China’s Outward foreign direct investment
by Joseph Joyce
China’s Outward FDI
According to the United Nations Conference on Trade and Development’s latest World Investment Report Overview 2014, Foreign Direct Investment inflows to China reached $124 billion last year, while outflows rose to $101 billion. The Report anticipates that outflows will surpass inflows within the next few years, changing China from a net recipient of FDI to a net supplier. This change will affect China’s external balance sheet, and its response to financial crises.
China’s foreign assets have traditionally been overwhelmingly concentrated in foreign exchange reserves. In 2011, for example, reserves accounted for two-thirds of all the country’s foreign assets. While the central bank’s holdings of foreign currencies (mostly held as U.S. Treasury securities) allowed it to deter any speculative currency attacks, they carried a low rate of return. That return fell even further during and after the global financial crisis as the Federal Reserve drove down interest rates, both short- and long-term. Therefore, China’s assets have not been very profitable. In addition, the foreign exchange reserves have lost value over time as the dollar depreciated. Menzie Chinn has pointed out that the political theater in Washington, DC only heightened Chinese concerns about their holdings of dollars.
A very large proportion of China’s foreign liabilities, on the other hand, has consisted largely of FDI; in 2011, the share of FDI in foreign liabilities was 59%. These investments were very profitable for the foreign firms that held them, producing a substantial stream of income. Consequently, as Yu Yongding, director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences has emphasized, China’s net return on international investments has usually been negative, despite its status as a net international creditor. China’s net international investment position in 2011 represented +21% of its GDP, but it recorded a negative net primary income flow of about -1% of its GDP.
More assets held in the form of FDI, therefore, will raise the income that China receives from its assets. Holding FDI in other countries will also give China a chance to diversity the currency composition of its assets. But there is a downside: equity holders share the risks of the ventures they own. In the past, this meant that China’s negative net FDI position acted as a crisis buffer. China’s net primary income turned positive in 2007 and 2008; its foreign exchange assets continued to pay returns, while the return on domestic FDI fell due to the global financial crisis. Moreover, a decline in the value of FDI as well as portfolio equity lowered China’s liabilities, contributing to an improvement in the net international investment position.
China is not unique in the composition of its foreign assets and liabilities. Philip Lane of Trinity College/Dublin has written about the “long debt, short equity” position of many emerging markets, which helped them ride out the economic turbulence of the global crisis. Many advanced economies, on the other hand, were “long equity, short debt,” which while profitable in normal times, exacerbated the decline in their economies when the crisis hit.
China’s situation will change if there is a shift towards a net positive FDI position. The flow of income from foreign assets will become more pro-cyclical. Moreover, those assets will lose value in the event of a downturn. A depreciation of the renminbi would only increase this valuation effect.
Chinese firms traditionally moved abroad to secure reliable supplies of natural resources. More recently, the surge of outward FDI has also reflected aspirations to venture into foreign markets. The movement outward will eventually raise China’s net investment return and provide it with the ability to hold assets in currencies other than the dollar. But it will also diminish the role of FDI liabilities to act as a crisis buffer. This is one factor that should be added to the list of benefits and costs of a change in China’s net FDI position.
cross posted with Capital Ebbs and Flows
Chinese holdings of U.S. Treasuries have been essentially flat in nominal terms for years at around $1 trillion even as Debt Held by the Public has gone up at a reasonably rapid rate. That is not only have official Chinese entities NOT been the buyers of first resort, they haven’t even been the buyers of LAST resort.
There has been a persistent narrative that the Chinese Central Bank essentially owns the Treasury market to the degree that if they ever stopped buying it would collapse (and so spike rates). Well they stopped buying on met some years ago and the sky didn’t fall.
I hasten to reiterate “official Chinese” because it is not easy to figure out how much of Foreign Held Treasuries in such entities as Hong Kong, the UK Channel Islands, and ‘Carribeean Banking Centers’ as well as traditional havens as Luxembourg and Switzerland are actually held for Chinese billionaires. But then again that is equally true for American billionaires. That is the simple split between U.S. And Foreign holdings is not simple at all in practice.
There are a lot of moving, and hidden, parts here. I have been asking for years now for authoritative treatments of this by people who are supposed to understand it, but haven’t gotten much response. So posts like this, hopefully accompanied by links to such authoritative treatments would be as helpful an they are necessary.
Well somebody collects numbers:
http://fas.org/sgp/crs/misc/RS22331.pdf
Foreign Holdings of Federal Debt
pg 1 Total Foreign Holdings of Public Debt:
2008: 51.3% 2013: 47.1%
pg. 3 Chinese Holdings
2009: 24.3% of $3.865 tn or $894.8
2014: 21.9% of $5.802 tn or $1.270
Foreign holdings of U.S. Public Debt down 3.7 percentage points
Chinese holdings of Foreign Held U.S. Public Debt down 2.4 percentage points
Parse the intermediate numbers how you want but the final calculation is: less Chinese ownership of Public Debt, more Domestic.
Of course the number that would be REALLY interesting to me is that which gives the proportion of Foreign held to U.S. Federal Reserve held to U.S. held. And then take the first and third totals and break them down between actual private holdings in offshore accounts between U.S., Chinese and others. Because there are a huge heaping piece of U.S. Public Debt floating around the interstices represented by third party Luxembourg, Swiss, UK Channel Islands and Caribeean Island Banks.
But none of it is as simple as the Right narrative that “the Chinese OWN us”. While the numbers are fuzzy enough there is no way to resolve them that actually produces that result.