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China, as the world’s largest saver, has a major role to play in the global financial rebalancing toward emerging markets. Today, these countries represent 38 percent of worldwide GDP but account for just 7 percent of global foreign investment in equities and only 13 percent of global foreign lending.1 Their role seems poised to grow in the shifting postcrisis financial landscape, since the advanced economies face sluggish growth and sobering demographic trends. As a lead player in that shift, China could become a true global financier and, with some reform, establish the renminbi as a major international currency.

Growth and growing pains in China’s markets

As China’s financial markets have become more robust and deeper, the value of its domestic financial assets—including equities, bonds, and loans—has reached $17.4 trillion, trailing only the United States and Japan (Exhibit 1). That’s a more than tenfold increase in a span of two decades, and it doesn’t include Hong Kong’s role in channeling funds to and from China.

Exhibit 1

A surge in lending has boosted China’s financial assets by $3.8 trillion since 2007, but growth has not kept pace with that of GDP.

Unlike many major equity markets, China’s stock market has not rebounded since the financial crisis and global recession. Total market capitalization has fallen by 50 percent since 2007, plunging from $7.2 trillion in 2007 to $3.6 trillion in the second quarter of 2012. Investors sent valuations soaring at the market’s peak, but fears of a slowdown and a more realistic view of company valuations dampened their enthusiasm, underscoring the fact that China’s equity markets, like those of other emerging economies, remain subject to sharp swings.

Cross-border investment surges

China has defied global trends in cross-border capital flows, which collapsed in 2008 and remain 60 percent below their precrisis peak. For China, by contrast, foreign direct investment (FDI), cross-border loans and deposits, and foreign portfolio investments in equities and bonds are up 44 percent over 2007 levels (Exhibit 2). Total foreign investment into China reached $477 billion at the end of 2011, exceeding the 2007 peak of $331 billion.3 Foreign companies, eager to establish a presence in China, account for roughly two-thirds of the inflows.

Exhibit 2

China’s capital flows have been approaching new heights.


Chinese companies are also stepping up their role in global finance. Foreign direct investment by both state-owned and private-sector Chinese companies grew from just $1 billion in 2000 to $101 billion in 2011. At the end of 2011, Chinese companies accounted for $364 billion of global foreign direct investment, with most of it tied to commodities. About half of these investments went to other emerging markets—a share higher than that for companies in advanced economies.

To assume the role of financier to the world, China will have to embrace financial globalization and advance reform more fully, and that won’t happen overnight. There is already movement toward greater openness, though, which makes China’s recent once-in-a-decade leadership transition a telling moment: if the new economic team picks up the pace of reform, the world financial system could have a very different look in just a decade’s time.
 
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