the backdrop of sluggish economic growth and weak private investment, the importance of retaining and attracting foreign capital has significantly increased.

Foreign investment has played an indispensable role in China’s rapid development over the past half-century.

In the early stages of China’s opening up, foreign investment represented the most advanced technology. Foreign companies brought to China their advanced experience in building factories, production, management, and new business models while investing in the country. For foreign investors, China offered not only cheap labor and a vast market but also tax incentives from both central and local governments eager to attract foreign capital. Initially, the influx of foreign investment was concentrated in manufacturing, gradually expanding to consumer goods industries such as food, beverages, home appliances, and automobiles. For a long time, China held a leading position globally in receiving foreign direct investment (FDI).

Before 2000, the average annual growth rate of foreign investment in China exceeded 20%. From 2000 to 2010, this growth rate slowed to around 10% annually, but considering the base effect, this was still rapid growth. After 2010, the growth rate of foreign investment slowed to single digits. By 2023, China’s net outflow of FDI reached $152.5 billion, and the actual use of foreign capital nationwide fell by 8% compared to 2022.

In fact, the exodus of foreign capital began before the pandemic, but the sharp decline in 2023 brought it to widespread attention. Before the pandemic, foreign investment shifts were primarily driven by cost considerations—as labor and land costs in China increased, global supply chains began to shift towards more affordable regions in Southeast Asia, Latin America, and Africa. After the pandemic, the outflow of foreign capital accelerated, driven more by strategic reasons such as geopolitical tensions and concerns over supply chain security.

Foreign investment relocations motivated by cost considerations are a natural outcome of economic development. This type of foreign capital, typically in labor- and resource-intensive industries, may help accelerate China’s industrial upgrading as low-end manufacturing relocates abroad. However, China does not wish to see an overly rapid exodus of manufacturing, as the supply chain is interconnected, and the rapid departure of low-end manufacturing could also impact the Chinese economy.

Strategic relocations of supply chains, on the other hand, stem from many Western countries’ reflections during the pandemic. They began to rearrange their global supply chains, with key segments even being repatriated. Additionally, the US has imposed restrictions on investments involving China amid China-US tensions, prompting some foreign investors to partially withdraw to mitigate risks. This type of foreign capital exodus poses a more significant challenge to the Chinese economy.

Why is the Chinese government reviving the focus on foreign investment?

As China’s economic growth slows, the government is seeking various engines to drive the economy, and foreign investment is one of the crucial forces. In 2022, foreign companies accounted for 33% of China’s total imports and exports. They also contributed one-sixth of tax revenue and 10% of urban employment. Furthermore, employees of foreign companies generally earn higher incomes than the national average, meaning this population also has relatively stronger consumption power.

Moreover, China’s industrial upgrading cannot occur without the technology and management expertise brought by foreign companies. A typical example is Tesla’s entry into China, establishing a Gigafactory in Shanghai, which spurred industry competition. China’s electric vehicle companies have made continuous breakthroughs in areas like autonomous driving, range, and smart features, partly due to the “catfish effect” of Tesla.

At the same time, we believe China remains attractive to foreign investors. Although the cost advantage has diminished, China still boasts the world’s most complete, mature, and responsive industrial supply chain, along with a large pool of high-quality labor. China’s market is highly competitive, requiring foreign companies to excel not only in R&D and quality compared to domestic competitors but also in speed. However, China’s market is also vibrant, with advanced industries offering more growth opportunities than most overseas markets.

While economic slowdown and geopolitical factors will continue to influence foreign companies’ decisions regarding their presence in China, we believe that when the Chinese government demonstrates sincerity and makes concerted efforts to attract foreign investment, there is a greater chance for positive changes to occur.


Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.

In respect of any discrepancy between the English and Chinese version, the English version shall prevail.

Opportunities and Challenges in China’s Exports


If investors were to visit the Xiaomo International Logistics Port in Shenzhen, they might have the chance to see a particularly unique giant ship moored at the port. Measuring about 200 meters in length, this ship, unlike regular container cargo ships with open cargo holds, has a sealed hull, resembling a white sardine can. This is the first ship built by the Chinese automotive brand BYD for its overseas fleet, named Explorer No.1, capable of carrying 7,000 vehicles. On January 15th, Explorer No.1 set sail from Shenzhen, carrying 5,449 new energy vehicles destined for the Netherlands and Germany.

Ports are one of the best places to observe a country’s export trends. In the past two years, major Chinese ports such as Shanghai, Ningbo, Shenzhen, and Qingdao have seen a booming development in the export of Chinese electric vehicles (EVs). In addition to EVs, other products related to new energy have also accelerated their pace of going global, among which EVs, solar cells, and lithium batteries lead the growth. These are even given the code name “new three” by the authorities, corresponding to China’s previous export pillars of “old three “: clothing, household appliances, and furniture.

In 2023, China’s overall exports were relatively weak, but exports of the “new three” steadily increased, with the export value of these three items reaching about 1.06 trillion yuan, an increase of about 30% year-on-year. Not only is the proportion of the “new three” in China’s exports increasing, but their global market share is also significantly rising. Data shows that China now accounts for over 80% of global solar cell exports, over 50% of lithium battery exports, and over 20% of EV exports.

Ordinary people may not be deeply aware of solar cells and lithium batteries, as they mostly belong to the intermediate links of industrial production. However, the rapid development of Chinese EVs is believed to be visible to most investors.

As the second-largest consumer product after housing, decisions to purchase automobiles are usually made after careful research and comparison. Chinese EVs have not only penetrated markets in Southeast Asian countries such as Thailand and the Philippines but also witnessed thriving sales in traditional automobile manufacturing countries in Europe such as Belgium, the UK, and Spain. Statistics show that in the first half of 2023, about 350,000 new energy vehicles were exported to Europe, accounting for about a quarter of the sales volume of EVs and plug-in hybrid EVs during this period. Winning recognition in the European market also demonstrates the attractiveness of Chinese EVs in terms of performance and price.

Challenges Behind the Strong Performance of the “New Three”

Investors focusing on the Chinese stock market may be aware that despite the impressive export data of the “new three” last year, the performance of new energy stocks has been disappointing. On one hand, the market’s tolerance for high-growth companies has significantly decreased due to rising interest rates and a withdrawal of liquidity. On the other hand, excessive internal competition within the new energy sector has also harmed the interests of companies within the sector.

In recent years, strong support and massive subsidies from national policies for renewable energy have led to rapid growth in the industry. However, this has also brought about disorderly expansion and excessive competition.

Since 2022, competition in the Chinese EV market has become increasingly fierce. In order to achieve ambitious sales targets, China’s EV manufacturers have had to reduce prices to capture market share. Therefore, behind the impressive sales figures, many car manufacturers have experienced declining profit margins.

Competition in the lithium battery industry is also fierce. Due to oversupply, lithium carbonate prices plummeted last year. The average price of lithium per ton in the fourth quarter of 2022 was still around 550,000 yuan. But by April 2023, lithium prices had plummeted to around 180,000 yuan.

In addition to intense domestic competition, exports of new energy also face trade restrictions from the US and Europe. In September last year, the EU initiated an investigation mainly because it believed that cheap Chinese EVs were flooding the European market, posing a threat to the local EV industry. The US also indirectly excluded Chinese EVs by passing extremely exclusionary provisions on EV subsidies in the Inflation Reduction Act (IRA). The Biden administration initially imposed a 25% tariff on Chinese solar products. On top of that, sanctions against Chinese solar companies were repeatedly launched, with punitive tariffs of up to 254% on some Chinese solar cell exports.

Irreplaceable Advantages

In response to the intense domestic competitive landscape, new energy enterprises are also exploring various avenues and strategies. In addition to expanding overseas markets and increasing export efforts, companies are also venturing abroad. For example, BYD established a factory in Hungary last year, and its factories in Thailand and Brazil are expected to start production this year. By exploring different developments, companies try to take greater initiative in fiercely competitive markets.

Given the various challenges facing the new energy industry, whether the “new three” can maintain a leading edge in the international market is also a focus of attention. We believe that the advantage of Chinese enterprises comes not only from the vast domestic market that promotes economies of scale (while also bringing fierce competition) but also from the continuous innovation and well-established supply chain. The average education level of newly added labor force in China has increased to 14 years, with a population of 240 million having received higher education. In 2018, China’s per capita GDP was $9,771, but its innovation index score has approached that of European countries with a per capita GDP of around $50,000. Southeast Asian countries are unable to compete with China in terms of innovation and technology in the short term. Although European and American countries have begun to bring back some supply chains after the pandemic, the completeness and flexibility of their supply chains are also difficult to compete with China.

Therefore, while the “new three” face challenges, a great part of those challenges come from internal competition. On the international competitive level, Chinese new energy enterprises still have irreplaceable advantages.

Many new energy enterprises are experiencing the process of “big fish eats small fish,” where small businesses gradually exit the market, and winning companies gain a larger market share. Before the visibility of industry differentiation becomes higher, we will remain a cautious stance towards companies in over-competitive industries. We emphasize a careful balance between growth potential and the risk of declining margins due to heightened competition.


Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.

In respect of any discrepancy between the English and Chinese version, the English version shall prevail.