China is the world’s third largest creditor economy. This article discusses China’s international investment position (IIP) and it’s major components.
The IIP of a country is a balance sheet of the country’s assets and liabilities vis-à-vis the rest of the world. Note that IIP is a stock concept and reflects a snapshot of a country’s position on a particular date as opposed to the balance of payments (BoP) which is a flow concept and records the inflows and outflows for the same data over a period of time.
The World’s Third Largest Creditor
Countries having a surplus on their IIP are classified as net creditors to the world while those having a deficit are net debtors By this measure, China is the world’s third largest creditor economy having generated an external surplus of USD 2.1 tn for the year 2018.
In fact it had been the world’s second largest creditor for a decade before being overtaken by Germany in 2017. The major components on the assets side include outward direct investment, portfolio investment, financial derivatives, other investment and reserve assets. The liabilities side include inward direct investment, portfolio investment, other investment and financial derivatives.
FX Reserve Dominate External Assets
In 2018 the value of China’s external assets exceeded USD 7tn representing a doubling over the past decade. The largest chunk of these assets was accounted by the FX reserves held by the People’s Bank of China (PBoC). In 2009, the share of FX reserves peaked at nearly 70% of the total stock of external assets.
Since then this ratio declined primarily due to the drain on reserves over late 2014 to 2016 as the PBoC repeatedly intervened in the FX market to ward off RMB depreciation pressures. By the end of 2018, FX reserves accounted for 42% of external assets.
While reserve assets (of which FX reserves mentioned above are a part) are the largest category on the assets side, the second largest category is outward direct investment. It accounted for 25% of total external assets in 2018. Till the early 2000s direct investment assets were dominated by holdings of state owned enterprises (SOEs) in emerging economies in Africa and resource rich developed economies like Australia in sectors like mining, metals and energy. Over the past five years, however, the composition has been shifting towards private companies making investments in sectors like tourism and entertainment.
The third largest component in the assets side is other investment and it accounts for 22% of these assets.
Direct Investment Dominates External Liabilities
The largest component of China’s total external liabilities, that were worth more than USD 5tn in 2018, has been foreign direct investment (FDI). The liberalization of FDI inflows in the early 1990s led to the build up of a sizable stock of FDI liabilities that now account for 52% of total liabilities.
Such investment typically takes the form of partnerships between foreign and local companies, which are known as foreign invested enterprises (FIEs). Collectively FIEs accounted for 29% of exports and 37% of imports in 2018. The economic linkages of FIEs via supply chain and employment effects makes them influence domestic growth to some extent.
The second largest component on the liabilities side was other investment which accounted for 24% of total external liabilities in 2018. It mainly includes items like loans, deposits and trade credit by the banking sector. Portfolio investment was the third largest category on the liabilities side and accounted for 22% of external liabilities. Foreign financial inflows under this category are governed by a variety of rules and regulations.
Importance Of Analyzing IIP
Monitoring a country’s gross external positions is important because large gross positions can lead to greater exposure to external shocks. Thus if China runs a net surplus on its IIP, doesn’t imply that it is an unambiguously strong position. This point is well illustrated by the fact that investment banks like Lehman Brothers had small net open positions during the 2008-09 financial crisis and relatively large gross positions on certain risky transactions. Eventually, these risky components of their gross positions pushed Lehman and other weaker companies to bankruptcy. What is true for companies is true of countries as well.
Macrologue 