By Zhao Jinping

I. Effect of Foreign Capital Utilization on Balance of Payments

(I) Effect on balance of capital and financial accounts

Capital and financial accounts in the Balance of Payments include capital account and financial account. Capital account registers capital transfers such as exemption of debts and account transfers of emigrates. The data in China's Balance of Payments mainly include payments made by Chinese citizens who emigrate abroad; whereas financial account records transactions in respect of change in China's foreign assets and title to external debts. As capital account involves a limited scope and is small in size, we do not make any specific analysis of it here. For the sake of simplicity, capital and financial accounts are briefly referred to as capital account below.

1. Features of China's capital account

Payments and receipts under capital account are overall reflections of capital flows. According to statistics, during the 1982-1999 period, China's capital account experienced a deficit in 6 years - 1982-1984, 1990, 1992 and 1998, and a surplus in the other 10 years, with a cumulative surplus of USD180.14 billion in the 18 years (Table 1). This shows that over the last two decades China has a net inflow of capital. In terms of structure, among payments and receipts under capital account, direct investment is the largest of all in surplus, securities investment as surplus sources of the capital account is not stable and usually turns out to be in deficit when economic growth goes downward remarkably and affects the balance between payments and receipts under the capital account. In most years, among the three kinds of investment-direct investment, securities investment and other investment, the last represents the greatest deficit factor, posing heavy pressure on the general balance of payments.

2. Balance of foreign capitals under capital account

In the capital account, three items - foreign direct investment(FDI), liabilities in securities investment and liabilities in other investment-represent net inflow of foreign capitals. We define their aggregate as balance of foreign capitals, the credit marks the increase of inflow of foreign capitals (assets of FDI in China, liabilities of securities and other investments), the debit marks the decrease of foreign capitals (assets of FDI in China, liabilities of securities and other investments), the balance between the credit and debit represents the net inflow of foreign capitals (Tables 1 and 2).

During the 1982-1999 period, foreign capital receipts and payments (balance) cumulated to be a surplus of USD363.83 billion, twice as much as that of capital accounts in the same period. That means, the net outflow of domestic capitals was only 50.5% of the net inflow of foreign capitals. Therefore, China's capitals inflow is in net terms, and the huge surplus of foreign capital receipts and payments is the basic guarantee for realizing a surplus under capital account. These features are in conformity with the status of China as a developing country.

In the balance of foreign capitals, FDI in China represents the largest element for its surplus, which in accumulation amounted to USD297.84 billion in 18 years, accounting for 81% of the surplus of foreign capitals in the same period. Therefore, FDI is not only the greatest element for the surplus of foreign capital receipts and payments but also the base for a sustained surplus of FDI for a long time, contributing a great deal to the general surplus of China''s capital account and even the balance of payments.

Regarding securities investment, a net increase is shown in China's overseas issuance of equity securities and bonds, indicating the net inflow of foreign capitals raised by stock and bond issuance. According to the statistics of balance of payments, during the 1982-1999 period the net income of foreign capitals from stock and bond issuance abroad reached USD23.91 billion, making up 6.6% of the surplus of foreign capitals, and contributing to a cumulative surplus in securities investment as a whole. Viewed from different stages, however, a deficit was recorded during the 1996-1999 period, mainly due to a drastic fall in the surplus of liabilities of securities investment in that period, lower than the increase of assets. It can be seen, therefore, that liabilities of securities investment as one source of foreign capital have a limited stimulative role in achieving a surplus of foreign capital receipts and payments and capital accounts.

The balance of liabilities of other kinds of investment represents the net inflow of foreign capitals in other forms. During the 1982-1999 period the cumulative balance of liabilities of other investments was a surplus of USD42.08 billion, accounting for 11.6% of the balance of all foreign capital receipts and payments, equal to 23.4% of the total surplus in the balance of capital receipts and payments, higher than the surplus of liabilities of securities investment. As the cumulative surplus is smaller than the deficit of other investments (- USD137.97 billion), however, it led to a deficit in the balance of foreign investments as a whole. Viewed from different stages, the surplus of other investments contributes to the balance of foreign capitals to a varied extent. During the 1982-1985 period the surplus of liabilities accounting for 62.7% of that of foreign capitals and being one of the three greatest factors for the surplus of foreign capitals utilized in three forms. During the 1986-1990 period the surplus of liabilities of other investments increased to USD15.06 billion, and its percentage in the surplus of foreign capitals reduced to 45%. And during the 1996-1999 period the surplus of liabilities is much smaller than the surplus of assets in size, with its percentage in the balance of foreign capital receipts and payments falling to 5-6%. That means, during the above-mentioned two periods, the role of other investment as the major form of absorbing foreign capital has changed. Generally speaking, because other investment as a form of introducing foreign capital is usually smaller than the increase of assets in size, a deficit is seen in the balance of other investment. Therefore, other investment is an uncertain factor affecting the balance of foreign capitals and capital accounts when foreign capitals (mainly trade-related credits) are utilized in such form, and its drastic decrease in times of uncertain economic growth more than often gives rise to a deficit in other investment receipts and payments and even in the balance of capital accounts.

From the above-mentioned analysis, it can be seen that the surplus of foreign capital receipts and payments has offset the outflow of domestic capital and led to a recurrent surplus of capital account, which contributes a great deal to the satisfaction of domestic demand for capital. In terms of composition, FDI inflow plays an irreplaceable role in maintaining the equilibrium of capital accounts. The net inflow of foreign capitals in the forms of securities and other investment holds a small percentage in the surplus of foreign capitals, and therefore its contribution to the surplus of capital accounts is limited. Under the situation where capital flight abroad is intensifying, such net inflow would be an uncertain factor affecting the balance of capital accounts for want of the base on which surplus can grow stably. Viewed from different periods of time, in the 1980's other investment mainly in the form of borrowing from abroad held the highest percentage of the net inflow of foreign capitals as a whole, but, after entering the 1990's, the net inflow of FDI as the main form of foreign capital accelerated and its percentage jumped over 80%, whereas that of other investment and securities investment fell down below 10%. Such a change improved, to a largest extent, China's structure of foreign capital inflows and helped to maintain general equilibrium of capital receipts and payments and lighten the debt service burden.

(II) Effect on the balance of current accounts

1. Features of balance of China's current accounts

Current accounts in the balance of international payments include trade of commodities and services, earnings, current transfers, etc. During the 1982-1999 period, the cumulative balance of China's current accounts was USD103.62 billion in surplus. Viewed by years, a deficit was seen in 5 years: 1985-1986, 1988-1989 and 1993. It was mainly due to the heated economy and its delayed effect as well as a huge trade deficit. In the 1980's a few years witnessed a deficit. Significant changes took place, however, since the beginning of the 1990's (Tables 3 and 4). In terms of its composition, trade surplus represented the base and main sources for the surplus of current accounts, whereas earnings posed an increasing pressure on the deficit of current accounts. The balance of current transfers is a stable source of surplus of current accounts.

2. Foreign capital under current account and its contribution

In the current account, what has direct relations with FDI is mainly commodity and service trade, investment earnings, etc.. As trade balance of foreign-funded enterprises is not separately listed under commodity trade in the statement of balance of payments, the customs statistics are adopted in the main, and exports by foreign-funded enterprises have entered the credit side in the balance of commodity trade, and their imports are on the debit side, the balance between exports and imports is defined as balance of commodity trade account. According to statistics for the 1982-1999 period, a cumulative deficit of USD92.75 billion was reported in commodity trade by foreign-funded enterprises, representing 58.5% and 89.5% of their total value of commodity trade and the surplus of current accounts respectively. The long-standing commodity trade deficit by foreign-funded enterprises is deemed as normal due to a few factors, for one thing, equipment and technology are the major means for FDI, their export takes the form of processing trade in most cases, components and raw materials make up a substantial part of import volume. The problem here is how to strike a trade balance by boosting the growth of domestic substitution for imports of intermediate inputs and local purchase of invested equipment needed for processing trade, and this should be the cutting point requiring policy priority. During the 1996-1999 period the trade deficit of foreign-funded enterprises scaled down remarkably, equal to 11.2% of the surplus of current accounts in the same period, and the 1998-1999 period even saw a surplus directly thanks to the fall of FDI. If equipment is deducted from their imports in other years, there would be a trade surplus, too. Viewed from the balance of commodity trade, therefore, the direct influence of foreign capital inflow finds itself in the pressure brought to deficit by the import of related goods for investment, however, the export growth of foreign-funded enterprises is higher than the average growth level of exports as a whole, this has, to a large extent, offset the increased portion of import of items for investment, and played a stimulative role in boosting export trade. In the service trade account receipts and payments of foreign-funded enterprises are not itemized separately, and no replaceable statistical data are available. As the opening of China''s service trade is limited, the size of trade in connection with foreign capital inflow is relatively small, it is therefore neglected here.

Investment earnings include interest incomes on profit under FDI and earnings on reinvestment, securities investment (dividend and bonus) and others. Those on the debit side represent earnings from FDI, securities investment and other foreign investment in China.

According to the statistics of the balance of payments for the 1982-1999 period, payments (debit) from investment earning cumulated to USD133.4 billion, 1.3 times the cumulative surplus of current accounts. The debit amount after 1996 substantially increased largely because of the transfer of outward remittance of investment earnings from actual to accrual basis. Therefore, the situation after 1995 is incomparable. Judging from the actual situation for the 1996-1999 period, payments from investment earnings exceeded USD16 billion each year, with the cumulative amount standing at USD86.52 billion. With its effect, the deficit in the balance of income accounts reached USD58.06 billion in accumulation, 2.2 times more than the deficit in the balance of service accounts, thus posing much greater pressure on the balance of current accounts.

If the aggregate of all items relating to inflow of foreign capitals under current account is defined as account under current foreign receipts and payments, and the commodity export by foreign-funded enterprises is taken as credit item there under, and the sum of the debits of commodity imports and investment earnings as the debit on the current account of foreign capital. The past 18 years, if not all, witnessed a deficit in the balance of foreign capital account, which reached USD226.15 billion in accumulation, 2.2 times as much as the cumulative surplus of current accounts in the same period. In the deficit of foreign capital current accounts, the trade deficit of foreign-funded enterprises accounted for 41%, and the deficit (including the debit of investment earnings) in their investment earnings for 59%. Viewed from different periods, however, the deficit percentage of investment earnings tends to go upward rapidly. Besides, after 1992 it was a period for fast growth in the deficit in the current account of foreign capital, which conformed to the growing tendency of actual inflow of foreign capital. This shows that when the inflow of foreign capitals on a large scale gives rise to the effect on the surplus of capital accounts, it is certain to bring about an expansive effect on the deficit under current account. Except the year 1993, a surplus of current accounts has been maintained since the beginning of the 1990's, which is mainly due to a huge surplus of commodity trade exceeding the deficit of current accounts created by the surplus of capital accounts. With the acceleration of repayment of long-term debts and accumulation of profits on FDI and gradually enlarged deficit in the service trade balance, pressure on the deficit of current accounts is growing remarkably.

3. Effect on overall balance of payments

Final balance refers to the aggregate of the balances of current accounts and financial accounts and is an important indicator reflecting a country's overall capacity of equilibrium in the balance of payments. Therefore, analysis of the effect of inflow of foreign capital on the final balance can illustrate its role and contribution in maintaining general balance of payments.

If the aggregate of items in the capital and current accounts that relate to the inflow of foreign capital (aggregate of balances of foreign current and capital accounts) is defined as "final balance of foreign capitals", there would be a surplus of USD137.68 billion in accumulation according to the statistics of balance of payments for the 18 years, accounting for 48.5% of the aggregate surplus in the same period, of which the surplus of foreign capital is 2.64 times as much as what the aggregate surplus of foreign capitals contributes to the final balance (see Tables 5and 6). That is why nearly half of China's total surplus in the balance of payments is attributed to foreign capitals. As the final balance is in surplus for long, even if with allowance for 45.1% errors and omissions, China's reserve assets (overall balance = final balance minus error and omission) keep an upturn momentum, and among them foreign exchange reserve increased by USD141.97 billion in accumulation in 18 years.

A long-standing surplus of capital accounts directly results in the accumulation of debts. Judging from the actual situation in the 1982-1999 period, long-term debts take the major part in terms of maturity, and prime rate loans from foreign governments and international organizations make up a lion's share in terms of creditors. Therefore, security and stability of these debts are ensured to a large extent, and such indicators as debt ratio measuring the extent of debt crisis are still kept within the safety limit. What is worth notice is that, however, direct borrowings by foreign-funded enterprises set up in the form of FDI has constituted the major part of external debts.

Overseas borrowings of foreign-funded enterprises as important foreign borrowers in China have some influence on the equilibrium in its balance of payments and debt burden. While Chinese enterprises borrowing from abroad are subject to state quota and approval, foreign-funded enterprises can get foreign loans without approval, borrowing by the latter has rapidly expanded. By 1985 the outstanding balance of external debts by foreign-funded enterprises stood at USD420 million, making up a tiny portion of 2.7% of the total, but the amount had multiplied to USD47.3 billion by 1999, accounting for 31.2% of the total. During the 1985-1999 period their external debts grew at the annual average rate of 40.1, 22.6 percentage points higher than the annual average growth rate of China's external debts. Net growth in the external debts of foreign-funded enterprises increased supply of foreign exchange in the country. After the Asia financial crisis was triggered off, however, affected by consecutive downward adjustments to the Renminbi interest rate and growing anticipation of devaluation of the Renminbi exchange rate, the net growth rate of overseas borrowings by foreign-funded enterprises drastically plunged to 4.6% in 1999 from 50% on the eve of the crisis, and their percentage of the net increase in China's external debts sharply dropped from 85% to 36%.

II. Effect on the Balance of Foreign Exchange

Foreign exchange receipts and payments are the concrete expression of the tendency of currency flow in the balance of payments, and have more direct and prominent effect on the stability of micro economy. Thanks to the effect of long-standing surplus in the balance of payments, China has by and large maintained a surplus of foreign exchange except for the 1984-86 period and 1992, and its foreign exchange reserve increased very fast, which is, among others, mainly due to the inflow of foreign capitals.

Table 8 Balance of Foreign Exchange by Foreign-funded Enterprises (Unit:USD100 ml.)

	Net Outward Transfer or Net Settlement (A)	Change in Forex Reserve (B)	A/B (%)
1991	16.5	106.2	15.5
1992	24.2	-22.7	- 106.7
1993	60.0	17.6	341.7
1994	44.0	304.2	14.5
1995	121.3	219.8	55.2
1996	144.5	314.5	45.9
1997	165.9	348.4	47.6
1998	16.2	50.7	32.0
1999	60.0	97.2	61.8
Total	508.1	1435.9	35.4

 Data source: SAFE

Thanks to a larger receipt than sales of foreign exchange during the 1995-1999 period, China realized a surplus of USD103.34 billion in the balance of foreign exchange received and sold which is of the following characteristics (see Tables 9 and 10). First, the net income of foreign exchange directly related to the inflow of foreign capitals stood at USD48.8 billion, accounting for 47.2% of the total. Of the amount, the portion from foreign-funded enterprises reached USD38.9 billion, making up 37.6%. This shows that foreign capital inflows represent the main source of increase in the net income of foreign exchange, and contributed as high as 52.4% to the further increase of the state foreign exchange reserve. Second, in terms of accounts, the state net income of foreign exchange was entirely from the surplus of receipts and sales of foreign exchange under current account. According to statistics, the net income of foreign exchange received under current account for the 1995-1999 period was 1.3 times as much as the total net income. Third, the amount of foreign capital inflows including the net income of settlement exceeded that of capital accounts. For instance, their net income under current account amounted to USD38.9 billion, 6.03 times than that under capital account. T

his strikes big contrast with the huge surplus of foreign capital under capital account and the huge deficit under current account as shown in the Balance of Payments Statement (BPS). This situation is mainly contributed to three factors: (1) the net inflow of FDI in the BPS is the main source of the surplus, but since a larger part of such investment was made in terms of machinery, equipment, technology, etc., the net capital inflow did not directly result in a net income of foreign exchange, moreover, the corresponding portion of commodity import under current account was realized in kind and did not pose any demand for foreign exchange; (2) the outward remittance of profits by foreign-funded enterprises under current account in the BPS was the main source of their deficit in receipts and payments. After 1995, however, the statistical method for this item changed from actual to accrual basis, by which their income of profit was included in the expenses even if it was not remitted abroad, as a result, expenses listed in the BPS were higher than actually expended; (3) China's exchange control system has changed from conditional convertibility to convertibility under current account, whereas rigid restrictive measures are still taken for the conversion of Renminbi under capital account. Therefore, part of purchases of foreign exchange under capital account is actually completed under current account.

Table 9 Basic Situation of the Balance of Foreign Exchange

 

	1995	1996	1997	1998	1999	2000
Balance of foreign exchange	251.3	285.7	402.1	-18.7	113.0	61.7
F-f enterprises Total of foreign capitals	59.9 68.1	113.5 129.8	163.3 197.8	-7.1 24.2	59.4 68.2	41.6 43.8
Balance of c. accounts	300.0	334.1	431.0	97.0	221.5	102.1
F-f enterprises Total of f. capitals	49.3 49.3	93.6 93.6	120.1 120.1	-3.7 -15.6	65.6 47.7	40.2 34.8
Balance of c. accounts	-50.6	-52.6	-31.8	-115.8	-108.5	-40.4 " Foreign economic relations