China has emerged as the world’s second-largest international creditor. Only Japan has a stronger net international investment position. China’s net foreign claims amount to USD 2 tr, compared to Japan’s USD 3 tr. Germany is in third place with net foreign claims of USD 1.7 tr. Compared to advanced economies, China’s de facto international financial openness is limited due to continued capital account restrictions. Gross foreign assets amount to 60% of GDP, compared to 150% in Japan and the US - and more than 250% in Germany and Taiwan. As the authorities continue to liberalise two-way capital outflows, Chinese foreign assets will experience substantial growth in the coming years.
Where do things stand at the moment? First, Chinese foreign holdings have grown rapidly, rising to USD 6.1 tr from USD 3 tr in 2008. This compares to USD 9.5 tr and USD 8.6 tr worth of foreign assets held by Germany and Japan. China is catching up, while it continues to pale next to the United States’’ USD 24 tr of overseas assets. Second and significantly, the PBoC controls the bulk of China’s foreign assets. Reserve assets make up 2/3 of all foreign claims, compared to less than 1/5 in Japan and less than 3% in reserve-currency-issuing countries like Germany and the United States. This is of course largely the legacy of large balance-of-payments surpluses and a FX intervention policy geared towards keeping the exchange rate competitive. Third, the total value of foreign portfolio investment has remained largely unchanged in recent years, fluctuating in the USD 200-280 bn range. This contrasts sharply with FDI, other investment and reserve assets, all of which grew vigorously in 2006-13. Within the portfolio investment category, a shift has occurred away from bonds to equities. The latter grew from practically zero in 2006 to USD 150 bn today. Portfolio equity investment nonetheless amounts to less than 3% of total foreign assets. In Germany and Japan, the share is 10% and in the US it is 27%. But even in a newly-industrialised economy like Korea the figures exceeds 10%. This would point to considerable catch-up potential.
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| Source; SAFE |
This figure is likely to underestimate Chinese holdings of foreign equities, though. The US Treasury estimates mainland Chinese holdings of US equities alone at USD 260 bn, significantly higher than total reported Chinese foreign portfolio equity investment. Reasons for this discrepancy are: holdings in individual companies exceeding 10% are classified as FDI rather than portfolio equity investment; net errors and omissions; to the extent that foreign portfolio equity investment is denominated in a convertible currency, liquid and directly or indirectly controlled by the central bank, it can be booked as a reserve asset. Unfortunately, very little is known about the PBoC/ SAFE investment portfolio. Anecdotal evidence suggests that SAFE started to diversify into equities as early as 2007-08. Nonetheless, the bulk of assets managed by SAFE likely remains invested in highly-rated, liquid sovereign bonds.
According to US Treasury data, China’s holdings of US government securities has remained more less unchanged at USD 1.1.-1.3 tr since 2011, while FX reserves have increased from USD 3 tr to USD 4 tr over the same period. This does not mean that the entire USD 1 tr increase in reserve assets has gone into higher-risk assets, but concerns about the value of the dollar and the financial outlook in the US more generally will have induced SAFE to move some of the recently accumulated reserve assets into equities. Competition with its rival, China’s sovereign wealth fund (or CIC) will have provided the necessary political-bureaucratic incentive to do so. Unfortunately, there is just no way of knowing to what extent SAFE has acquired, for instance, foreign equities. What is known is that CIC increased its global equity holdings from 2.3% (or USD 2 bn) in 2008 (CIC was created in 2007) to 40.5% (or an estimated USD 80 bn) in 2013. SAFE is unlikely to hold 40% of its assets in the form equities. But given that Chinese holdings of US treasuries (or agencies) have barely increased since 2011, some of the additional reserve assets will likely have been invested in higher-risk foreign assets, including equities.
The broader point is this: China holds more FX reserves than it needs for balance-of-payments financing purposes. There are different metrics to estimate adequate FX reserve levels. China’s IMF-defined reserve adequacy ratio is about 200%, while a ratio of 100-150% is considered adequate. Given still extensive controls on resident outflows, China would therefore be more than fine even with a ratio less than 100%, for the time being. In other words, out of USD 4 tr worth central bank foreign assets, the Chinese government could afford to invest at least USD 2 tr in higher-risk international assets.
How significant would this be? By comparison, global equity markets are worth USD 65 tr (or slightly more than USD 60 tr, ex-China). The US accounts for USD 24 tr. US bond markets are valued at USD 38 tr, including USD 12 tr worth of treasuries. Euro area bond markets are worth USD 20.6 bn out of which USD 8.5 bn consist of central government securities. In short, USD 2 tr is sizeable, but not overwhelming from a global market perspective. Nonetheless, changes to China’s (or SAFE’s) asset allocation strategy could have more important effects at the individual country level. After all, USD 2 tr is equivalent to Germany’s and France’s market cap and it is about twice the size of the Korean or Taiwanese market.