International Investment Patterns Philip R. Lane WBI Seminar, Paris, April 2006
Introduction What determines aggregate capital inflows and outflows? What determines bilateral patterns in international investment? Role of Institutions and Policies Lessons from recent literature Case study: China and India Case study: Central and Eastern Europe (CEE) Challenges for macroeconomic policy; the adjustment process
Level of International Financial Integration Increasing in income per capita Increasing in trade openness - complementarity Increasing in domestic financial development Increasing in external account liberalization
Panel Analysis of financial integration, 1982-2001 (Dep. Var.: change in financial integration) (1) (2) (3) (4) (5) External 0.17 0.03 0.02-0.01-0.01 Liberalization (3.69)*** (.5) (.36) (.5) (.2) Trade openness 2.35 2.96 1.10 1.53 (3.62)*** (4.88)*** (3.37)*** (4.58)*** Log GDP per 2.15 0.99 1.56 capita (2.74)*** (3.65)*** (5.06)*** Stock market 0.92 0.93 capitalization (18.3)*** (17.4)*** Adjusted R 2 0.12 0.31 0.41 0.89 0.9 Number of obs. 72 72 72 66 59
Net Creditors versus Net Debtors Level of income per capita Demographic factors Level of public debt
Institutions Good institutions lead to: Greater financial integration Greater ability to attract capital inflows Improved quality of inflows more portfolio equity, more FDI, more bonds Improved quality of outflows less capital flight; lower need to hold reserves Lower spreads Institutional mix: general versus financial
Bilateral Investment Patterns What explains why country A invests in country B? Country A s propensity to invest overseas Country B s general attractiveness as a destination Bilateral linkages between A and B Important for investor base Important for transmission of shocks Important for risk analysis Important for asset pricing and return comovements
Bilateral Linkages Optimal diversification has a bilateral dimension Trade risk GDP / return risk Information frictions Gravity variables (Distance, Language, Colonial Ties ) Also Trade volume Bilateral trading costs Bilateral exchange rate stability, language, common institutional framework etc
Main Findings Asset holdings significantly correlated with trade linkages Distance also matters (more so for FDI, banks than portfolio flows) Institutional similarity Asset holdings less influenced by return hedging factors Strong impact of currency union (EMU) on equity; portfolio debt More generally, regional policies matter
The International Financial Integration of China and India
Introduction Goal: quantitative profile of the IFI of China and India Current situation; future evolution Volume-based approach: EWN II; CPIS; BIS; national sources Net positions Gross holdings of foreign assets and liabilities External capital structure Geographical distribution Currency composition
Outline The International Balance Sheets of China and India: A Profile The Future Evolution of Capital Flows Macroeconomic Policy and International Financial Integration Conclusions
Net Foreign Asset Positions 10 China India 5 0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004-5 -10-15 -20-25 -30-35
XS of NFA Positions 100 NAM BW A SAU 50 YEM NFA to GDP 0-50 -100 TZA IRN DZA MUS SW Z VEN TKM CHN RUS MYS KOR IND BIH ZAF GTM BFA ALB NPL EGY UKR BLR SVN UZB MAR JOR ISR PRY URY KEN BGD THA SEN PAK MKD COLROM LTUSVK CZE NGA CMR CHL KHM TJK ARM GABTUR MEX BGR HND IDN BRA CRI ARG SYR LVA POL MLI UGA LKA PER MDA VNM PHL DOM ETH SLV KAZ HRV MOZ RWA JAM TTO CIV GEO KGZGIN PNG ECU MDG TGO GHA PAN SDNAGOBOL HUN TCD NIC AZE LBN TUN ZMB EST LAO -150 6.00 6.50 7.00 7.50 8.00 8.50 9.00 9.50 10.00 10.50 11.00 GDP per capita, PPP
World s Largest Creditors and Debtors Country NFA/GDPW NFA/GDPW Japan 4.34 India -0.18 Switzerland 1.25 Argentina -0.18 Taiwan 1.06 New Zealand -0.22 Hong Kong 1.05 Hungary -0.24 United Arab Emirates 0.54 Portugal -0.28 Germany 0.54 Indonesia -0.29 Singapore 0.46 Canada -0.30 Norway 0.40 Poland -0.32 Saudi Arabia 0.39 Turkey -0.33 China 0.32 Greece -0.37 Kuwait 0.31 United Kingdom -0.67 France 0.27 Mexico -0.71 Belgium 0.27 Brazil -0.72 Libya 0.16 Italy -0.75 Qatar 0.15 Australia -0.96 Iran, Islamic Republic o 0.12 Spain -1.19 Luxembourg 0.09 United States -6.49
IFI/GDP 120.00 China India 100.00 80.00 60.00 40.00 20.00 0.00 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
XS of IFI/GDP 400 LBN 350 PAN 300 URY EST 250 IFI to GDP 200 150 100 50 TZA SYR AZE JAM MYS ARG NAM ISR CHL JOR HRV LVA KGZAGO KHM HND HUN CIVTGOLAOGHA PNG BOL KAZ BGR NIC VEN CZE ZMB TUN ETH BIH SVK MDG RWA SVN MDA SWZ NGA MOZ TTO YEM EGY UGA SDN MAR PHL TCD SLV BWA RUSZAF MLI SEN GIN MKD THA POL VNM GEO ECU PER DOM SAU ARM CHNUKR LTU KOR NPL UZB IDNLKA COL PRY TUR BRA DZA ROM GAB CRIMUS TJK MEX PAK KEN CMR BFA GTM ALB IND TKM BGD IRN BLR 0 6.00 6.50 7.00 7.50 8.00 8.50 9.00 9.50 10.00 10.50 11.00 GDP per capita, PPP
XS: Foreign Assets / GDP 180 160 140 JOR SEN URY Foreign assets to GDP 120 100 80 60 40 20 SW Z PAN LAO AGO EGY SAU VEN ARGLBN SVK ISR SDN CHL JAM MKD BGD MDA EST HRV HND KGZ UZB SYR ARM VNM LTU CZE TJK GEO ZAF MLI MUS ID N MOZ BEN GIN KAZ SGP BGR TKM NGA RW TZAA GAB DZAZMB PAK SVNCYP LVA PRY TTO MAR MYS TUN BOL SLV CHN COL UKR HUN DOM NIC PER KEN MDG PNG POL BIH TUR BRA THA HKGIN D KHM GTM BLR TGO BFA KORNPL ETH CIVUGA MEX CRI RUS NAM BW GHAA ALB ECU YEM CMR AZE IR N 0 6.00 6.50 7.00 7.50 8.00 8.50 9.00 9.50 10.00 10.50 GDP per capita, PPP
XS: Official Reserves / GDP 60 JOR AGO LAO VNM 50 ISR EGY Reserves 40 TJK KGZ CZE MUS 30 MKD SGP ID N HND MLI LTU UZB HRV KAZ CYP TTO MOZ MYS CHN IR N SW Z SAU JAM GEOPOLURY MDA 20 BEN MAR TUN UKR BGD SVN RW BGRA GAB HKG SYR MDG BLRPER NGA SVK COG GIN TZA ZMB THA PNGPRY VEN CHL HUN LVA NIC IN D PAK TKM EST BIH UGA SDN TGO ARM GTM SLV COL KEN NPL KHM TUR ARG LBN 10 CIV CRI KOR BOL ALB BRA MEX RUS NAM DZA SEN BFA YEMBW ETH CMR A ZAF PAN TCD GHA ECU DOM AZE 0 6.00 6.50 7.00 7.50 8.00 8.50 9.00 9.50 10.00 10.50 11.00 GDP per capita, PPP
Global Distribution of Official Reserves Share in Global Country Reserves Japan 21.50 China 15.84 Taiwan 5.91 Euro Area 5.41 Korea 5.13 India 3.26 Hong Kong 3.19 Russia 3.11 Singapore 2.89 United States 1.96 Malaysia 1.71 Mexico 1.65 Switzerland 1.43 Brazil 1.36 Thailand 1.25
Share in Global Equity Liabilities 5.00 4.50 4.00 3.50 3.00 2.50 2.00 FDI Liab Share China FDI Liab Share India Port Eq Liab Share Chin Port Eq Liab Share India 1.50 1.00 0.50 0.00 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Share in Global Debt Liabilities 1.00 0.90 0.80 0.70 0.60 0.50 Debt Liab China Debt Liab India 0.40 0.30 0.20 0.10 0.00 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
China: Net Equity and Net Debt 40.0 30.0 20.0 10.0 0.0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 China NETEQ China NETDE -10.0-20.0-30.0-40.0
India: Net Equity and Net Debt 5.0 0.0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004-5.0-10.0-15.0 India NET India NET -20.0-25.0-30.0-35.0
Debt Shares in Foreign Assets and Liabilities 100.0 90.0 80.0 70.0 60.0 China D_SH_A China D_SH_L India D_SH_A India D_SH_L 50.0 40.0 30.0 20.0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
FDI Share in Foreign Equity Assets and Liabilities 100 90 80 70 China FDI_EQ_FA China FDI_EQ_FL India FDI_EQ_FA India FDI_EQ_FL 60 50 40 30 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
China s FDI Liabilities Share World 100 Hong Kong SAR 45 United States 8.9 Japan 8.7 Taiwan POC 7.4 British Virgin Islands 6.9 Korea 4.8 Singapore 4.8 United Kingdom 2.3 Germany 1.8 France 1.3 Other 8.2
India s FDI liabilities Share Mauritius 35.6 United States 16.5 Japan 6.9 Netherlands 6.9 UK 6.6 Germany 4.4 Singapore 3.1 France 2.7 Korea 2.2 Switzerland 2 Other 13.2 Total 100
Sources of Portfolio Investment China India Equity Debt Equity Debt World 100 100 World 100 100 United States 28.6 16.3 United States 41.2 13.4 EU15 24.7 20.4 EU15 24.1 22.8 Japan 4.6 10.3 Japan 0.2 11.9 Singapore 3.9 10.3 Singapore 0.4 16.6 Hong Kong SAR 34.3 36.7 Mauritius 31.5 27.8 ROW 4 5.9 ROW 2.6 7.6
Pattterns in BIS Banking Data China India Inward Outward Inward Outward Europe 7.1 14.1 30.8 36.3 UK 22.5 14.4 63 35.6 Japan 7.4 13.9 1.3 8.4 US 0 0.1 0.1 0.1 Hong Kong SAR 63.1 57.5 4.9 19.6 Total 100 100 100 100
China: Bilateral Regressions FDI Portfolio Portfolio Bank Equity Debt Liabilities Size 1.15 1.02 0.42 0.01 (7.0)*** (3.68)*** (2.31)** (.54) Trade 8.15 3.74-8.25 0.77 (2.59)** (.62) (1.96)* (1.88)* Distance -1.3-1.06-3.69-0.05 (1.93)* (1.04) (4.69)** (.47) ERVOL -0.02-1.06-1.31-0.012 (.17) (4.3)*** (6.94)*** (.78) Adj R2 0.77 0.5 0.75 0.84 N 25 37 26 15
India: Bilateral Regressions FDI Portfolio Portfolio Bank Equity Debt Liabilities Size 1.64 1.04 0.11 0.02 (6.22)*** (3.0)*** (.37) (.48) Trade 3.9 1.05 0.84-0.013 (2.7)** (1.7) (1.01) (.15) Distance -3.8 1.86 0.63-0.09 (1.15) (1.05) (.18) (.33) ERVOL -0.94-1.15-0.35-0.05 (.61) (3.27)*** (.32) (.51) Adj R2 0.76 0.38 0.25 0.07 N 15 30 16 15
Currency Composition of Debt Liabilities China India Dollar 89.9 71.8 Euro 1.9 10.1 Yen 6.9 0.6 Sterling 1.2 17.3 Swiss Franc 0.1 0.2
The Future Evolution of Capital Flows Depends on domestic financial reforms Depends on world market conditions NFA Level of IFI External Capital Structure Bilateral Patterns Currency Composition
90.00 80.00 70.00 60.00 50.00 40.00 30.00 20.00 10.00 0.00 China and India: Projected GDP relative to G-7 China India 2043 2045 2047 2049 2041 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2015 2013 2011 2009 2007 2005
Macroeconomic Policy Exchange Rate Regime Banking Reform Transformation of reserves Increase in macroeconomic volatility Valuation Channel
Capital flows to Emerging Europe
Objective Put trends in external capital flows and their composition in perspective (compare CEE with EU15, other emerging mkts) Provide simple calculations on sustainable future capital flows Draw implications for future trade surpluses
Road map Capital flows and external position: stylized facts (1995-2004) Bilateral exposure Implications for medium-term factor flows
Capital flows 1995-2004 Large! Initial liabilities very small (except Bul, Hun, Pol) Strong growth prospects Obsolete capital
External liabilities in 1994 were small... 20 Swaziland Net external position in 1994 (percent of GDP) NFA/GDP 0-20 -40-60 Latvia Slovak Republic Romania Namibia Paraguay Lithuania Estonia Russia Mauritius Iran Lebanon Colombia South Africa Guatemala El Salvador Macedonia Brazil Kazakhstan Fiji Poland Turkey Costa Rica Chile Bulgaria Egypt Thailand Morocco Jamaica Dominican Rep. Algeria Peru MalaysiaHungary Panama Czech Republic Venezuela, Rep. Bol. Uruguay Mexico Slovenia Argentina -80 Ecuador Jordan -100 Trinidad and Tobago Syria Tunisia Gabon -120 1000 2000 3000 4000 5000 6000 7000 8000 GDP per capita
...but MUCH larger at end-2004 20 Iran Algeria Mauritius Venezuela, Rep. Bol. Net external position (pct of GDP), 2004 0 Russia Malaysia Oman NFA/GDP -20-40 -60 South Africa Albania Guatemala Belarus Egypt Jordan Uruguay Paraguay Thailand Macedonia Romania Slovak Republic Czech Republic Colombia Lithuania Chile Turkey Gabon Mexico Bulgaria Costa Rica Brazil Peru Latvia Poland Kazakhstan Dominican Republic El Salvador Croatia Jamaica Argentina Trinidad and Tobago Slovenia Portugal -80-100 Ecuador Tunisia Panama Lebanon Hungary Estonia -120 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000 11000 GDP per capita
International financial integration is increasing... 450 400 350 300 250 EU 15 200 150 Other emerging markets 100 CEE countries 50 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
...with equity liabilities playing a more important role... 55 50 45 40 CEE countries 35 30 Other em. mkts EU 15 25 20 15 10 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
...and particularly so FDI... 45 40 CEE countries 35 Other em. mkts 30 25 20 15 EU 15 10 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
50 40 CEE countries FX share 30 20 10 Equity share 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Reserves play an important role among external assets, more so than elsewhere 50 40 30 20 10 EU 15 Equity share FX share 0 50 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Other emerging and developing economies 40 30 20 10 FX share Equity share 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
In most CEE countries net equity liabilities are larger than net debt 30 Czech Republic 20 10 net debt (pct of GDP) Slovak Republic 0-100 -90-80 -70-60 -50-40 -30-20 -10 0 Bulgaria Romania Slovenia Estonia Lithuania -10 Poland Latvia -20 Hungary Croatia -30-40 net equity (pct of GDP)
Returns on external liabilities Returns on FDI are linked to economic performance (high when the economy does well, low otherwise) This implies better risk-sharing relative to foreign-currency debt......and can help productivity growth......but the price is a higher cost
Financial integration with the EU is particularly strong Sources of FDI (2002) EMU UK US DEN SWE SWI. CEEC Bulgaria 87.0 5.3 5.7 1.0 1.0 Croatia 81.4 1.8 1.1 2.7 13.0 Czech Republic 82.3 5.3 4.3 1.0 1.9 4.4 0.9 Estonia 47.4 0.7 1.5 3.4 46.1 0.8 Hungary 79.2 7.3 8.1 0.7 2.3 1.5 1.0 Latvia 25.7 1.1-0.6 15.7 44.6 13.5 Lithuania 23.5 0.5 2.8 34.7 24.5 14.0 Poland 73.1 7.4 9.3 2.9 3.8 3.1 0.3 Romania 89.4 1.3 7.7 0.4 1.1 Slovakia 83.5 8.6 0.7 1.4 5.8 Slovenia 95.5 1.6 0.0 3.0
Implications for future flows External liabilities cannot grow faster than GDP forever... Sustainable flows imply a stable ratio of net external liabilities to GDP... For example, with 8% nominal growth and liabilities of 50% of GDP, the CA balance would be -4% SS ca ( g +π ) NFA t t SS
Does this imply that large capital inflows can persist without any adjustment? Not quite. As liabilities accumulate, investment income payments to foreigners increase To keep the CA from deteriorating, the trade balance (broadly defined) must improve......because servicing external debt and FDI is costly
...and the improvement must be large... Trade balance (average 2001-2004) NFAstabilizing trade balance Implied current account balance (baseline) Bulgaria -5.2 1.2-3.9 Czech Republic -1.3 1.3-2.2 Slovak Republic -3.6 1.3-2.8 Estonia -4.4 1.8-8.4 Latvia -8.1 0.8-4.8 Hungary -1.9 1.2-6.3 Lithuania -3.6 0.5-3.4 Poland -0.8 0.9-3.4
What can countries do? Strengthen export growth (and hope for recovery in the euro area!) Contain budget deficits (that contribute to widening current account imbalances) Be prepared for leaner times on global capital markets
Upside and downside risks Credible policies and integration with EU can lower spreads, implying more favorable debt dynamics... But there is limited scope for exchange rate correction to ease the trade balance adjustment, at least with current exchange rate regimes