Surge in Foreign Investment Reshapes Chinese Markets 2025

Recent developments show a sharp rise in foreign financial investment in China’s markets during 2025. Offshore investments in Chinese stocks reached $50.6 billion from January to October 2025, compared to $11.4 billion in the entire year of 2024. This influx has propelled the Shanghai Composite Index up by nearly 30 per cent compared to 15 months earlier. Alongside stocks, demand for Chinese dollar and euro-denominated bonds issued by banks and the government has hit record highs. These trends mark shift in China’s financial landscape, driven by foreign portfolio investment rather than direct investment.

Foreign Portfolio Investment Boom

Foreign investors are increasingly favouring Chinese stocks and bonds. In late 2025, China raised $8.6 billion from offshore bond sales with demand exceeding supply by 25 to 30 times. Yields offered are competitive, close to US and German government bonds. This surge contrasts with the previous years of muted foreign interest following the pandemic.

Shift from Direct to Portfolio Investment

China’s foreign investment pattern has changed dramatically since 2015. Foreign direct investment (FDI) once dominated inflows, accounting for 80 to 100 per cent. By 2024, FDI’s share dropped to 41 per cent. Absolute FDI inflows fell from $344 billion in 2021 to just $18.6 billion in 2024. The decline is linked to strained US-China relations and a shift towards more liquid portfolio investments.

Capital Inflows Exceed Current Account Surplus

China, traditionally a capital exporter with a current account surplus, has become a capital importer in recent quarters. Financial account inflows now equal or surpass the current account surplus regularly. This accumulation of foreign capital alongside trade surpluses is unusual and points to growing integration with global financial markets.

Local Government Debt and Bond Issuance

A large portion of foreign bond issuance is driven by heavily indebted local government financing vehicles (LGFVs). LGFV debt reached 60 trillion yuan by 2023, nearly half of China’s GDP. Local governments rely on land sales to service debt interest, but falling property prices have reduced this revenue source. The government has relaxed bond issuance limits to manage hidden debts, but this increases exposure to foreign creditors and financial vulnerability.

Financial Market Volatility and Risks

China’s financial flows have been volatile over the past two decades, alternating between net capital inflows and outflows. The growing dominance of portfolio flows makes China vulnerable to rapid shifts in investor sentiment. Such volatility resembles crises experienced by other emerging markets in the past. The divergence between real economy indicators and financial market trends marks complex domestic and foreign investor motivations.

Government Response and Economic Rebalancing

In response, China is working to cool its property market and manage local government debt. The government aims to rebalance the economy from export and investment-led growth to more sustainable domestic consumption and innovation. Despite large foreign liabilities, China’s substantial reserves provide some buffer against financial shocks.

Questions for UPSC:

1. Point out the impact of foreign portfolio investment on emerging economies with reference to China’s financial markets.
2. Critically analyse the role of local government financing vehicles in China’s economic stability and the risks involved.
3. Underline the significance of balance of payments components in assessing a country’s financial health. With suitable examples, explain how capital account surpluses can coexist with current account surpluses.
4. Estimate the effects of geopolitical tensions on foreign direct investment flows in global markets, citing the US-China relationship as a case study.

Answer Hints:

1. Point out the impact of foreign portfolio investment on emerging economies with reference to China’s financial markets.

1. Foreign portfolio investment (FPI) brings liquidity and boosts stock and bond markets, as seen in China’s 2025 surge in offshore investments.
2. FPI is more volatile than direct investment, causing rapid inflows and outflows that can amplify financial market fluctuations.
3. China’s shift from FDI to FPI increased exposure to global investor sentiment and potential sudden stops or reversals.
4. FPI can lead to asset price inflation, exemplified by a nearly 30% rise in Shanghai Composite Index within 15 months.
5. Emerging economies benefit from capital inflows but face risks of financial instability if portfolio flows reverse abruptly.
6. China’s experience parallels other emerging markets that faced crises due to overreliance on foreign portfolio capital (e.g., 1997 Asian Financial Crisis).

2. Critically analyse the role of local government financing vehicles in China’s economic stability and the risks involved.

1. LGFVs are key in financing local government projects, often through off-budget borrowing and bond issuance.
2. By 2023, LGFV debt reached about 60 trillion yuan, nearly 48% of China’s GDP, indicating heavy indebtedness.
3. LGFVs rely on land sales to service debt interest, but falling property prices reduce this revenue source, increasing default risk.
4. Relaxation of bond issuance limits aims to manage hidden debts but raises exposure to foreign creditors and financial vulnerability.
5. LGFV debt entanglement with local governments creates systemic risks, potentially destabilizing broader economic and financial systems.
6. Dependence on LGFVs for funding amid property market downturns threatens economic stability and complicates China’s rebalancing efforts.

3. Underline the significance of balance of payments components in assessing a country’s financial health. With suitable examples, explain how capital account surpluses can coexist with current account surpluses.

1. The balance of payments (BoP) records all economic transactions; current account reflects trade and income flows, capital account records financial capital movement.
2. BoP components help assess external vulnerabilities, currency stability, and investor confidence.
3. China’s case – despite a current account surplus (trade surplus), capital account inflows (portfolio investments, bond sales) have equalled or exceeded it, making China a capital importer.
4. Such coexistence occurs when foreign investors seek assets despite trade surpluses, driven by attractive yields and market potential.
5. This can lead to accumulation of foreign exchange reserves and financial account surpluses alongside trade surpluses.
6. However, large capital inflows can increase exposure to volatile financial markets and sudden reversals, impacting economic stability.

4. Estimate the effects of geopolitical tensions on foreign direct investment flows in global markets, citing the US-China relationship as a case study.

1. Geopolitical tensions create uncertainty, reducing investor confidence and leading to declines in FDI inflows.
2. US-China tensions since 2018 have contributed to a sharp fall in China’s FDI inflows from $344 billion in 2021 to $18.6 billion in 2024.
3. Trade disputes, sanctions, and technology restrictions deter long-term investment commitments and disrupt supply chains.
4. Companies may relocate investments to less contentious regions to avoid risks associated with geopolitical conflicts.
5. Such tensions shift investor preference towards more liquid portfolio investments rather than long-term FDI.
6. Overall, geopolitical conflicts can slow down economic integration and affect global capital allocation patterns adversely.