China in Transition

# China as a Financial Superpower: The importance of "China money" on the rise

Chi Hung KWAN
Consulting Fellow, RIETI

China's net external assets have been increasing rapidly in recent years, reaching $1.74 trillion at the end of 2012, second only behind Japan, which had net external assets of$3.43 trillion. Given expected progress in the liberalization of capital transactions in China, "China money" will become an increasingly important factor that could influence major trends in international financial markets.

## Sustained twin surpluses

The accumulation of net external assets is the direct result of a sustained surplus on the current account balance. The current account balance in turn is roughly equal to net exports, obtained by subtracting domestic investment from domestic savings on the basis of the gross domestic product (GDP) (Note 1). In China, the savings ratio (the ratio of savings to GDP) has consistently exceeded the investment ratio (the ratio of investment to GDP) since 1994. Reflecting this, the current account has been in surplus, with its ratio to GDP reaching its peak at 10.6% in 2007 (Figure 1).

## Expected changes in flow of funds as a result of capital account liberalization

The structure of external assets and liabilities in China that has caused this low rate of return reflects the fact that capital transactions are still severely restricted. However, this situation is likely to change significantly in the future as capital transactions become liberalized.

The Chinese government has cited the preparation of a concrete plan to advance the liberalization of capital transactions as one of the key points of the reform of its economic system in 2013 (a decision at the session of the Standing Committee of the State Council held on May 6, 2013). In that regard, a paper presented by a research team of the Research and Statistics Department of the People's Bank of China titled "Conditions for accelerating the liberalization of capital transactions of China have been almost put in place" (February 2012) will serve as the basis for discussion. This paper shows a roadmap with the three phases described below for liberalizing capital transactions over the next 10 years, taking the following conventional view on the order of liberalization: (1) capital inflow comes first, followed by capital outflow, (2) long-term transactions come first, followed by short-term transactions, (3) direct investment comes first, followed by indirect investment, and (4) institutional investors come first, followed by individual investors.

(1) Short-term target (1-3 years): Relax regulations on direct investment under the real demand principle and encourage outward direct investments by Chinese enterprises (Go Global, or "Zouchuqu" in Chinese).
(2) Medium-term target (3-5 years): Encourage deregulation of commercial loans related to international trade under the real demand principle and promote the internationalization of the Chinese renminbi.
(3) Long-term target (5-10 years): Liberalize capital outflows after liberalizing capital inflows, and gradually and carefully open investment in real estate, equities, and bond transactions to foreign capital.

If these proposals are realized, China's external assets will shift from foreign exchange reserves owned by the government to direct investment and securities investment by the private sector. In contrast to the dominance of inward direct investment observed in the past, it is expected that outward direct investment by Chinese companies will grow so that inward and outward direct investment will become more balanced. In addition, the securities market in China will become an important investment destination for foreign investors, and the presence of "China money" in international financial markets will also rise significantly.

The original text in Japanese was posted on July 3, 2013.

Footnote(s)
1. ^ Domestic savings are obtained by subtracting consumption from GDP. (Consumption and savings here include those in the government sector as well as those in the private sector). Also, while the current account balance includes the balance of factor income and the balance of transfer accounts from abroad, net exports based on GDP do not include these items.
2. ^ Domestic savings are obtained by subtracting consumption from GDP. (Consumption and savings here include those in the government sector as well as those in the private sector). Also, while the current account balance includes the balance of factor income and the balance of transfer accounts from abroad, net exports based on GDP do not include these items.
3. ^ Domestic savings are obtained by subtracting consumption from GDP. (Consumption and savings here include those in the government sector as well as those in the private sector). Also, while the current account balance includes the balance of factor income and the balance of transfer accounts from abroad, net exports based on GDP do not include these items.
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