China Becoming A Net Capital Exporter Could Boost Domestic Bond Market

WHAT DOES IT mean that China is set to become a net exporter of direct investment capital for the first time?

Outbound foreign direct investment (FDI) reached $75 billion in the first nine months of the year, up 21.6% on the same period a year earlier. Zhang Xiangchen, a senior official at the commerce ministry, said last week that it looks as if outbound FDI will exceed inbound FDI over the full year, and if not this year then certainly next.

Inbound foreign investment at $87.4 billion between January and September was down 1.4% from the same period of 2013, itself a record year at $118 billion.

A degree of caution is in order when considering these numbers. Most inbound FDI comes from Hong Kong, Taiwan and Japan. Influences on flows from three places are different to the considerations weighing on the minds of European and American executives pondering investments in operations in China.

Passing the net-capital-exporter milestone was already a matter of if not when. China has $4 trillion in foreign-exchange reserves, an official policy to push Chinese companies out into the world, and an easing back from encouraging inward investment to acquire technology and know-how. The Chinese economy is suffering from chronic domestic over-investment, so the rate of outbound FDI is only likely to increase as Chinese companies hunt for acquisitions abroad.

One question is whether they will avoid the excess of the Japanese companies before them who trod a similar path in the 1980s and ended up paying pretty fancy prices for some assets. Another is the extent to which portfolio investment will become the swing factor in overall capital flows.

The conditions are there for it to do so. Net FDI flows are turning negative. Inbound FDI accounts for less than 3% of fixed-capital formation, down from 6.8% before the 2008 global financial crisis. Exports account for a diminishing share of the economy — at 1% of GDP they are one-tenth as important as in 2007.

Portfolio investment inflows can be a challenge for any economy as they are fickle. If they are to become more important to China’s capital account, then development of domestic financial markets, and particularly the domestic bond market, becomes even more urgent.

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