China and Developing Asia: Integration through Foreign Investment and Aid Vineet Kohli.

China and Developing Asia: Integration through Foreign Investment and Aid

Vineet Kohli

Broad Framework

• China has emerged as an important recipient of foreign investment from developed Asian countries

• Inward foreign investment and export growth has resulted in accumulation of Forex reserves

• Maintaining large dollar reserves expose China and rest of east Asia to risk arising from the loss of confidence in the value of dollar

• Large Forex reserves have supported the recent wave of FDI and aid from China to developing Asia

• But has this FDI and aid helped developing countries or only served to recreate regressive pattern of specialization?

FDI in China: Main Trends

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• Chinese economy opened itself to FDI in 1978. But major wave of FDI comes after 1992.

• In 1992 China’s path of market socialism was confirmed and inflows began to surge. FDI to China increased from $4.37 bn in 1991 to $11 bn in 1992 and further to $27.5 bn in 1993.

• Temporary disruption due to East Asian Crisis, but flows resume trend after 2000.

China’s FDI Success in Comparative Context

• China’s share in FDI flows to developing countries was 0.76% in 1980, 9.9% in 1990, 15.9% in 2000 and 16.7% in 2007. China is currently the largest destination for FDI within the developing world.

• China has also accounted for an increasing share of world FDI flows- 0.1% in 1980, 1.7% in 1990, 2.9% in 2000 and 4.5% in 2007

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China as a % of World China as a % of Developing Countries

Regional Composition of China’s Inward FDI

• Asia is the most significant source of FDI for China- accounting for 57% of FDI in 2007. LA is second accounting for 27% of total FDI into China in 2007.

• Most of the FDI from LA- nearly 95% in 2005- is received from two tax havens namely Cayman Islands and British Virgin Islands. The share of Europe and North America were 5.9% and 4.6% respectively.

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• LA tax havens may only be round-tripping Chinese capital into China.

• They may also be redirecting Asian FDI into China. For example, the number of companies in Hong Kong that were incorporated in Bermuda and the Cayman Islands jumped 5.2 times from 178 in 1990 to 924 in 2000. British Virgin and Cayman Islands rank second and third after China as recipients of foreign investments from Taiwan. What appears as FDI from LA may actually be FDI from rest of Asia.

• Within Asia, Hong Kong accounts for nearly 65% of FDI into China. Korea, Japan, Singapore and Taiwan are other major investors.

CountryTop 10 Asian investors in

2007

$mn % of Asia

Hong Kong, China 27703.42 65.78

Republic of Korea 3678.31 8.73

Japan 3589.22 8.52

Singapore 3184.57 7.56

Taiwan, China 1774.37 4.21

Macao, China 637.00 1.51

Malaysia 397.25 0.94

Brunei 376.88 0.89

Philippines 195.32 0.46

Indonesia 134.41 0.32

The problem of round tripping

• There is a huge gap between inflows of FDI reported by China and outflows to China reported by source countries. For example in 2003, HK reported an outflow of $7.7 bn to China whereas China reported an inflow of $17.7 bn from HK. In 2007, China reported an inflow of $5.2 bn from Korea whereas total FDI outflow reported by Korea in that year was $4.3 bn. So, Chinese figures involve a substantial degree of over-reporting.

• This may be due to round-tripping. Effective enterprise tax rate on domestic firms was 25% whereas than that on FFE was 14.5% (van der Hoek et al., 2008). This created incentive for domestic firms to first take capital abroad through such means as trade mis-invoicing and then faking this purely domestic capital as foreign investment to benefit from differential tax structure.

Is the integration through FDI genuine?• While Chinese data certainly exaggerates the amount

of inward FDI, integration appears strong even if we examine outflow data from source countries.

• China has become the single largest destination of FDI from its developed neighbours.

- It accounted for nearly 50% (HK $ 167 bn) of total FDI outflow (HK $ 349 bn) from HK in 2006. Japan was a distant second accounting for less than 10% of HK FDI.

- China accounted for 38% of Singapore’s outward FDI stock in manufacturing in 2006 whereas the whole of ASEAN accounted for just 36%.

- The outstanding amount of Korean FDI in China stood at $16.98 billion in 2006. Second ranked HK could only manage $3 bn of FDI from Korea.

- China received FDI worth $6.49 bn from Japan in 2008. ASEAN 4 and Vietnam were second accounting for $5.29 bn.

• Notwithstanding the problem of round-tripping, China’s significance as a magnet of FDI from Asia is strong.

China as MNC export platform

Sales destination of Japanese MNCs in China (% of total)

Exports Exports to Japan

Local Sales

1997 70 35 30

2007 47 25 53Sales destination of Korean MNCs in China (% of total)

ExportsExports to

KoreaLocal

Sales

1996 77.4 25.8 22.6

2003 65.8 17.8 34.2 According to Chiang and Gerbier (2008), 53 of the top 100 exporting companies in China in 2004 were foreign enterprises. Out of these 53, 21 belonged to Taiwan. In 2007, FIEs accounted for 57% of China’s total exports

Input Procurement from Home country

• Similarly Taiwanese MNCs in China procure 39.4% of their inputs from Taiwan. In plastics, this ratio is as high as 50%. Imports from third countries were 10.7%.

• Asian MNCs thus use China to process inputs into final goods that are imported back into source country or exported to some third market.

• Triangular Trade: Asia exports to China and China exports to first world markets especially the US

Sources of procurement of Korean MNCs in China (% of total)

LocalProcurem

ents

Imports from Korea

Imports from third country

1996 26.5 64.7 8.8

2003 45.6 36.9 17.5

China as an FDI destination: Implications for developing SE Asia

• China accounts for larger share of developing country FDI but it may not have displaced FDI from developing SE Asia where FDI seems to have maintained its historical trend.

• Production networks may have made FDI to two regions complimentary.

• Imports from third countries by Korean and Taiwanese MNCs are likely to be from SE Asia

• “A 10 percent increase in the FDI inflows to China would raise the level of FDI inflows to the East and Southeast Asian countries by about 5 to 6 percent” (Chantasasawat et al., 2004).

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Unprecedented flow of FDI to SE Asia

The sustainability of FDI-driven export growth• Because of heavy reliance on FDI and exports, China has

surplus in both current and capital accounts. • Forex reserves have grown from around $600 million at

the end of 2004 to $2.13 trillion by June 2009. • As of June 2008, 66% of these reserves were invested in

US financial securities.• Almost 44% of these investments were in LT treasury

securities and another 43% in government agency securities.

• Reserve holdings are a necessary to sustain export growth. If PBOC refuses to hold incoming dollars, it will force yuan to appreciate leading to loss of competitiveness.

• Yet such holdings are undesirable since: -They expose China to the risk of erosion in the value of

dollars. -They are unutilised claims on foreign goods and services.

Can be used to raise domestic standards of living.• Not only China, but the whole of Asia that exports to

China faces this risk.

• The strategy of export driven growth was premised on continued increase in world, especially US, demand. Financial collapse and recession in the US have thus highlighted the importance of regional sources of growth in East Asia.

• Trade surplus in the first half of 2009 was $ 60.9 bn less than the corresponding figure for the first half of 2008. Over the same period, FDI fell by $ 20 bn.

• As a result, China has been forced to re-orient its growth strategy towards domestic demand. China’s fiscal stimulus of $586 bn (6.9% of GDP) is the largest in the world. Growth has recovered in the second quarter of 2009 and stood at 7.1% p.a. in the first half of 2009.

• Yet, there is no sign of slowdown in reserve accumulation.

• Reportedly, China’s trade surplus and FDI in second quarter of 2009 were $34.8 bn and $21.2 bn respectively. Yet its forex reserves increased by an unprecedented $178 bn in this period due to inflows of speculative capital.

• To the extent that growing reserves are a problem for China some curbs on speculative capital may have to be considered.

China’s Forex Reserves ($ billion)

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Reserves growing due to hot money flows

The Other Implication of Growing Forex: Outward FDI and Aid

• By the end of 2007, Chinese investment in US financial securities was nearly 1.05 trillion dollars whereas total aid and FDI from China amounted to just 51 billion dollars. So forex is mainly used in purchasing financial securities but some amount also goes towards aid and FDI.

• China’s outward FDI has grown in recent years and stood at $25 bn in 2007. In the same year, China received $75 bn as FDI.

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Regional Composition of China’s outward FDI

• Almost 60% of China’s outward FDI in 2007 is directed towards Asia. LA accounts for another 18%.

• 99% of FDI to LA in 2006 went to Cayman Island and British Virgin Island.

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Country composition of outward FDI

Country 2007

$ millions % of Asia

Hong Kong 13732.35 82.76

Singapore 397.73 2.4

Vietnam 110.88 0.67

Indonesia 99.09 0.6

Thailand 76.41 0.46

Korea 56.67 0.34

Macao 47.31 0.29

Japan 39.03 0.24

• China is not a significant source of FDI for developing neighbours.

FDI from China as a % of total FDI

2004 2005 2006

Malaysia 0.18 1.43 0.12

Laos 20.94 73.50 25.69

Thailand 0.40 0.06 0.18

Vietnam 1.05 1.03 1.84

Cambodia 22.53 1.83 2.03

Indonesia 3.268 0.241 0.683

Sectoral Composition of China’s Outward FDI

• Contrary to popular perception, Chinese FDI is not mainly directed at primary commodities. Most of the FDI goes to services sector.

Stocks at the end of

Agriculture, forestry, husbandry, fishery

MiningManufactu

ringServices

2005 0.89 15.12 10.09 73.90

2006 0.90 19.75 8.31 71.04

2007 1.10 12.73 8.09 76.17

The size and nature of Chinese aid

• China does not maintain official record of aid.• We use data provided by survey carried out by NYU

Wagner School that tabulated pledges of aid by China. • Chinese aid is different because besides grants and

concessional loans, it also includes government sponsored investment.

• These investments are often secured through official bilateral agreements and their ownership remains with the host country. Thus these flows have some traits of development assistance

• Aid flows often benefit China by requiring recipients to export raw materials to China.

• So China secures its supply of primary commodities through aid and not FDI.

• Chinese aid increased from $51 mn in 2002 to $25 bn in 2007.• For the entire period 2002-07, Africa received 33.14 billion

dollars, Latin America received 26.74 billion dollars and South East Asia nearly 14.83 billion dollars as aid from China.

• Within SE Asia, top recipients were Philippines, Vietnam and Burma with total assistance of 5.4, 3.4 and 3.1 billion dollars respectively

Reported aid provided by China

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Reported Chinese Aid by Funding Source and Region, 2002-2007 (Million US$)

Africa Latin America

Southeast Asia

Govt.-Sponsored Investment

8,042 24,389 7,429

Concessional Loan 22,379 1,950 7,114

Grant 1,851 421 231

Debt Cancellation 850 0 60

In-kind Aid 21 1 0

Total 33,143 26,761 14,834

Chinese Aid by Type

Africa Latin America

Southeast Asia

Total

Natural Resources Extraction/Production

9,432 18,585 4,788 32,805

Infrastructure/Public Works

17,865 7,535 6,438 31,838

Not Specified/Other 5,024 608 2,276 7,908

Humanitarian 802 32 159 993

Military 4 0 170 174

Technical Assistance 10 1 3 14• Most of the Chinese aid goes towards natural resource

extraction. The second largest amount is directed towards infrastructure/public works

• In SE Asia, infra/public works most important followed by natural resource extraction

Net Impact of Chinese Aid

• Is Chinese aid today playing the same role as private investments in the primary commodity sector of developing countries in the past?

• Unlike private investment, Chinese aid does not lead to transfer of ownership allowing developing countries freedom to utilise the surplus from these assets for internal development including industrialisation programmes.

• Besides the supply side factors - China’s bourgeoning forex reserves and the benefits of such aid to Chinese economy - demand side factors from developing countries may have also led to growth of Chinese aid.

• There are few conditions on environmental standards and penalties for corruption in the use of funds as has been stressed by the World Bank.

• Finally, China has stepped up its assistance in recent months but like IMF has not insisted on deflationary conditions.

Thank You!