Treasury Staff Insights: Rangitaki article by Mario di Maio
Modelling an illustrative scenario of Chinese capital market liberalisation suggests Chinese-NZ investment flows will increase significantly over the next few decades and most of the increase in flows will occur in portfolio and other flows.
Foreign investment flows into New Zealand assets raise a host of legal, political and economic issues. Often the political issues of the day and the source of the investment can obscure the longer-term trends. At the moment, risks around a smooth transition of the sources of growth for the Chinese economy have seen an acceleration of capital outflows. We decided to abstract from these near-term issues and take a longer perspective on what might happen to two way flows and stocks of investment between New Zealand and China over the next several decades.
Chinese economic integration has proceeded rapidly with large implications for the world economy. In less than three decades China's global export market share has gone from less than 5 percent of world exports to more than 15 percent. For New Zealand, the consequences are powerfully demonstrated by the sharp increase in imports, exports, and tourism flows that has taken place since 2000 as documented here by Bowman and Conway.
In contrast, capital market integration is far less advanced. On some of these measures, China is about as well integrated with the rest of the world as India (see Chart 1). Measures of de facto integration (measured by looking at the proportion of international assets and liabilities as a percent of GDP) and de jure controls (measured by the Chinn-Ito index of financial openness) suggest that the capital account is closed. There are numerous controls on the purchase of Chinese assets by foreigners and the Chinese purchase of foreign assets. In addition to formal or 'de jure' capital controls access to foreign exchange for Chinese individuals and entities, and access to domestic credit is limited.
- Chart 1: Chinese capital account openness
- Source: Chinn-Ito http://web.pdx.edu/~ito/Chinn-Ito_website.htm (updated in 2011) and external debt and assets data from Lane and Milesi-Ferretti (2009)
In China's latest five-year plan, Chinese authorities refocused effort on capital market liberalisation as a policy goal. There remains a live debate in China (and among the international economic community) on the conditions under which the benefits exceed the risks from capital market liberalisation. While the end goal is liberalisation of capital markets the path towards this goal is less clear. Bayoumi (2013) notes that a pledge for full currency convertibility was made in 1993 but was shelved with the onset of the Asian Financial crisis.
Studies of Chinese capital account liberalisation predict a very substantial increase in gross cross border financial assets (both liabilities and assets). The papers also suggest that the increase in outflows (ownership of foreign assets) is likely to be greater than the increase in inflows. More specifically,
- The Bank of England suggests capital flows could increase from around 5 percent of world GDP to around 30 percent of world GDP.
- The IMF estimates an increase in Chinese assets abroad of 15-25 percent of world GDP and a stock adjustment of foreign assets in China of 2-10 percent of GDP.
- He and others (2012) estimate an increase in international portfolio assets and liabilities of 21 and 16 percent of GDP respectively by 2020 and in direct investment assets and liabilities of 22 and 11 percent of GDP respectively.
Using a simple methodology, we developed one possible scenario to illustrate the potential change in the cross border stocks of New Zealand-China investment. This reinforces that over the longer term China will assume a much more central role as an investor and as a destination for New Zealand investment. The drivers comprise a catch-up factor in terms of openness and the growth in the size of the Chinese economy.
Under this scenario, two-way Chinese-New Zealand investment stocks could roughly double (Chart 2). The share of New Zealand international assets in China could go from around 3 percent to 5.5 percent of total assets and liabilities. The share of investment from China could increase to 7 percent of total liabilities from 3 percent. Much of the overall increase in investment stocks in the two countries would be in portfolio and other investment flows, rather than direct investment.
Foreign investment from (and into) China is likely to increase significantly over time.This could potentially take some time or might occur more rapidly and would contribute positively to New Zealand economic performance at the margin. The maintenance of a stable and predictable business environment will be an important factor in ensuring that foreign investment flows from China benefit New Zealand.
Some specific investments have been taken that can smooth two-way investment flows between China and New Zealand.This includes negotiation of a swap agreement (RMB 25 billion / NZ$5 billion) between central banks to provide liquidity to support trading in RMB; (ii) the issuance of RMB denominated corporate debt by Fonterra; and (iii) the registration of three Chinese-owned banks in 2013 and 2014. That most of the increase will occur in portfolio and other investment flows suggests where attention might focus in the coming decade.
- 1 The index is based on the binary dummy variables that codifies the restrictions on cross-border financial transactions reported in the IMF's Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER).
- 2 He, D,Cheung,L,Zhang, W and Wu, T (2012), 'How would capital account liberalisation affect China's capital flows and the Renminbi real exchange rates?', Hong Kong Institute for Monetary Research Working Paper No. 09/2012.
- 3 The modelling assumes that: (i) economic development are consistent with long-term fiscal model (updated in Budget 2015); (ii) China's capital account liberalisation is complete and China occupies broadly the role that US does now in NZ's international investment flows (Bank of England, 2013); (iii) New Zealand's net external position remains stable as a proportion of nominal GDP and the cross positon is remain proportional to the net position.
The Treasury welcomes feedback on this article. If you intend to email comments or questions on this article please note these provisions.
Treasury Staff Insights: Rangitaki
See Treasury Staff Insights: Rangitaki for other articles in this series.