There’s a big change that is taking place in global financial flows. The layperson’s view is that the Western nations have all the money and they’re kind enough to lend a bit of it to us to help us build our economies and lift our stock markets.
More informed opinion knows that Americans finance their shopaholic lifestyles by borrowing from the rest of the world, mainly China. The stylized anecdote about the global economy runs thus—the Chinese export to the US, save a large part of the proceeds from those exports and then lend those savings back to the US, where it finances the consumption binge, which, in turn, boosts Chinese exports and so on in a circle.
But these capital flows are now changing. The International Monetary Fund’s Global Financial Stability Report has been monitoring capital flows for several years and the data show that a vast and very rapid change is taking place in capital flows.
Consider the facts. In 2003, Japan provided as much as 20.8% of the world’s sources of capital, followed by Germany with 9.8%, Russia and Switzerland with 6.2% each, Norway 4.6%, Taiwan 4.2%, Hong Kong 3.8%, France and Singapore 3.7% each, Saudi Arabia 3.6%, China 3.3% and the list continues.
Who were the major capital receivers? The US was the biggest capital importer, gobbling up as much as 74.2% of all capital imports. Australia was a distant second, with its share of global capital imports at 3.5%, followed by Spain 3%, the UK 2.3%, Italy 2.1%, Mexico 1.9%, and Greece 1.5%. Other capital importers accounted for the balance 11.5%.
But that was in 2003. Three years later, in 2006, the picture had changed dramatically. China has emerged as a huge source of capital, accounting for 17.3% of global capital exports. From 3.3% to 17.3% in three years is quite a jump. In 2005, Japan’s share, at 14.2%, was bigger than China’s 13.7%. But not any longer, with China’s share going up in 2006 and Japan’s dropping to 11.8%. The share of the other capital exporters in 2006, in order of size is: Germany 10.1%, Saudi Arabia and Russia 6.6% each, Switzerland 4.6%, the Netherlands 4%, Norway 3.8%, Kuwait 2.9%, Singapore and the UAE 2.5% each, and so on.
Where did all this capital go? The US still accounts for more than half of all global capital imports, but its share is down to 59.6% . The countries that have taken up the slack are Spain 7.8%, the UK 6.5%, Italy 3.3%, Australia 3%, Turkey 2.3% and Greece 2.2%, with other countries(15.2%) also chipping in.
India, of course, is a net capital importer, thanks to our negative current account balance.
What the data tells you is that while China’s share in global capital exports is growing by leaps and bounds, the US share in capital imports is declining. That’s because the US role as the sole driver of the global economy is rapidly diminishing. The anecdotal view of Chinese savings funding US consumption is still largely correct, but there are important provisos to that story. A more nuanced version would go somewhat like this: Chinese export earnings lead to higher savings that are then exported mainly to the US, but also increasingly to other countries. Oil exporters too have become major sources of capital, not all of which is going to the US.
That effect is seen from the increasing role of the Euro Area in fund flows. In 2006, capital inflows and outflows to and from the Euro area were $2,104 billion (Rs83.7 trillion) and $1,941 billion, respectively, while the corresponding numbers for the US were $1,859 billion and $1,055 billion. While inflows to the UK were lower than for the US, outflows from the UK amounted to $1,198 billion in 2006, more than from the US. The emerging markets and developing countries as a whole were a net supplier of capital to the rest of the world, with capital inflows of $993 billion and outflows of $1,723 billion.
This state of affairs, with capital flowing from poorer countries to the rich, has long been castigated by economists. However, as a matter of fact, the much-awaited global rebalancing already appears to be happening, although it could be argued that while the huge US imbalance is diminishing, the Chinese one is not.
With the dollar weakening by the day, the share of the US in global capital imports is likely to fall even further. Moreover, with China, Japan and the oil producers being the biggest sources of capital, why should the biggest investment banks be American? That’s the logic behind the rise of the sovereign wealth funds. The capital exporters are clearly saying—it’s our money and we’re going to have a greater say in its management and control. It does seem rather strange to lend money to the US, which is then routed by US investment banks to emerging markets. Why not invest directly in emerging markets instead?
What’s more, a recent trend highlights the fact that even US investors seem to have become wary of investing in their own country. A study by fund tracker Lipper finds that fund flows in the US into mutual funds, which invest in domestic stocks, have halved since 2003. On the other hand, inflows into funds, which invest in the global markets, have gone up. With other economies showing rates of growth far higher than the US, there’s every reason for diversification by American investors.
Mint’s resident market expert Manas Chakravarty looks at trends and issues related to investing in general and Indian bourses in particular. Your comments are welcome at capitalaccount@ livemint.com