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, while 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 in recent years has created an economy well suited to designing, building and servicing large infrastructure projects. Although we argue that there is still plenty of room for Beijing to keep investing in domestically, the peak may have passed. So it makes sense for China to look overseas to put all that capacity and expertise to use.
It may not have to look far. As result of Asia’s great urbanisation process, the region’s urban population is projected to rise by 650m between 2010 and 2030. In turn, we estimate that Asia needs to invest US$11tn in urban infrastructure to accommodate this demographic shift.
However, capital for infrastructure investment has become scarce despite low global interest rates. The 2007-08 financial crisis reversed the steady rise of outward direct investment (ODI) flows on a global level. China’s investment is now less reliant on foreign investment given its high national saving rate, but the same cannot be said for many other developing countries with investment/funding gaps.
Normally, this investment is the government’s responsibility because infrastructure creates wider benefits to society that are difficult for the private sector to monetise. However, policymakers have prioritised fiscal prudence. Although the private sector is being encouraged to contribute, especially through public-private partnerships, 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 US$100bn, the China-led Asian Infrastructure Investment Bank (AIIB) offers an alternative funding source. First proposed by Beijing in October 2013, the AIIB will have a mandate to fund infrastructure projects in Asia on commercial terms. As of June 2014, 22 countries in Asia and the Middle East had expressed interest in joining the AIIB, which is expected to be established by year-end.
Chinese funding has tended to come from a mix of State Owned Eneterprise (SOE) deal-making and China’s Export-Import (Exim) bank loans. For example, the state-owned China Communications Construction Company (CCCC) formed a joint venture with PT Jakarta Monorail to design and construct an integrated transit system in Jakarta.
CCCC agreed to invest US$1.5bn in the monorail project as well as funding the construction of a monorail assembly plant in Indonesia. Meanwhile, Exim bank has provided credit support for 24 highways, 3 railways, one port, 3 airports and 9 bridges in the Mekong region and the 10-nation Association of South East Asian Nations (ASEAN). The AIIB is set to complement and coexist with these funding channels.
We also believe there will be no shortage of applicants keen to tap into this new source of capital. Officials in the region are becoming more vocal about their funding gaps for infrastructure investment. For example, India’s latest Five-Year Plan projected a funding gap equivalent to 23 per cent of total infrastructure investment. The Asian Financial Crisis of 1997-98 created a general aversion to foreign loans. The AIIB loans will be made on commercial terms though, rather than being conditional on implementing structural reforms, and so should be more politically viable.
What’s in it for China?
It still runs an overall current account surplus, but a persistent and increasing deficit on its income account. That means China earns less on its foreign investments than other countries are repatriating in profits earned in China. Fair enough; foreign investment brought better technology and management techniques. Still, China now needs to find more ways of recycling its US$4tn of accumulated foreign reserves.
That can be done by investing differently, shifting in particular from portfolio investment (much of which goes into US treasuries) towards higher-yielding direct investment. ODI is also good for trade. In countries where China invests the most, Chinese exports have also gained market share at a faster-than-average rate (with the exception of some European countries due to EU tariffs). Demand and jobs do not follow ODI out of China: indeed, ODI creates larger external markets for China’s exports. Finally, increased capital and trade flows both help in China’s quest to internationalise its currency, the renminbi.
Foreign direct investment has benefitted China’s own 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 to narrow Asia’s funding gap and in the process achieve its own policy objectives.
This article was co-authored by Ronald Man, HSBC’s Asian Economist, and John Zhu, HSBC’s Greater China Economist.