September 12, 2012
The emerging economies are playing an increasingly important role in the global economy. Their share of global GDP, trade and investment flows is increasing. They have already gained a greater say in multilateral financial institutions in recent years as well as a ‘seat at the table’ with the creation of the G20. The four largest emerging economies, the so-called BRICs, already rank among the world’s eleven largest economies.
In terms of international investment, however, the BRIC countries punch below their weight. Foreign assets amount to 2/3 of GDP in both China and Russia and less than 1/3 of GDP in both Brazil and India. By comparison, US foreign assets amount to 145% of GDP. Foreign liabilities amount to 60% of GDP in Brazil and Russia, and around 40% of GDP in China and India. US liabilities stand at 165% of GDP. In dollar terms, the differences are obviously even more striking. For instance, US foreign assets are five times larger than China’s and a stunning 50 times larger than India’s.
In terms of net international investment position (i.e. the difference between international assets and liabilities), China is the only BRIC country with a sizeable net positive position, making it somewhat of an anomaly among emerging economies, generally speaking. Only Argentina and a few newly-industrialised economies (e.g. Hong Kong, Singapore and Taiwan) are net international creditors. China’s net international investment position (IIP) currently stands at 26% of GDP or USD 1.9 tr. (In dollar terms, only Japan has a larger net IIP of USD 3.3 tr.) The US, by contrast, has a net negative position of USD 4 tr.
All BRICs – like most other emerging economies – are ‘long debt’ (mainly in the form of reserve assets) and ‘short equity’ (FDI and portfolio equity). A large share of foreign assets therefore consists of low-yielding foreign government debt securities, and a significant share of liabilities is made up by generally high(er)-yielding equity investments, the combination of which translates into poor financial returns. Even China with its very large creditor position at present barely turns a profit. After all, 70% of its foreign assets consist of official reserves. The US, of course, is the mirror image of China, generating net financial returns despite being the world’s largest debtor. This balance sheet structure is largely due to (past or present) controls on private capital outflows and the desire among emerging economies to accumulate official reserve assets – either as a form of insurance against balance-of-payments shocks or as the byproduct of persistent currency intervention in the context of an undervalued exchange rate.
The BRICs are getting a proverbial raw financial deal, at least from an external cashflow point of view. (The benefits that an economy derives from FDI inflows in terms of higher investment and the transfer of technology and know-how may provide a non-financial offset.) Furthermore, in purely financial terms, the public sector as the main holder of low-yielding foreign debt also runs a ‘negative carry’ as a result of (sterilised) FX intervention. (Where FX accumulation is only partially sterilised, or not at all, it translates into opportunity costs all the same.) To the extent that the public sector is net long foreign currency (FCY), which is the case in all four BRICs, it may be able to offset the losses from the negative offshore-onshore interest rate differential by way of currency depreciation. If, on the other hand, the currency tends to appreciate in nominal terms over the medium term, the public sector will suffer valuation losses, on top of carry-related losses.
While the BRIC public sectors are ‘long’ FCY, the economy-wide exchange rate risk is more difficult to quantify. At the risk of over-simplification, assuming that all or most foreign assets are denominated in FCY and all foreign liabilities (except equity liabilities) are also denominated in FCY, all BRICs are ‘longer’ FCY than the net IIP position might imply. Thus, China’s net long dollar position is significantly larger than its positive net IIP implies (USD 3.7 tr versus USD 1.9 tr) and Brazil, India and Russia are also all net FCY creditors (chart), in spite of the first two having a negative net IIP.
The public sector’s long foreign assets and FCY position may be rationalised economically in terms of the need to provide hedge/insurance to the (typically) net short FCY private sector. However, the consolidated private and public-sector balance sheets point to a long aggregate FCY position. From a purely fiscal-financial point of view, leaving aside precautionary motives and trade competitiveness concerns, the public sectors in the BRICs should have an interest in reducing their net long FCY position – or at least in limiting their future growth.
All this may help explain why China seeks to renminbi-ise its foreign assets by way of RMB internationalisation and to gradually allow the private sector to accumulate higher-yielding foreign assets by way of capital account liberalization. If successful, this would help limit FCY mismatches in the public sector, limit the negative carry incurred by the public sector and raise the return on China’s net foreign assets. By the same token, it would not be advisable to reduce public-sector FCY liabilities. On the contrary, from a purely financial point of view, it would seem to make sense for China – and somewhat less so for the other BRICs – to sell more rather than less FCY-denominated debt to foreigners given the government’s and the economy’s large net long FCY positions.
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