This paper argues that multinational firms can benefit from indigenous knowledge diffusion in a host developing country so that there can be two-way productivity spillovers between foreign and local firms even in the developing world. This new argument is confirmed by a very large firm-level data set from the Chinese manufacturing sector. After grouping firms based on their trade orientation, we find that foreign firms have a positive impact on local-market-oriented Chinese firms. When the degree of foreign presence is sufficiently high, there will be negative productivity effects on export-oriented Chinese firms. On the other hand, local Chinese firms have a positive impact on export-oriented foreign invested firms. After dividing foreign firms according to their sources, we find that the beneficial spillovers between OECD and local Chinese firms are much greater than those between Hong Kong/Macao/Taiwan and local Chinese firms.