China’s Large Net Foreign Assets an indication of Economic Weakness

China’s international investment position has been characterized by its huge and increasing net foreign assets – and despite its low per capita incomes and relative scarcity of capital – is positioned as a net creditor. Her net foreign assets in 2006 accounted for 25% of the country’s GDP growth – in stark contrast to many countries who hold a higher GDP per capita and still have relatively large net foreign liabilities.

Author of “China as a Net Creditor: An Indication of Strength or Weaknesses?” Mr. Xin Wang said, “There is no reason for China to be complacent in spite of her large current account surplus and quick build-up of foreign exchange reserves. As a very poor country in terms of GDP per capita, China continues to provide large amount of capital to the outside world- including the richest countries. It is quite unusual and may be reflective of deeply-rooted institutional and structural problems.”

Some of the issue China face include underdeveloped capital markets, biased resource allocation and a defective social security system – all of which have contributed to her rapid increase in national savings which have not been fully and efficiently utilized. The high cost of China’s foreign liabilities and her corresponding low returns on her foreign assets also mean that China’s has yet to generate positive return, while facing potentially large exchange risks.

China must readjust her development model and make improvements to her social security system in order to put the country’s economic development on a more solid base. Some of the recommendations include the gradual opening up of domestic financial markets, loosening of restrictions on domestic private firms, adjusting preferential policies enjoyed by foreign-funded firms as well as gradually enlarging the channels overseas investments to build up China’s domestic asset management capabilities.

Mr. Wang adds, “China must speed up her economic reforms and allow the market to play a fundamental role in resource allocation. Only then will the resulting decrease of net foreign assets no longer become a cause for concern, but rather, a sign of good times.”

This paper is published in the November-December 2007 issue of China & World Economy. The abstract is available free online