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International Investment Patterns
Philip R. LaneWBI 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)
0.17 0.03 0.02 -0.01 -0.01 External
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)***
2.15 0.99 1.56 Log GDP per capita (2.74)*** (3.65)*** (5.06)***
0.92 0.93 Stock market capitalization (18.3)*** (17.4)***
Adjusted R2 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
-35
-30
-25
-20
-15
-10
-5
0
5
10
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
ChinaIndia
Net Foreign Asset Positions
XS of NFA Positions
R O M
PO L
BIH
M KD
SVN
H R V
LT U
H U N
LVA
EST
SVK C ZEU ZB
U KR
T KMC H N
T JK
R U S
M D A
BG R
KG Z
KAZ
G EO
ALB BLR
AZE
AR M
PN G
ZM B
BFA
U G A
T U N
T G O
T ZA
SW Z
SD N
N AM
SEN
R W A
N G A
M O Z
M AR
M U S
M LI
M D G
KEN
C IVG IN
G H A
G AB
E T H
T C D
C M R
BW A
AG O
D ZA
VN M
T H A
PH L
PAK
N PL
M YS
LAO
KO R
ID N
IN D
LKA
KH M
BG D
YEM
EG Y
SYR
SAU
LBN
JO R ISR
IR N
T T OJAM
VEN
U R Y
PER
PR Y
PAN
N IC
M EXH N D
G T M
SLV
EC U
D O M
C R I
C O L C H L
BR A
BO L
AR G
ZAF
T U R
-150
-100
-50
0
50
100
6.00 6.50 7.00 7.50 8.00 8.50 9.00 9.50 10.00 10.50 11.00
G D P per cap ita , PPP
NFA
to G
DP
World’s Largest Creditors and Debtors
Country NFA/GDPW NFA/GDPW
Japan 4.34 India -0.18Switzerland 1.25 Argentina -0.18Taiwan 1.06 New Zealand -0.22Hong Kong 1.05 Hungary -0.24United Arab Emirates 0.54 Portugal -0.28Germany 0.54 Indonesia -0.29Singapore 0.46 Canada -0.30Norway 0.40 Poland -0.32Saudi Arabia 0.39 Turkey -0.33China 0.32 Greece -0.37Kuwait 0.31 United Kingdom -0.67France 0.27 Mexico -0.71Belgium 0.27 Brazil -0.72Libya 0.16 Italy -0.75Qatar 0.15 Australia -0.96Iran, Islamic Republic o 0.12 Spain -1.19Luxembourg 0.09 United States -6.49
IFI/GDP
0 .0 0
2 0 .0 0
4 0 .0 0
6 0 .0 0
8 0 .0 0
1 0 0 .0 0
1 2 0 .0 0
1 9 8 5 1 9 8 6 1 9 8 7 1 9 8 8 1 9 8 9 1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4
C h in aIn d ia
XS of IFI/GDP
RO M
PO L
BIH
M KD
SVN
HRV
LTU
HUNLVA
EST
SVK CZE
UZBUKR
TKM
CHN
TJK
RUSM DA
BG RKG Z KAZ
G EO
ALB
BLR
AZE
ARM
PNGZM B
BFA
UG A
TUNTG O
TZASW Z
SDN
NAM
SEN
RW ANG A
M O ZM AR
M US
M LI
M DG
KEN
CIV
G IN
G HA
G AB
ETH
TCD
CM R
BW A
AG O
DZAVNM
THA
PHL
PAKNPL
M YS
LAO
KO RIDN
IND
LKA
KHM
BG D
YEM EG Y
SYR
SAU
LBN
JO R
ISR
IRN
TTO
JAM
VEN
URY
PERPRY
PAN
NIC
M EX
HND
G TM
SLV
ECU DO M
CRICO L
CHL
BRA
BO L
ARG
ZAF
TUR
0
50
100
150
200
250
300
350
400
6.00 6.50 7.00 7.50 8.00 8.50 9.00 9.50 10.00 10.50 11.00
G DP per capita, PPP
IFI t
o G
DP
XS: Foreign Assets / GDP
T U R
Z A F
A R G
B O L
B R A
C H L
C O L
C R I
D O M
E C U
S L V
G T M
H N D
M E X
N IC
P A N
P R Y
P E R
U R Y
V E N
J A M
T T OC Y P
IR N
IS R
J O R
L B NS A U
S Y R
E G Y
Y E M
B G D
K H MH K G IN D
ID N
K O R
L A O
M Y S
N P L
P A KS G P
T H A
V N M
D Z A
A G O
B W AC M R
B E N
E T H
G A B
G H A
G IN
C IV
K E N M D G
M L IM U S
M A R
M O Z
N G A R W A
S E N
N A M
S D N
S W Z T Z A
T G O
T U N
U G AB F A
Z M B
P N G
A R M
A Z E
B L R
A L B
G E OK A Z
K G Z
B G R
M D A
R U S
T J K
C H NT K M
U K R
U Z BC Z E
S V K
E S T
L V A
H U N
L T UH R V
S V N
M K D
B IHP O L
0
2 0
4 0
6 0
8 0
1 0 0
1 2 0
1 4 0
1 6 0
1 8 0
6 .0 0 6 .5 0 7 .0 0 7 .5 0 8 .0 0 8 .5 0 9 .0 0 9 .5 0 1 0 .0 0 1 0 .5 0
G D P p e r c a p ita , P P P
Fore
ign
asse
ts to
GD
P
XS: Official Reserves / GDP
P O L
B IH
M K D
S V N
H R VL T U
H U N L V AE S T
S V K
C Z E
U Z B
U K R
T K M
C H N
T J K
R U S
M D AB G R
K G Z
K A Z
G E O
A L B
B L R
A Z E
A R M
P N GZ M B
B F A
U G A
T U N
T G OT Z A
S W Z
S D N
N A M S E N
R W AN G A
M O Z
M A R
M U S
M L I
M D G
K E NC IV
G IN
G H A
G A B
E T H
B E N
C O G
T C DC M RB W A
A G O
D Z A
V N M
T H A
S G P
P A K
N P L
M Y S
L A O
K O R
ID N
IN D
H K G
K H M
B G D
Y E M
E G Y
S Y RS A U
L B N
J O R
IS R
IR NC Y P T T O
J A M
V E N
U R Y
P E RP R Y
P A N
N IC
M E X
H N D
G T M S L V
E C U D O M
C R I
C O L
C H L
B R AB O L
A R G
Z A F
T U R
0
1 0
2 0
3 0
4 0
5 0
6 0
6 .0 0 6 .5 0 7 .0 0 7 .5 0 8 .0 0 8 .5 0 9 .0 0 9 .5 0 1 0 .0 0 1 0 .5 0 1 1 .0 0
G D P p e r c a p ita , P P P
Res
erve
s
Global Distribution of Official Reserves
Country
Share in Global
ReservesJapan 21.50China 15.84Taiwan 5.91Euro Area 5.41Korea 5.13India 3.26Hong Kong 3.19Russia 3.11Singapore 2.89United States 1.96Malaysia 1.71Mexico 1.65Switzerland 1.43Brazil 1.36Thailand 1.25
Share in Global Equity Liabilities
0 .0 0
0 .5 0
1 .0 0
1 .5 0
2 .0 0
2 .5 0
3 .0 0
3 .5 0
4 .0 0
4 .5 0
5 .0 0
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
F D I L ia b S h a re C h in aF D I L ia b S h a re In d iaP o r t E q L ia b S h a re C h inP o r t E q L ia b S h a re In d ia
Share in Global Debt Liabilities
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
0.90
1.00
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Debt Liab ChinaDebt Liab India
China: Net Equity and Net Debt
-40.0
-30.0
-20.0
-10.0
0.0
10.0
20.0
30.0
40.0
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
China NETEQChina NETDE
India: Net Equity and Net Debt
-35.0
-30.0
-25.0
-20.0
-15.0
-10.0
-5.0
0.0
5.0
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
India NETIndia NET
Debt Shares in Foreign Assets and Liabilities
20.0
30.0
40.0
50.0
60.0
70.0
80.0
90.0
100.0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
China D_SH_AChina D_SH_LIndia D_SH_AIndia D_SH_L
FDI Share in Foreign Equity Assets and Liabilities
30
40
50
60
70
80
90
100
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
China FDI_EQ_FA China FDI_EQ_FLIndia FDI_EQ_FAIndia FDI_EQ_FL
China’s FDI Liabilities
Share
World 100Hong Kong SAR 45United States 8.9Japan 8.7Taiwan POC 7.4British Virgin Islands 6.9Korea 4.8Singapore 4.8United Kingdom 2.3Germany 1.8France 1.3Other 8.2
India’s FDI liabilities
Share
Mauritius 35.6United States 16.5Japan 6.9Netherlands 6.9UK 6.6Germany 4.4Singapore 3.1France 2.7Korea 2.2Switzerland 2Other 13.2
Total 100
Sources of Portfolio Investment
China IndiaEquity Debt Equity Debt
World 100 100 World 100 100United States 28.6 16.3 United States 41.2 13.4EU15 24.7 20.4 EU15 24.1 22.8Japan 4.6 10.3 Japan 0.2 11.9Singapore 3.9 10.3 Singapore 0.4 16.6Hong Kong SAR 34.3 36.7 Mauritius 31.5 27.8ROW 4 5.9 ROW 2.6 7.6
Pattterns in BIS Banking Data
China IndiaInward Outward Inward Outward
Europe 7.1 14.1 30.8 36.3UK 22.5 14.4 63 35.6Japan 7.4 13.9 1.3 8.4US 0 0.1 0.1 0.1Hong Kong SAR 63.1 57.5 4.9 19.6Total 100 100 100 100
China: Bilateral Regressions
FDI Portfolio Portfolio BankEquity 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 BankEquity 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 71.8Euro 1.9 10.1Yen 6.9 0.6Sterling 1.2 17.3Swiss 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
China and India: Projected GDP relative to G-7
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
90.00
2005
2007
2009
2011
2013
2015
2017
2019
2021
2023
2025
2027
2029
2031
2033
2035
2037
2039
2041
2043
2045
2047
2049
ChinaIndia
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...
Net external position in 1994 (percent of GDP)
Kazakhstan
Syria
MoroccoEgypt
Swaziland
Ecuador
Iran
Bulgaria
Paraguay
Guatemala
Algeria
Macedonia
Tunisia
Romania
Jordan
Russia
Dominican Rep.
Namibia
Peru
Thailand
FijiEl Salvador
Colombia
Latvia
Lithuania
Turkey
Estonia
South Africa
Mauritius
Slovak Republic
Jamaica
Poland
Malaysia
Brazil
Panama
Lebanon
Costa Rica
Hungary
Gabon
Chile
Czech Republic
Trinidad and Tobago
Venezuela, Rep. Bol.
Mexico
UruguayArgentina
Slovenia
-120
-100
-80
-60
-40
-20
0
20
1000 2000 3000 4000 5000 6000 7000 8000
GDP per capita
NFA
/GD
P
...but MUCH larger at end-2004
Net external position (pct of GDP), 2004
Slovenia
Portugal
Oman
Trinidad and Tobago
Argentina
Czech Republic
Mexico
Uruguay
Chile
HungaryEstonia
Poland
Croatia
Venezuela, Rep. Bol.
Costa Rica
Latvia
Slovak RepublicLithuania
Panama
Lebanon
Mauritius
Malaysia
GabonBrazil
South Africa
Turkey
Jamaica
Dominican Republic
Thailand
Tunisia
Russia
Peru
El Salvador
RomaniaColombia
Algeria
Bulgaria
Jordan
Kazakhstan
Iran
Macedonia
GuatemalaEgyptBelarus
Albania
Ecuador
Paraguay
-120
-100
-80
-60
-40
-20
0
20
1000 2000 3000 4000 5000 6000 7000 8000 9000 10000 11000
GDP per capita
NFA
/GD
P
International financial integration is increasing...
CEE countries
EU 15
Other emerging markets
0
50
100
150
200
250
300
350
400
450
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
...with equity liabilities playing a more important role....
CEE countries
EU 15
Other em. mkts
10
15
20
25
30
35
40
45
50
55
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
...and particularly so FDI....
CEE countries
EU 15
Other em. mkts
10
15
20
25
30
35
40
45
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Reserves play an important role among external assets,
more so than elsewhere
CEE countriesFX share
Equity share
0
10
20
30
40
50
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
EU 15
FX share
Equity share
0
10
20
30
40
50
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Other emerging and developing economies
FX share
Equity share
0
10
20
30
40
50
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
In most CEE countries net equity liabilities are larger than net debt
Bulgaria
Czech Republic
Slovak Republic
Estonia
Latvia
Hungary
Lithuania
Croatia
Slovenia
Poland
Romania
-40
-30
-20
-10
0
10
20
30
-100 -90 -80 -70 -60 -50 -40 -30 -20 -10 0
net equity (pct of GDP)
net d
ebt (
pct o
f GD
P)
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 1.0Croatia 81.4 1.8 1.1 2.7 13.0Czech Republic 82.3 5.3 4.3 1.0 1.9 4.4 0.9Estonia 47.4 0.7 1.5 3.4 46.1 0.8Hungary 79.2 7.3 8.1 0.7 2.3 1.5 1.0Latvia 25.7 1.1 -0.6 15.7 44.6 13.5Lithuania 23.5 0.5 2.8 34.7 24.5 14.0Poland 73.1 7.4 9.3 2.9 3.8 3.1 0.3Romania 89.4 1.3 7.7 0.4 1.1Slovakia 83.5 8.6 0.7 1.4 5.8Slovenia 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 SS
t tca g NFAπ≈ − +
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)
NFA-stabilizing
trade balance
Implied current account balance
(baseline)
Bulgaria -5.2 1.2 -3.9Czech Republic -1.3 1.3 -2.2Slovak Republic -3.6 1.3 -2.8Estonia -4.4 1.8 -8.4Latvia -8.1 0.8 -4.8Hungary -1.9 1.2 -6.3Lithuania -3.6 0.5 -3.4Poland -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