Neither a borrower nor a lender: does China's zero net foreign asset position make economic sense?

Neither a borrower nor a lender: does China's zero net foreign asset position make economic sense?

Published Jan 2005

Authors

D. Dollar, A. Kraay

Publisher

Focus themes

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Predictions for China's future as a net foreign creditor

China in the past few years has emerged as a net foreign creditor on the international scene with net foreign assets slightly greater than zero percent of wealth. This paper starts from the fact that this is surprising given that China is a relatively poor country with a capital-labour ratio about one-fifth the world average and one-tenth the U.S. level. It asks whether it makes economic sense for China to be a net creditor and how China’s net foreign asset position might evolve over the next 20 years. It finds that China’s extensive capital controls can explain why its current net foreign asset position is far away from what is predicted by open-economy models and cross-country empirics. It also predicts that China’s international financial integration will increase over time.

Some of the paper's conclusions are:

  • with regard to inward flows of direct foreign investment, inflows are large relative to global capital flows and to the size of the Chinese economy
  • in recent years net inflows of direct investment have been more than offset by reserve accumulation
  • in general, low-middle-income developing countries with good institutions are net debtors, but China is a modest net creditor

The most plausible scenario for the future is one in which China’s reform continues, so that per capita GDP growth and productivity growth are relatively high, while savings declines in response to financial sector improvements. In this scenario China is predicted to have net foreign assets of minus nine percent of wealth in 20 years. Even with stagnant reform and continued very high savings, the authors predict China will be a modest net debtor in 2025, requiring current account deficits of 2 percent of GDP to get there. As China continues its reform and liberalises its financial system, including the capital account, a significant amount of the world’s wealth is going to want to move into this attractive location. This capital inflow can help increase output and welfare in China, but managing the adjustment will require significant planning.

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