China and Developing Asia: Integration through Foreign Investment and Aid

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China and Developing Asia Integration through
Foreign Investment and Aid

• Vineet Kohli

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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?

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FDI in China Main Trends

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

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Chinas FDI Success in Comparative Context

• Chinas 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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Regional Composition of Chinas 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.

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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.

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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 Singapores
  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,
  Chinas significance as a magnet of FDI from Asia
  is strong.

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China as MNC export platform

• 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 Chinas total
  exports

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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

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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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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.

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• 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.
  Chinas 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, Chinas 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.

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Chinas Forex Reserves ( billion)

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

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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.
• Chinas 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 Chinas outward FDI

• Almost 60 of Chinas 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
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• China is not a significant source of FDI for
  developing neighbours.

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Sectoral Composition of Chinas Outward FDI

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

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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.

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Reported aid provided by China

• 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

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

• 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

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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 - Chinas
  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.

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• Thank You!