The BRICs accounted for a significant share of total EM capital outflows during 2005-08. China alone accounted for more than 1/3 of total flows. China is, and will remain, in “pole position” among the BRIC countries. Its increasing financial power is based on the size of its foreign assets, its net international creditor position, continued (net) foreign asset accumulation and very importantly, the very significant concentration of ownership and control in the hands of the government and quasi-government entities.
Following last April’s G20 meeting, the emerging markets (EM) experienced a sharp rise in foreign capital inflows. As the Institute of International Finance (IIF) perceptively points out in a recent note, the current surge in capital inflows is the fourth of its kind since the 1970s and, if history is anything to go by, marks only the beginning of a sustained, multi-year rise in capital flows to EM. Significant as this is, it must not be allowed to mask an equally important trend: the emergence of EM as international investors in their own right.
Throughout much of the post-WWII period, the vast majority of the EM – as (upper-) middle income countries started to be called in the 1980s – did not generate any sizeable capital exports – Middle Eastern oil exporters post-1973 excepted. Extensive capital controls severely restricted cross-border private capital outflows. When private capital flows to the EM recovered during the 1970s, they were largely utilized to finance trade deficits. Official holdings of foreign assets were therefore never significant and often even proved insufficient to avert international payments crises. EM capital outflows during this period took largely the form of “capital flight” (showing up as E&O), often caused by domestic economic, financial and political instability.
Things changed dramatically during the 1990s, and especially after the 1997 Asian crisis. Most Asian EM switched to a deliberate FX reserve accumulation policy on the back of surging trade surpluses and, in many cases, surging capital inflows, frequently supported by undervalued exchange rates. Similarly, large current account surpluses in oil-exporting countries due to rising energy prices led to rapid official foreign asset accumulation during the 2000s. In the Middle East, this not infrequently took the form of non-reserve assets controlled by the official sector rather than reserve accumulation. Unwilling to revalue their currencies, several large EM soon ended up holding “excess” FX reserves, leading them to set up sovereign wealth funds (SWF) with the explicit mandate to invest “excess” reserves in higher-yielding assets.
EM capital outflows almost quadrupled between 2000-04 and 2005-09, half of which was accounted for by reserve accumulation. The IIF projects total annual EM capital outflows to range between USD 1,000 bn - 1,200 bn in 2010-11. To put this into perspective, during the 2005-07 boom period, US capital outflows averaged USD 1,100 bn and Eurozone outflows USD 2,100 bn. In 2010-11, official reserve accumulation will average USD 600 bn, net resident lending USD 310 bn and net equity outflows USD 240 bn, nearly USD 200 bn of which are accounted for by FDI outflows. The level and composition of EM outflows will, by and large, remain unchanged over the next couple of years. Significantly, FDI is forecast to grow the fastest.
Not surprisingly, the BRICs accounted for a significant share of total EM capital outflows during the 2005-08 period, namely 60%. They accounted for 70% of FX reserve accumulation, 60% of FDI outflows, 45% of resident-lending and (only) 12% of portfolio equity outflows. The importance of BRIC outflows varied greatly, however. Interestingly, Russia compared quite favourably to China in terms of non-reserve-related outflows (at least until 2008!). In terms of EM outflows, China accounted for 1/2 of FX reserve accumulation, 1/4 of resident lending but (only) 15% of equity related outflows. Impressively, China accounted for more than 1/3 of total EM capital outflows during 2006-08.
China is, and will remain, in “pole position” in terms of both flows and stocks. As of 2008, BRIC total external assets amounted to USD 4,700 bn. Adjusted for end-2009 FX reserve holdings, they should currently exceed USD 5,000 bn. Absent greater capital account openness, China’s foreign asset accumulation will remain much more heavily skewed towards reserve assets than in Brazil and Russia, where the capital account is more open. This helps to explain why China and India hold more than 70% of their external assets in the form of FX reserves versus less than 50% in the case of Brazil and Russia. This has important implications. China’s financial power is based not just on the enormous size of its foreign assets or its equally impressive net international creditor position. It is also underpinned by continued very large (net) capital exports.
Last but not least, in China – to a much higher degree than in Brazil and Russia – it is the official sector that, directly or indirectly, controls the bulk of the country’s foreign assets. This is true whether or not one considers the foreign assets of state-owned banks and FDI by SOEs to be “official” holdings. This is simply a long and convoluted way of saying that the Chinese government has a far, far greater capacity to exercise international financial influence than the other BRIC governments.