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Economy

Xia Le: China's numbers don't tell full story on foreign investment

There was a lot of excitement earlier in the year about figures suggesting that China's outward investment roughly matched the amount it received from abroad last year.

     Optimism seems well-founded. According to data from the Ministry of Commerce, foreign direct investment in China increased by an anemic 1.7% in 2014 compared with the previous year, reaching $119.6 billion. Meanwhile, overseas direct investment from China rose by almost 7.6% to $116 billion. The implications of this shift appear huge, marking a turning point in China's development and representing an unprecedented shift in economic influence away from developed economies and toward emerging Asia. But China's official statistics may be significantly distorted and should be taken with a grain of salt.

Less than meets the eye

In fact, a closer look at the data reveals just how premature observers were in proclaiming outward investment overtook FDI.

     Chinese ODI statistics are distorted by a number of factors, paramount among which is the fact that the Ministry of Commerce requires companies to register the first, rather than the final, destination of cross-border transactions and does not take into account reverse flows.

     To put this into context, some 70% of all Chinese ODI goes to Hong Kong, the Cayman Islands and the British Virgin Islands, an amount that far exceeds the financing needs of those economies. These are predominantly stopovers that serve two important functions. First, China's tight capital controls mean that these locations act as intermediaries for investment flows between China and the rest of the world, a phenomenon known as offshoring.

     To further complicate things, funds are sometimes channeled via these stopover locations with the goal of bringing them back to China as FDI to take advantage of preferential terms. This "round-tripping" is estimated to comprise around 40% of total outbound investment flows to these stopover locations.

     Assuming the capital sent to offshore centers gets reinvested at its final destination, and the round-tripping money returns to China as FDI in the same year, this should give us a picture of the true ratio of outbound to inbound investment. Unfortunately, it is not that simple. It can take a number of years for this capital to complete its journey, so round-tripping and offshoring can boost outbound figures without being balanced out by the inbound data from the same year. This distorts both sets of data.

     Any analysis that fails to take into consideration these limitations in the data should be considered inconclusive. According to our estimates, Chinese ODI flows in 2013 may have been overstated due to round-tripping, with the true figure closer to $82 billion. The same is probably true for 2014, and calls into question the assumption that Chinese ODI will exceed FDI very soon.

     China may very well become a net exporter of capital in the near future. The upward trend in China's ODI is here to stay. China is already the third-largest foreign direct investor in the world, but its share of world ODI remains modest, at 2.3%. Japan accounts for 4.5%, while the U.S. share is 22%. China's share may be even smaller when factoring out funds that are round-tripped. Nor do the official statistics include the devaluation of assets over time. So China has a lot of catching up to do.

     Beijing is seeking to accelerate its "going out" strategy and has already taken a number of measures to further ease procedures for ODI. In addition, we expect to see more initiatives that aim to boost China's influence overseas formally drafted into the country's 13th five-year plan, such as the Asian Infrastructure Investment Bank and the "One Belt, One Road" strategy.

     The acceleration of China's ODI will help the country in its rebalancing efforts, in internationalizing its companies and in raising productivity. This will also help China to put its $4 trillion of foreign reserves to good use by diversifying its international investment position away from reserve assets and toward ODI.

     It remains to be seen whether China will soon become a net exporter of capital. The economy is well-positioned to go past that tipping point, but it may not happen as soon as the official figures suggest.

Xia Le is chief economist for Asia at BBVA Research. He is also a research fellow with the International Monetary Institute at Renmin University of China.

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