China offers a prime example of export-led growth that has benefited from learning by doing and by adopting foreign know-how, supported by a complex industrial policy. Arguably, a modern version of mercantilism has been at work. The Global Crisis put an abrupt end to China’s export-led, high growth and large current-account surplus trajectory. In the US, the private sector was forced to de-leverage and lower demands for imports. Other crisis-hit developed countries also cut back on imports. Consequently, the Global Crisis and its aftermath induced rapid Chinese internal balancing, reducing the scope of future reserve hoarding. Since the Crisis, China’s current-account surplus fell from 10% of GDP in 2007 to 2% in 2013.
A legacy cost of Chinese policies during the 2000s is its skewed external balance. China’s been long on low-yielding foreign assets (mostly international reserves) and short on high-yielding assets (mostly large liabilities associated with past net FDI inflows). While China’s net external financial assets in 2013 was about 20% of China’s GDP, the real net return on these assets was negative (see Hanemann 2014). This reflects two fundamental factors:
- The low real return on Chinese international reserves, which is two-third of its gross external assets; and
- The high return on past FDI inflows to China, which accounts for about 60% of Chinese external liabilities.1
The low return on Chinese foreign assets is bad news, especially considering the rapid ageing of China’s population. This is in contrast to Japan, where the sizable return on its foreign asset position helps in buffering the future income of its rapidly greying population.
A way of mitigating the adverse consequences of China’s legacy of external balance sheet exposure is external rebalancing, that is ‘swapping’ some of its international reserves with higher yielding foreign equities and outward Chinese FDI (e.g. Shotter 2014). Indeed, China embarked on diversifying its holdings of dollar international reserves by channeling surpluses into a sovereign wealth fund, encouraging outward FDI in tangible assets, and offering much higher expected returns.2 The outcome has been growing FDI in the global resource sectors and infrastructure services, especially in commodity and mineral exporting countries, which includes developing countries and emerging markets in Africa and Latin America. In a way, China has joined the trend of other emerging markets.3
Bilateral central bank swaps
After the Global Crisis in 2008, China embarked on large bilateral currency-swap agreements with other countries. This was done in tandem with the unprecedented provisions of swap-lines among the OECD countries and the more selective provision of four swap-lines by the Fed to selected emerging market economies. Comparing the bilateral swap-lines offered by the Fed and the People’s Bank of China reveals key differences. Most of the swap-lines offered by China have been to commodity countries – developing and emerging market economies – whereas most of the bilateral swap-lines offered by the Fed are between the OECD countries and four emerging markets: Brazil, South Korea, Mexico, and Singapore.
In Aizenman and Pasricha (2010), we point out that the selection criteria explaining the Fed’s supply of bilateral swap-lines to emerging markets were:
- Close financial and trade ties;
- A high degree of financial openness; and
- A relatively good sovereign credit history.
Chances are that similar factors account for the Chinese supply of renminbi bilateral swap-lines to a growing list of developing and emerging markets, as has been vividly illustrated by Garcia-Herrero and Xia (2015).4 This strategy blends very well with the trade internationalisation of the renminbi in the context of the broader outward FDI strategy of China, and is consistent with the channeling of China’s net foreign-asset position into an outward FDI-cum-credit strategy.
In our own work, we take stock of what may be the new chapter of Chinese-outward mercantilism, which is aimed at securing a higher rate of return on its net foreign asset position, leveraging its success in becoming the global manufacturing hub (Aizenman et al. 2015). We suppose that in the aftermath of the Global Crisis, China bundled outward FDI with its finance dealing (lending, swap-lines, trade credit), its trade and foreign investment (including exports of Chinese capital products and labour services), and leveraged its growing market clout.
This bundling strategy has been mostly applied to developing and emerging market economies, and to ‘commodity-countries’. During the Global Crisis and its aftermath, China rapidly increased its outward FDI, swap-lines, imports and exports to selected countries. Such a bundling strategy is consistent with Adams and Yellen (1976) – bundling as a manifestation of market clout in which the bundling party leverages its market powers aimed at increasing its surplus. Accordingly, China may use its market power in the provision of ‘swap and lender of last resort’, supplying capital goods and infrastructure services to its trading partners.
We find that:
- Chinese manufactured exports to, and commodities from, its trading partners are positively associated with the outflows of FDI to the recipient countries;
- The provision of a renminbi swap-line is positively associated with the size of Chinese bilateral trade with the swap-line recipient countries; and
- Small countries tend to be the recipients of renminbi swap-lines.
Focusing on Chinese greenfield FDI abroad and distinguishing between the FDI outflows into tradable sectors, non-tradable sectors, and natural resources, we find:
- Chinese trade influences the natural resources sector FDI;
- Exports of manufactures are negatively associated with FDI outflows while the effects of commodities imports are positive;
- The association between Chinese FDI outflows in the natural-resources sector and commodities imports has become stronger since the Global Crisis;
- The positive association between Chinese-outward FDI and commodities imports increases with the provision of renminbi swap-lines to China’s trading partners.
The influence of renminbi swap-lines is especially large on the Chinese-outward FDI in the natural resources sector. The overall findings support the notion that in the aftermath of the Global Crisis, Chinese-outward FDI is bundled with trade and financial linkages, thereby increasing the country’s influence in the international markets, and securing its long-run access to a stable supply of commodities.
Figure 1 shows a heat map of average Chinese bilateral trade, outward FDI, and renminbi swap-lines as a ratio of a recipient country’s GDP in the sample. Figure 2 overviews the relationship between Chinese FDI, trade, and swap-lines. The diamond chart plots – based on bilateral data – Chinese FDI, exports, imports, and swap-lines, all measured as a ratio of a recipient country’s GDP and weighted by the sample means. The dotted, dashed and solid lines plot the statistics before, during and after the Global Crisis (2008-2009), respectively. The diamond charts indicate concurrent and significant surges in Chinese-outward FDI, swap-lines, imports and exports to the selected countries.
Figure 1. Chinese-outward FDI, bilateral trade, and renminbi swap-lines. The heat maps plot sample means of greenfield FDI, aggregate FDI, bilateral trade and renminbi swap-lines as a ratio of recipient country’s GDP. Darker colours corresponds to higher intensity
A. China’s greenfield FDI
B. China’s aggregate FDI
C. China’s bilateral trade
D. Renminbi swap-lines
Figure 2. Relationship between Chinese FDI, trade, and swap-lines
The diamond chart plots – based on bilateral data – Chinese FDI, exports, imports, and swap-lines, all measured as a ratio of a recipient country’s GDP, weighted by the sample means. The dotted, dashed and solid lines plot the statistics before, during and after the Global Crisis, respectively. The recipient countries are listed in Table 1.
A. Chinese greenfield FDI
B. Chinese aggregate FDI
Table 1. China’s top industry activities and investing companies in outward greenfield FDI before and after the Global Crisis. This table reports the largest capital investment by China in host countries from January 2003 to January 2015, based on the ‘fDi Intelligence database’ (a database run by the Financial Times).
The shortness of the sample we use and the lack of more detailed data do not allow us to evaluate the success of the bundling strategy in delivering higher returns to the Chinese net foreign asset position. The willingness of China to extend credit lines and invest in countries with a history of default – including Argentina, Venezuela, and Zimbabwe – raises concerns about the growing exposure of China to sovereign defaults and the risk of partial nationalisation of its outward FDI assets.
‘In kind’ payment
One should keep in mind, however, that some Chinese lending to commodity countries is secured by ‘in kind’ long-run payment in the form of oil flows and other commodities back to China.5 Arguably, Chinese outside exposure may be also partially hedged by the growing dependence of some developing countries on Chinese infrastructure services needed to maintain their upgraded rail system, the growing importance of China as the prime destination of their imports, and, for some, their dependence on China as their only ‘lender of last resort’.6
While it is premature to estimate the returns on this bundling strategy, the outcome has been markedly increased access for emerging African, Asian and Latin American countries to improved infrastructure services that are both co-financed and constructed with the help of Chinese capital goods and knowhow and co-paid by the growing exports of commodities and minerals to China. The proposed formation of the Asian Infrastructure Investment Bank, in which China would be the main shareholder, may well be viewed as a follow up of this bundling strategy.
Adams, W, J and J L Yellen (1976), “Commodity Bundling and the Burden of Monopoly”, Quarterly Journal of Economics 475.
Aizenman J, Y Jinjarak and H Zheng (2015), “Chinese Outwards Mercantilism – the Art and Practice of Bundling”, NBER Working Paper No. 21089.
Aizenman J, Y Jinjarak and N Marion (2013), “China’s Growth, Stability, and Use of International Reserves”, Open Economies Review: 1-22.
Aizenman, J and J Lee (2008), “Financial versus monetary mercantilism–long-run view of large international reserves hoarding”, World Economy 31(5): 593–611.
Aizenman, J and G K Pasricha (2010), “Selective swap arrangements and the global financial crisis: Analysis and interpretation”, International Review of Economics & Finance 19(3): 353-365.
Aizenman, J and G K Pasricha (2013), “Why do emerging markets liberalize capital outflow controls? Fiscal versus net capital flow concerns”, Journal of International Money and Finance 39: 28-64.
Blonigen, B, R Davies, G Waddell, and H Naughton (2007), “FDI in space: Spatial autoregressive relationships in foreign direct investment”, European Economic Review 51: 1303-1325.
Garcia-Herrero, A and L Xia (2015), “China’s RMB bilateral swap agreements: What explains the choice of countries?”, Asia-Pacific Journal of Accounting & Economics, forthcoming.
Hanemann, T (2014), “China’s international investment position: 2014 update”, Rhodium Group, 9 April.
Kynge, J, and G Wildau (2015), “China: with friends like these”, Financial Times, 17 March.
McMahon, D (2013), “China Eases Rules on Foreign-Bound Deals”, The Wall Street Journal, 19 December.
Shotter, J (2014), “China and Switzerland sign bilateral currency swap line”, Financial Times, 21 July.
1 According to the State Administration of Foreign Exchange (SAFE), China’s external financial assets were about $6 trillion at the end of 2013, of which two-thirds were international reserves ($3.9 trillion), the outbound direct investment about 10%, securities investment about 4%, and other investment about 20%. The country’s external liability position was $4 trillion, out of which FDI in China was $2.35 trillion (60% of the total liability). The investment in securities and other aspects took up 10% and 30%, respectively.
2 On 19 December 2013 the Wall Street Journal reported, “Beijing will ease the approval process for all but the largest Chinese investments in overseas companies and projects, a major relaxation of regulatory oversight that analysts say is aimed at encouraging Chinese firms to expand abroad” (McMahon 2013).
3 Aizenman and Pasricha 2013 note that emerging markets eased outflows of capital more in response to higher stock price appreciation, higher appreciation pressures in the exchange market, a higher international reserves to GDP ratio, and higher real exchange rate volatility.
4 Garcia-Herrero and Xia (2015) concluded that the choice of countries signing a renminbi-denominated bilateral swap agreement with China was predominantly by ‘gravity motifs’; that is, by country size and distance from China, as well the trade motif in terms of both exports to China and the existence of a Free Trade Agreement with China. Institutional soundness also matters, since countries with better government and less corruption are more likely to sign a renminbi-denominated bilateral swap agreement.
5 The Financial Times commented on 17 March 2015, “Credit risks (of Venezuela) are soaring, with the economy set to shrink by as much as 7 per cent this year. The slump in crude prices is clobbering Caracas’s ability to finance its debt. The markets are pricing in about a 90 per cent probability that Venezuela will default on its debt over the next five years. Chinese lending may, in effect, be senior to that of international bond holders, secured as it is against 450,000 barrels a day of oil”. And “Russia’s financial arrangements with China are shrouded in mystery, which is reinforced by western sanctions imposed on Moscow since the Ukraine crisis began. However, several analysts put Chinese state-backed lending to Russian corporations at well over $30bn, much of it secured by oil shipments to China” (Kynge and Wildau 2015).
6 Our conjecture is in line with recent case studies – three out of the largest five industry activities of China’s-outward greenfield FDI are in the natural resources sector, before and after the Global Crisis (see Table 1). Seven out of ten of the largest capital investments abroad by Chinese companies have operated in host countries that receive renminbi swap-lines in the aftermath of the Global Crisis.