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06/08/2009

BRIC Outward FDI - the Dragon Will Outpace the Jaguar, the Tiger and the Bear

Markus Jaeger, Deutsche Bank, New York.

This article appeared in the February 2009 issue of Current Economics with permission of the author.

Key Concepts: Foreign Direct Investment (FDI) | Economic Growth Potential |

Key Economies: Brazil | Russia | India | China |

Economic and financial commentary often focuses on BRIC (Brazil, Russia, India and China) FX reserve accumulation. BRIC outward foreign direct investment typically attracts less attention. While BRIC FDI (foreign direct investment) remains relatively small, their FDI potential is substantial. On account of its economic size, rapid economic growth, large external surpluses and the nature of political-strategic incentives, China has by far the largest outward FDI potential. It will be interesting to observe whether the current crisis will lead China to move closer to realizing its considerable potential.

The BRICs are becoming increasingly important economic players. In 2007 the BRIC countries' share of global GDP amounted to almost 13% (measured at market exchange rates) or to 20% (in purchasing power parity terms). The BRICs are also becoming increasingly important financial players. BRIC external assets amounted to more than USD 4.1tn in 2007, a 45% increase from the previous year! Although combined BRIC external assets remain much smaller than the United States' estimated USD 17tn, the medium-term outlook for external growth remains favourable, current volatility in global financial flows notwithstanding.

BRIC FX reserve accumulation generally receives more commentary than BRIC outward FDI, politically sensitive investment projects excepted. This is not surprising. In spite of considerable external asset growth, BRIC outward FDI flows and stocks remain relatively small. In 2007, the BRIC share of the global FDI stock was a mere 3.3% (USD 510bn), while flows amounted to a somewhat higher 4.5% (USD 90bn), much smaller than the BRIC countries' economic weight. To put these numbers into perspective, combined BRIC outward FDI flows were smaller than Italy's. The BRIC share in global flows has, however, increased substantially from 1% in the 1990s to 4% during 2003-07. Although China's outward FDI remains smaller than Russia's, there are good reasons to believe that it will increase more quickly and substantially in the coming years.

First and most trivially, China's greater economic size, its faster economic growth rate and, especially, its larger external surpluses are likely to support significant external asset accumulation. On the current account side, China will run much, much larger surpluses than the other BRICs (which won't run any surpluses at all over the next few years). On the capital account side, China will receive larger equity inflows (incl. FDI) and benefit from sizeable debt inflows, generating persistent capital account surpluses over the medium term (partly thanks to tighter restrictions on capital outflows). A share of this surplus will be recycled in the form of FDI.

Second, China's "catch up" potential is significant. Its outward FDI stock and flows are low as a share of GDP and as a share of total external assets. The FDI stock amounts to a mere 3% of GDP, compared to Brazil's 10% and Russia's 20%. External asset holdings are also heavily skewed towards reserve assets and in dollar terms Chinese FDI is smaller than Brazilian and Russian FDI! The lower level of FDI is in part due to the rapid increase in the size of the denominator (GDP measured in USD, external assets) and in part due to (historically) significant restrictions on outward FDI. Rapidly rising per capita income over the coming years should therefore support rising Chinese outward FDI. Admittedly, all these metrics are very rough but they do give an indication of China's catch-up potential.

Third, the government has liberalized regulations governing outward FDI flows in recent years and has streamlined bureaucratic procedures. The government offers various kinds of support for Chinese companies seeking to invest overseas as part and parcel of its "going abroad" and "national champion" policy. Today the FDI regime is much more supportive of (or at least far less restrictive towards) outward FDI than in the 1990s and this should help lead to increased outward FDI flows.

BRIC: FDI outflows are
taking off
USD bn
BRIC Chart image
Chinese & Indian outward FDI have considerable "catch-up" potential
Gross external assets, USDbn (2007)
Chinese & Indian outward FDI Chart image

Last but not least, wider strategic objectives should support Chinese FDI outflows. As a consequence of very resource-intensive economic growth, China's commodity dependence has increased significantly in the past few years. The government will likely be very supportive of Chinese companies that seek to acquire natural resource assets in particular by limiting commercial risk and providing financial incentives to Chinese companies to "go abroad". True, governments in Brasilia, Delhi and Moscow also face strategic incentives to support outward FDI, but their commodity dependence is (much) less pronounced.

China has by far the greatest FDI potential among the BRICs on account of economic size, rapid economic growth, large external surpluses and the nature of political-strategic incentives. Assuming (and this is just an assumption) that Chinese companies face the same intensity of microeconomic incentives (e.g. market-efficiency, asset-seeking) as companies in the other BRICs, Chinese FDI could outstrip the combined outward FDI of all other BRICs already a few years from now. China certainly has the potential to become one of the top global foreign direct investors over the course of the next decade. It will be fascinating to see how Chinese companies will respond to the recent cheapening of company valuations in developed and emerging markets, and to the slowing economic growth in their home market.


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