The flow of foreign direct investment into China has declined significantly in recent years. Balance of payments (BOP) statistics indicate that net FDI inflows plummeted from a peak of $344 billion in 2021 to $51.3 billion in 2023 and further to just $18.6 billion in 2024 — the lowest in three decades.

Although this happened amid a global decline in FDIs, the sharp drop has fuelled concerns about a potential exodus of foreign capital from China. However, a deeper examination of the data shows the situation is more nuanced than it appears.

In contrast to the FDI data in BOP data, utilized FDI, reported by the Chinese Ministry of Commerce, paints a more robust picture. Despite declining from its 2022 peak, utilized FDI stood at $163.3 billion in 2023 and $116.2 billion in 2024, significantly exceeding the FDI figure in the BOP data. While BOP foreign direct investment measures net capital flows (inflows minus outflows), utilized FDI focuses on gross capital inflows but excludes reinvested earnings, retained profits and intra-company debt transactions, making it an important complementary measure of foreign investment activity.

A recent AMRO study attributes the decline in China's BOP foreign direct investment primarily to cyclical factors rather than structural ones. Tighter global liquidity conditions and higher borrowing costs abroad, spurred by the US Federal Reserve's aggressive interest rate hikes from 2022-24, have dampened foreign capital inflows into China.

Additionally, reversed and widening interest differentials have prompted foreign companies in China to repatriate profits and repay debts to parent companies abroad, further reducing net FDI flows.

Despite ongoing US-China trade tensions, which have eased after the recent trade talks between the two sides in Geneva, geopolitical tensions have had a limited impact on overall FDI flows. AMRO's research shows no significant correlation between political distance and foreign investment in China.

Similarly, rising labor costs in China, often cited as a deterrent, have not diminished China's attractiveness as an FDI destination either. Foreign companies continue to be drawn to the country's vast domestic market, efficient supply chains and world-class infrastructure.

The geographical distribution of utilized FDI inflows also underscores enduring global economic integration rather than fragmentation. Asian economies, with the Hong Kong Special Administrative Region, acting as the primary gateway, continue to dominate China's utilized FDI inflows. European investments, particularly the Netherlands' investments, in China jumped 306.5 percent in 2022, and 19.2 percent in 2023. And utilized FDI from the United States increased 51.7 percent in 2023 despite the ongoing tensions.

Additionally, when adjusted for indirect investments routed through offshore financial centers, the actual FDI positions demonstrate even stronger linkages with key regions. The adjusted figures suggest significantly stronger linkages with Asia, Europe and North America — nearly two to three times higher than the initially reported data.

From an industry perspective, China's FDI landscape is undergoing a significant transformation. Traditional sectors such as real estate, retail, wholesale and conventional manufacturing are witnessing a reduction in utilized FDI. In contrast, high-tech industries, including advanced manufacturing, pharmaceuticals, electric vehicles and research and development, are experiencing substantial growth.

Between 2019 and 2023, utilized FDI in the high-tech industries grew at an average annual rate of 11.78 percent, now representing 37 percent of total inflows. These shifts underscore the importance of foreign investments' participation in China's transition toward an innovation-driven economy.

Although the recent decline in FDI does not represent a broad withdrawal of foreign capital from China, challenges remain. Slower economic growth, global economic uncertainties, and the ongoing geopolitical tensions could undermine investors' confidence. To mitigate these risks, China has to maintain open and regular dialogue with foreign enterprises, ensuring regulatory clarity and reliable market access.

The Chinese authorities have already taken steps to enhance the investment climate in order to boost investors' confidence. Recent initiatives aimed at expanding market access, reducing restrictions, and streamlining regulatory frameworks should continue.

Both central and local governments have implemented targeted incentives and supportive policies designed to attract foreign investment in high-tech industries, reinforcing China's strategic shift toward high-quality growth. Alongside these measures, stabilizing domestic growth is also crucial for maintaining the momentum of FDI.

Despite short-term fluctuations, China's fundamental advantages in attracting FDI remain intact. Its vast and expanding domestic market, comprehensive supply chains, strong manufacturing capability, skilled labor force, well-developed infrastructure and extensive free trade agreements continue to make it a top investment destination. Ensuring transparency, effectiveness, and consistency in policy implementation will further stabilize and attract FDI, contributing to China's long-term economic development.

Ke Ji and Yang Jiao are an economist and an associate with the ASEAN+3 Macroeconomic Research Office, respectively. The views don't necessarily reflect those of China Daily.

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