Rory Green, chief China economist at macroeconomic forecasting consultancy TS Lombard, sat down with Investment Monitor to talk about the company’s 2023 predictions and analysis, with an emphasis on foreign direct investment (FDI)

How did investment into and out of China shape up in 2022?

Last year was a slow one for China in terms of inbound FDI. A lot of the stuff that they classified as FDI was basically retained profits or retained earnings. The headline numbers show growth of 15%, which sounds pretty good on the face of it, but most of that was just companies keeping profits in China, not new FDI. Meanwhile, moving money out of China has also been in slowdown. There are a couple of interesting trends that have been around a while that are now becoming more pronounced. Number one is a pullback of Belt and Road Initiative-related investment and lending. Number two is the impact of geopolitical rifts with the West, which is restricting where China can invest in the US, Europe and elsewhere. We are seeing these trends starting to emerge much more strongly in the 2022 data, and these are going to run on for the next decade.

Despite this slowdown, where is China looking to invest the most?

Commodities (particularly those related to the energy transition) and in tech and intellectual property (IP) acquisitions. These are the two, by far, most dominant state-backed areas where we will see a lot of the political capital, both in terms of direction from Beijing but also state-sponsored enterprises. So this is where we will see the most Chinese outbound FDI. Under Xi Jinping there has always been a focus on technology upgrading and securing natural resources, but at the most recent Party Congress it really got taken up a notch, not least after Joe Biden’s statement that he wanted to slow China’s technology development, which is effectively a declaration of war. China’s reaction to this, as has been its policy for years, is to roll out the red carpet even more so as to pull in more foreign capital, especially more foreign IP technology (as they have done with Tesla, and some of the big German chemical companies) before Biden puts the hammer down and starts to cut it off from the US side. 

Where are you seeing the most economic decoupling?

The internet and, to a lesser degree, software decoupling, which has been led by China. Bill Clinton famously said that trying to control the internet is like trying to nail jello to the wall. China firmly hammered that jello to the wall and created the Great Firewall, which led to the internet and a lot of software decoupling. Now we appear to be at the early stages of some hardware decoupling, and this time it is Biden that is leading it, following in Donald Trump’s footsteps, albeit in a way that is increasingly systematised, especially with regards to advanced semiconductors. The geopolitical implications here are very significant in terms of hardware.

As this trend progresses, it will get much harder for China to innovate and keep up with the West economically. Yes, the Chinese economy will grow at around 4% a year for the next five years, which is decent, but the lack of access to the most advanced technology will hurt the economy as a whole, as well as its military – and this is where Taiwan comes in. What we are seeing is that China has always thought that time was on its side with regards to Taiwan: the longer it waits, the stronger the Chinese economy and military gets, so why rush, basically? This logic could flip with tech decoupling. If China is falling further and further behind the US on the tech side, particularly around the military, and the US is selling much more strongly into Taiwan, suddenly it is better to go harder earlier, rather than wait. 

How much relocation and reshoring of foreign companies are you seeing in China?

The trend is real but overhyped. That said, the Covid-related slowdown in China has had an impact in this regard, as have political shifts [such as the ‘dual-circulation’ policy]. So I am definitely hearing more about people investing in China for the China market, or a ‘China plus one’ strategy. People are more mindful of hedging their bets solely on China for export-oriented manufacturing but still wanting access to the Chinese market, both from a demand side and because, despite the wage increases, it is still a very efficient and fairly productive place to manufacture.

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What is your macro forecasting for the Chinese economy?

The current state of the Chinese economy is dire, but from now until the second quarter of 2023, we will be seeing a very long, bumpy, stop-start reopening process out of the Covid coma. Even from the second quarter, not everything is going to bounce back. The reopening boom will release a lot of pent up demand and savings. There will be quite a lot of economic scarring related to the property sector, but we think 2023 could see 5% growth in China.

Beyond that, and this is key for long-term, fixed-investment decisions around China, is the country’s structural slowdown based on ‘the three Ds’: debt, deglobalisation and demographics. China’s growth beyond this Covid cycle will average about 4% for the next five years, but then drop to 2% by the end of the decade. That is quite a slowdown relative to the past decade, but, for now, trying to reopen is going to be really difficult for China.

The zero-Covid policy worked well at first. It was Xi’s flagship, and he put his name all over it, so he couldn’t easily backtrack for a while. That said, the healthcare constraint remains massive. There are too many people, too many unvaccinated, and not enough hospitals and ICUs. The healthcare system is wholly inadequate and I think this is genuinely a big fear. The Chinese government’s model says that a couple of weeks of uncontrolled outbreak would overwhelm the healthcare system, leading to potential excess deaths of around 20 million this winter. They really need to address vaccine hesitancy, especially among the elderly. On top of this, there is growing risk of civil unrest from a continued zero-Covid policy, especially in tier-three and tier-four cities.