Working Papers No 286
China’s emergence as a major player in world trade is well known, but its rising role in global finance is perhaps underappreciated. China is the second largest creditor in the world today, with a net creditor position of exceeding 30% of GDP in 2007. In this paper, we test the importance of growth differential, demographics, government debt, financial depth and the exchange rate in shaping China’s net foreign asset position. Our findings highlight the sharp fall in youth dependency as one key driver behind China’s puzzlingly large net lender position and also confirm the neoclassical prediction that faster growth attracts more capital inflows. Looking ahead, our findings also suggest that China is unlikely to turn into a meaningful net debtor nation over the next two decades. Moreover, we project that, as China engages in increased cross-border asset trade, its gross foreign assets and liabilities could triple in 10 years. While adjustments in China’s net foreign asset position are expected to be gradual and may thus facilitate its capital account opening, increasing exposure to external shocks and growing interactions with the rest of the world may present challenges both to China and to the global financial system.
JEL Classification Numbers: F21, F31, F32, F36
Keywords: international investment position, external balance sheet, current account balance, financial integration