China has been a favoured destination for foreign direct investment since its economy opened up more than three decades ago. However, the country’s own investments abroad will soon overtake inflows.
This is good for China and the rest of the world: China stands to make better returns on its foreign reserves while generating demand for its exports and countries in need of investment can tap into a new and fast-growing source of funding. How China exports its excess savings abroad will be a major theme driving flows into different countries and sectors.
Infrastructure is a good place to start. China’s infrastructure boom has created an economy well suited to designing, building and servicing large projects. Although there is still plenty of room for Beijing to keep investing domestically, the peak may have passed. It makes sense to look overseas to put that capacity and expertise to good use.
China’s infrastructure boom has created an economy well suited to designing, building and servicing large projects
It may not have to look far. Asia’s urban population is projected to rise by 650 million between 2010 and 2030 and we estimate the region needs to invest USD11 trillion in urban infrastructure. Normally, such investment is the government’s responsibility: however, policymakers have prioritised fiscal prudence and the private sector is finding that commercial viability is often a challenge.
As a result, funding gaps have emerged, especially in Indonesia, India and Thailand. With a proposed capital base of USD100 billion, the China-led Asian Infrastructure Investment Bank offers an alternative funding source. It is expected to be established by the end of 2014 and will have a mandate to fund infrastructure projects on commercial terms. By June 2014, some 22 countries in Asia and the Middle East had expressed interest in joining.
China still runs an overall current-account surplus, but has a persistent and increasing deficit on its income account. It earns less on its foreign investments than other countries repatriating profits earned in China. Foreign investment has brought better technology and management techniques, but China now needs to find more ways of recycling its USD4 trillion of accumulated foreign reserves.
That can be done by investing differently, particularly from portfolio investment (much of which goes into US treasuries). Higher-yielding outward direct investment is also good for trade.
In countries where China invests the most, its exports have also gained market share at a faster-than-average rate (with the exception of some European countries, because of EU tariffs). Demand and jobs do not follow direct investment out of China: indeed, it creates larger external markets for China’s exports. And increased capital and trade flows both help in China’s quest to internationalise its currency, the renminbi.
Foreign direct investment has benefited China’s economic development, helping it to invest in infrastructure. So there is potential for another ‘win-win’ situation, with capital this time going the other way. China can help narrow Asia’s funding gap and in the process achieve its own policy objectives.
This article was first published on 8 August 2014.