China’s Ministry of Commerce said yesterday, Jan. 5, that foreign investment in China had reached $126 billion in the first 11 months of 2015. The announcement came on the same day that the China Securities Regulatory Commission verbally informed shareholders with greater than a 5 percent interest in Chinese companies on the stock market that a ban on selling their stock would remain in effect for an unspecified amount of time beyond the initial 6-month timeframe that was set to expire on Jan. 8. Furthermore, official government statistics indicate that in 2015, more than $600 billion left the country. There is a basic contradiction in trying to understand these numbers. Why is Beijing preventing Chinese institutions from selling stocks if there is so much foreign investment, and why is there such an increase in the level of capital flight?
Let’s begin with the foreign investment numbers. The Ministry of Commerce claimed not just $126 billion in foreign investment, but that $114 billion was non-financial investment, an increase of 7.9 percent compared to the previous year’s total foreign investment of $119.6 billion. The report also noted that 2014 was the first time that China had overtaken the U.S. as the world’s largest recipient of foreign investment. The report claimed that 24,000 foreign funded enterprises were founded in the first 11 months of 2015, and that an increasing amount of capital was flowing to the service sector and advanced manufacturing.
The first thing to note about these numbers is that they differ from UNCTAD (United Nations Conference on Trade and Development) figures. UNCTAD data supports the notion that China overtook the U.S. in terms of foreign investment last year, but UNCTAD said China received $128 billion in 2014. Meanwhile, the World Bank has a different set of figures, putting the number of total foreign direct investment flow to China at just over $280 billion. These numbers all generally point to the same general conclusion – that investment in China has increased. But we have three different numbers to choose from and that is one indicator of how unreliable these numbers can be.
The second thing to note is that no matter which set of data you decide is most reliable, there is another wrinkle. The World Bank figure is so much larger than UNCTAD and Chinese government data likely because it combines foreign investment flow into China and Hong Kong into one number. China’s Ministry of Commerce reported last month that by far the biggest source of foreign investment in China was Hong Kong at $83.8 billion, or over 66 percent of total foreign investment in China. The next largest was Singapore, at $5.8 billion. That is because it is still far easier to structure investment bound for China in Hong Kong as a result of the regulatory challenges one would face in China.
Some of this investment is no doubt foreign investment in the traditional sense. But some of it isn’t. Some of the foreign investment into China from Hong Kong is actually from China itself – a result of domestic Chinese individuals or companies seeking to receive incentives reserved for foreign investors. It’s impossible to know just how much of investment in China from Hong Kong falls into this category. But if we look at data from the Hong Kong Census and Statistics Department for the year 2013, we see that China was the largest source of direct investment flow into Hong Kong, which was reported at 8 percent, or approximately $6 billion – and that’s just the money that is on the books. The best thing one can do to try to figure out how much of the money from Hong Kong is actually money rerouted from China is guess.
This has been a statistics heavy explanation, but bear with us for two more examples before we conclude. Back on July 8, when China’s stock market was in the midst of a rout that would result in the loss of over $5 trillion worth of value, rules were put in place preventing major shareholders and executives of Chinese companies from selling stock. Those rules were set to come off the books on Jan. 8 – but the prospect of those sales being legal were enough to send the Chinese markets into a nosedive on Jan. 4. Goldman Sachs reported that the ban may have resulted in at least $185 billion of shares being kept off the market, but that seems like a relatively small number compared to Monday’s fire sale. Here again though, we have no clear way of knowing just how much money those who were forced by the government to hold on to their shares lost.
China has also expressed concern in recent months about the huge levels of capital flight leaving the country. Chinese government data indicates that in the past year, over $600 billion worth of assets in Chinese Yuan were converted into a foreign currency. After the summer stock market scare, in August and September, that number reached over $100 billion a month. This is again a terribly tricky thing to try and estimate. For example, it is difficult to know how much is capital flight, and how much might simply be foreign investment – which has been Chinese government policy to increase in recent years. The U.S. Treasury Department, using Chinese balance of payments data, calculated that in the first half of 2015, non-foreign direct investment outflows from China totaled $250 billion, a massive increase from the $26 billion of the same period in 2014. But here, much of what goes into the statistics relies on guess-work. China reportedly broke up an underground banking network this past November which handled some $64 billion in illegal foreign exchange transactions – and that was just one such network.
Now that we have sufficiently muddled the seeming clarity of the situation, we return to our initial question. How does it make sense that foreign investment in China is reaching new highs at the same time that capital flight is reaching new highs and the Chinese Securities Regulatory Commission is preventing Chinese executives and businessmen from selling shares on the stock market? To our view, it does not make sense, which means the stats about foreign investment are wrong, or the stats about capital flight are wrong, or both are wrong. All are viable explanations. What we can say is the Chinese are touting high levels of foreign investment at the same time that there are reports of extremely high sums of money leaving the country and restrictions on what individuals can currently do with assets they own.
The problem of accurate statistics is an old problem for China. When Emperor Yongzheng ascended to power in the Qing dynasty in 1723-1735, his first step in attempting to reform and streamline the tax system began with accumulating accurate information – something to which he did not have access. It is a problem that plagues all statistics that come out of China to this day. There is no unified statistical reporting system in China. Statistics are gathered at the local level and passed upwards until they reach the central government. The bureaucrats involved in running this system enjoy professional success and advancement when their numbers are good – and therefore have an incentive to manipulate them – to inflate them to appear successful, to moderate them in order to avoid attention. This is to say nothing of the fact that the central government has reasons of its own to manipulate the figures it presents to the public. China releases its GDP numbers for the previous year usually in the third week of January – this despite the fact that any one who appreciates the complexity of calculating such a figure takes far longer than three weeks.
The point here is not to join the chorus of glib naysayers about Chinese economic statistics. Indeed, China is not unique among world nations when it comes to the unreliability of statistics about its economic performance or its demography. All nations have difficulties with economic statistics. It is extraordinarily difficult to measure economic activity in countries with millions of people and trillions of transactions. We are also not saying that it is impossible to say anything with certainty and that all is vanity. There are some things we can say with confidence – like the fact that the People’s Bank of China pumped $20 billion into the country’s financial system on Tuesday to prop up the struggling Chinese stock market, and that the Shanghai Composite responded by closing down just 0.26 percent on the day as a result.
So while there are such things as concrete facts, there are many more things we cannot say with confidence, and it is important to be honest about what those things are. It also happens to be why we believe our model-based approach is effective. Rather than looking at numbers we know are faulty and chaining our analysis to divining an incomplete understanding from them, we take the numbers into account – both what they say and what the person who published them might want us to conclude. That is the point at which you can begin to decide what they really mean.