CHINA’S INTERNATIONAL INVESTMENT POSITION

UPS AND DOWNS AHEAD OF CHINESE ECONOMY

China Daily, December 15, 2011

Catherine Shu-Ling Tan, Steffen Dyck and Syetarn Hansakul

China's financial integration into the world economy progressed rapidly between 2004 and 2010, mostly through accumulation of reserve assets and direct investment. A study of China's international investment position, an important holistic indicator of the extent of its financial integration into the world, sheds light on the strategy and motivation behind China's growing importance in the global financial system. 

China's overseas assets and liabilities both grew strongly during 2004-2010. Its net foreign assets increased more than six-fold from $276.4 billion in 2004 to $1.79 trillion in 2010, which translates into 36.5 percent compound annual growth rate (CAGR). 

This was primarily driven by the growth of reserve assets, which increased at 29.5 percent CAGR during the same period. China ranks among the world's major creditors in contrast to the United States, which had an external net debtor position of $2.47 trillion in 2010. 

By component, reserve assets represent the lion's share of China's total assets, with the share fluctuating between 65 and 70 percent. The second largest component on its assets side is "other investment", which comprises trade credits, loans, currency and deposits and other assets, accounting for 16 percent of the total assets in 2010. 

The stock of outward portfolio investment (6 percent of total assets) exceeded that of inward portfolio investment. In the case of direct investment, the opposite was true: the stock of inward foreign direct investment (FDI) far exceeded outward direct investment (ODI), which made up 7.5 percent of the total assets. 

The profile of China's international investment position can be characterized as "long debt, short equity". While this phenomenon is not unusual among emerging markets with capital flow restrictions for residents, the return differential between equity and debt carries a cost. Specifically in China's case, its sizeable holdings of foreign governments' debts mean that it pays more on its equity liabilities (that is, inward FDI) than it earns on its debt assets. In addition, China is vulnerable to credit risks such as the downgrade of developed markets' sovereign debt ratings. 

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