Thank you for reading Chartbook. To support the project, sign up for one of the subscription options.
Thus blared the Bloomberg headline a week ago.
In the days that followed, the article by Sivabalan, Chakraborty and Sircar was widely syndicated across platforms both in Asia and the West. Sitting by chance next to a colleague on a flight back from Vegas the other day, the article immediately came up. It fits the narrative of the moment so well. But what does it really tell us? Globalization and deglobalization are complex phenomena. They involve multiple different dimensions of interaction: trade, direct productive investment and portfolio flows. Financial markets flows may tell a very different story than trade flows. And in comparing India and China, there is a risk of equating apples and oranges. In their combined and uneven development, India and China are in very different places. When Modi’s government announces a target of an 11 percent increase in infrastructure spending to $134 billion for 2024 it seems a bold step that sets markets alight, because the Indian economy measured at market exchange rates is slightly larger than that of the UK. China is in a different league. And, in any case and inevitably, our assessment of these data are entangled with broader narratives and political positioning. In commentary on the future of CCP-run China there is no place of innocence. The loudest sources in the West on the state of China are, on the one hand, business people who have projects and wagers to promote, whether they are long or short China, and, on the other hand, China-watcher analysts and journalists many of whom can no longer safely return to China on account of their critical commentary and the repressive sanctions they might face. They write from the position of exile. Added to which we have the vantage point of India, which cannot help but be preoccupied with the question of who will be Asia’s #1. My own position is that of a Western left liberal who broadly supports detente and peaceful adjustment of the world order and the Western “worldviews” that go with it, to accommodate China’s rise and the broader shift towards a truly multipolar world. In so doing, I hold to the possibility of distinguishing, as EU policy does for instance, between areas of cooperation, competition and rivalry. So I approach the dramatic narrative of transition pitched by the Bloomberg piece with a degree of skepticism. *** Look at the Bloomberg piece in detail and what does the evidence consist of?
Then there are the quotes from portfolio managers in Singapore, the impressions of strong interest on investors calls, a smattering of fund flow data for Q4 2023, a Morgan Stanley outlook, a little geopolitical rumination and the observation that
I don’t highlight this collagist approach so as to criticize it. This is how business reportage gets done, and history-writing too. But it does pose the question of the frame within which this collection of data and quotes should be placed. It leads us to ask, how does portfolio investment, the kind of financial flows that are brokered by Wall Street hedge funds, fit into the broader picture of globalization? What is the scale of these flow? How do they compare to other vectors of globalization? And aside from the general story of China’s crisis and India’s rise, what is the specific history of these financial flows and their significance? *** Viewed in broader terms, the dynamics of China’s international economic integration right now are a picture of contrasts. China’s trade surplus is hard to fully account for, but it is clearly gigantic and increasing in recent years. A figure of around $800 billion in surplus seems reasonable at the current time. Source: Brad Setser On net, China continues not to import capital - the issue highlighted by the Bloomberg piece - but to export capital to the rest of the world on an unprecedented scale. It is typical of China’s model that this outflow takes the form not of private capital flows, but of official reserve accumulation and accumulation of claims by state-controlled banks. Brad Setser has compiled these remarkable numbers of the shifting pattern of reserve accumulation in China. So as far as global trade is concerned, plus ça change. China runs a huge surplus. The USA runs a huge deficit. For all the talk of rebalancing or decoupling, there is little evidence of any fundamental shift of the basic dual-pole structure of the world economy. In this schema, India is not an emerging challenger for China. As makes sense for a populous and poor developing country, for most of its history since independence, India has run trade deficits. It has imported capital. The only significant exception was the massive disruption of COVID. In Setser’s graph above it is the ore-colored band below the USA. Source: Trading Economics *** If you want to see dramatic changes in the world economy, decoupling and rebalancing, the place to look is not to trade, but FDI (Foreign Direct Investment). Since 2022, inbound FDI to China, once the world’s premier destination, has fallen off a cliff. Of course, the interest rate hikes made 2022-2023 a bad period for global capital flows generally. India’s FDI flows are off their peak too. But the Chinese collapse is dramatic and clearly reflects investor worries about geopolitics and the domestic policy regime in China. As recently as a few years ago, FDI to China was outstripping India’s by a huge margin. In 2023 FDI to India, even running below its peak rate easily exceeded that. to China. This clearly does reflect a shift. But given the vast stock of foreign capital already committed to China - which is in the oder of several trillions dollars - it will take years before the total foreign commitment to India will match that already committed to China. The huge investments by Apple and Tesla are indicative both of the change in direction and the time and money it will take to achieve a substantial rebalancing. Furthermore, given China’s sophistication in manufacturing and the political pressures for decoupling, one would in any case expect a rebalancing from foreign-led investment into China, to Chinese-led investment in locations like Vietnam, Mexico etc. As China develops, it is not surprising that the net balance of direct investment should shift from a large surplus to a deficit. Added to which, given China’s vast current account surplus, we would expect the capital account to be in deficit i.e. for China to be exporting rather than importing capital. China cannot import capital on a huge scale whilst exporting the way it does. The giant infrastructure projects of One Belt One Road were once widely seen as an “escape valve” for China’s surpluses. That was Chinese out-bound FDI. *** One of the unusual and important aspects of China’s globalization is that it was led by trade and FDI i.e. international flows directly connected to the production and distribution of goods. By contrast, portfolio investment, the variable that the Bloomberg article focuses on, the acquisition across borders of financial claims in the form of bonds and equities, has only recently taken on any significance at all. Source: Rhodium It is a striking feature of China’s international balance sheet that on the liability side (i.e foreign claims) inward FDI is more than two times larger than foreign portfolio claims. Meanwhile on the Chinese asset side, private portfolio claims are a very minor component, dwarfed by Chinese FDI and even more by official reserves and quasi-official reserves (other) held on the balance sheets of state banks. If you look at US Treasury data on US holdings of foreign financial assets it would seem that US investor claims against India already exceed those against China - $287 billion to $243 billion. If anyone took those numbers at face value there would be no cause to write the kind of piece that appeared in Bloomberg. The numbers are misleading because they fail to capture all the indirect ways in which US investors, notably those of the hedge fund variety, actually locate their holdings of financial assets. Much of it is held offshore or through indirect vehicles, not captured in the Treasury data. Thankfully, the Rhodium group in 2021 prepared an in-depth report on the depth of US China financial connections. All told Rhodium figures that American investors had $1.2 trillion in financial claims against China at the end of 2020, most of that in equities. It seems pretty certain that despite the recent enthusiasm for India’s booming stock market, this figure exceeds any equivalent claims on India. The real question is why the scale of claims on China is not far larger. The answer is that serious accumulation of portfolio claims against China began only a decade ago when China began a slow and partial opening-up of its financial markets. Up to that point the restrictions of short-term capital movement were a key part of what some observers dubbed the Bretton Woods 2 system under which Beijing fixed the exchange rate of the RMB - first against the dollar and then a basket of currency - and managed capital flows to maintain the peg. Though Wall Street has been pushing the China connection since the 1990s and the China connections of figures such as Dalio, Paulson and Schwarzman are the stuff of legend, the partial globalization of Chinese finance is a relatively recent phenomenon. Source: Robin Brooks The striking fact is that despite China’s centrality to global trade, until 2015 non-resident portfolio flows to other EM far outweighed those to China. It was only in the course of the 2010s that the network of Western bank presence expanded dramatically significantly across China. Source: Petry 2023 As researcher Johannes Petry points out in a fascinating paper,
It was after 2016 that foreign portfolio claims were allowed to surge. And it was only in 2020 amidst the global crisis of COVID that non-resident portfolio investment in China came to dominate the entire EM scene. In 2020 and 2021 hundreds of billions in portfolio flows poured into China. This was completely unprecedented. The historic irony is that Wall Street’s very long-term play on China finally began to pay off precisely at the moment in which geopolitical tension made its continuation less and less tenable. As voices like Li Yuan and Lananh Nguyen noted in October 2021 and November 2021 in the NYT, there was a stark contrast between Wall Street’s new infatuation with China and the mood both within China and on the broader global political scene. *** The break came in 2022. The combination of surging inflation, interest rate hikes and Putin’s war, suddenly shifted the global mood. The talk was now of polycrisis. As the IIF data show, non-resident portfolio investment in EM generally collapsed. China was particularly hard hit. On an annualized basis, the swing from peak to trough in portfolio investment to China was a massive $400 billion. As is true for FDI, there is no doubt that the combination of global geopolitical escalation, the disaster of Chinese COVID policy over the summer and fall of 2022, the implosion in the real estate market, and now the stock market rout, have made China extremely unattractive as a destination for capital flows. India and other EM are profiting. But portfolio flows to India were also subject to shocks - admittedly on a much smaller scale. And there is no evidence in the aggregate data on portfolio flows in 2023 for a surge into India in any way commensurate with the collapse in flows to China. *** The Chinese authorities are not oblivious to the scale and impact of these shocks. They seem to be doing their best to obscure the scale of their gigantic trade surpluses and reserve accumulation. The FDI numbers are embarrassing and we should expect to see noises out of Beijing welcoming new investment. Beijing is also actively intervening in the stock market, not for the sake of foreigners of course, but to avoid a disastrous blow to the wealth of China’s upper middle class. Though the interventions are not targeted at foreign portfolio flows, the impact on foreign interests is real. In the days since the Bloomberg article on India appeared, there have been huge opportunistic flows into China equity funds, looking to benefit from the official intervention. The big worry on Beijing’s part are not the relatively modest foreign portfolio flows. The real risk is that giant pools of Chinese wealth will start heading for the exit. It is not foreign jitters but a general panic and capital flight that is the real threat to Xi’s regime. It is not surprising to see a tightening of foreign exchange controls. The essential point is that Beijing has always approached financial integration with the West cautiously. If portfolio investment takes a breather, Beijing will shrug. Western interests that play by Beijing’s evolving rules will continue to be welcome. But China is not competing with India for the attentions of Western hedge funds. |