Study, The Level And Structure Of China's Foreign Liabilities

The level and composition of China's foreign liability changed dramatically in the past 30 years due to the open policy. Not only huge amount of foreign capital has poured into mainland China with a 240-time increase ever since 1981, the dominate type of foreign liability has shifted from debt to equity, especially Foreign direct investment or FDI. As the scale of China economy boomed and GDP per capital increased in recent years, FDI slowed down its pace to flow to the country while portfolio equity speeded up, leaving a dynamic composition of foreign liability which sees increasing portfolio equity share and stabilized FDI share. In this paper we try to understand those influential factors driving this picture of China's foreign liability. To name a few, economic factors such as real GDP, trade openness and institutional quality are said to be important in the formation of a country's external capital structure. Therefore we have built a vector error correction model to investigate the dynamics between China's external capital structure and those interested variables. The rationale to conduct such a study lies in its policy implication for the government to gain insight into domestic drivers of different types of foreign capital and implement a policy set guiding foreign capital in better serve domestic economic growth and transformation process. With the VECM model we have identified some stylized facts about the relationship between FDI level, Portfolio equity level, FDI share, Portfolio equity share and those interested variables. Since consensus view says China will enjoy a much slower but more stable economic growth in the next decade, global FDI and portfolio equity are searching for other destinations with a much smaller economic scale and much lower labor cost, such as our neighbor country Vietnam, in seek of higher return. Although the neighbor effect explains China and Vietnam are in a competition for FDI, our results show that good growth prospect and consistent improvement of institution quality would still attract FDI and Portfolio equity to come to China. While public institution quality will mainly affect FDI, development of financial market and financial institutions will highly affect Portfolio equity. Though domestic credit to private sector will produce an opposite effect on FDI and Portfolio equity level, it can promote FDI share and Portfolio equity share simultaneously. It is very necessary for the country to improve its external capital structure through more policy changes toward FDI and more support of the financial market development. We suggest the authority adjust its benefit policies toward FDI to attract more qualified FDI instead of those seeking for natural resources and low labor cost. Meanwhile constant improvement of public and financial institution should be carried out to facilitate the preferred change of our external capital structure.