China's average investment return on its foreign assets is much lower than the return China pays to foreigners on their investments in China. As a result, China's net foreign factor income as a percentage of its gross national product has hovered around zero for a long time. China should devise a strategy to promote outbound non-governmental investment as part of the effort to improve the composition of its foreign assets.

In 2013, China's reserve assets accounted for 65.4 percent of its foreign assets while non-reserve assets (that is, foreign assets held by the non-government sector) comprised a bit over 30 percent. A comparison with other countries shows China's 65 percent reserve assets proportion is very high. This proportion is about 17 percent in Japan and only 2 percent in the United States and Germany. That means the proportion of foreign assets held by the non-government sector is more than 80 percent for Japan and over 90 percent in the US and Germany.

This explains why China's net investment income (investment return on foreign assets minus investment return paid on foreign liabilities) is low: the majority of China's foreign assets are in foreign reserves which emphasize the principles of liquidity and safety. To the contrary, non-governmental investments, of which a major part are FDI and equity portfolio flows, can deliver a much higher return on a long-term basis, but unfortunately account for an insignificant portion of China's foreign assets.

Thus, China should strive to change the composition of its foreign assets to raise its net factor earnings. Specifically, it should increase the proportion of non-government owned foreign assets as a percentage of the country's total foreign assets.

Outbound investments by the non-government sector include those by banks, other institutional investors (such as funds), companies, as well as households. What is lacking are the channels and capacities for facilitating these outbound investments.

To this end, domestic banks should take a lead in going global, following the model of Industrial and Commercial Bank of China. The ICBC has already opened branches in more than 40 countries and acquired many foreign banks around the world, including Industrial and Commercial East Asia Financial Holding Limited, Indonesian HALIM and Standard Bank, resulting in fast growth of its international business. The rapid expansion of ICBC's international business has benefited from its concurrent steps with domestic enterprises' overseas investment and the yuan's internationalization.

The yuan's internationalization is a powerful driver of Chinese banks' international business expansion. Statistics shows that in the first half of this year China's outbound direct investment settled in the yuan grew by 293 percent year-on-year, and yuan-denominated direct investment made by foreign investors in China registered a growth rate of 137 percent during the same period.

The fast growth of such investment activities undoubtedly require banking services. Domestic banks have a huge potential for overseas business expansion if they better use such opportunities. And with such bank services, the country's outbound and inbound direct investments will expand further. In a sense, the expansion of domestic banks overseas can serve as a guiding and propulsive force for the expansion of China's foreign assets.

Outbound investment via Chinese investment funds (including funds engaged in direct investments overseas) is another way to rationalize the composition of China's foreign assets. To facilitate such a trend, the country should lift many restrictions and address policy hurdles such as double taxation on investment returns. Besides, efforts should be made to lower the financing costs for domestic investors seeking global opportunities. We should study Japan's experience of its "capital recycling program" and offer low-cost financing to domestic companies and investment funds that eye the overseas investment market.

Promoting overseas acquisitions by domestic private enterprises also has its significance. Although private companies are smaller in size, their overseas investment can facilitate the overseas expansion of mightier State-owned enterprises.

Finally, Chinese households will also become a very powerful sector to invest globally, partly due to the need for asset diversification and partly due to strong growth potential for pension assets in the coming decades. In this regard, China should gradually lift its foreign exchange restrictions on overseas investment by individuals, and develop multiple channels for households to access global financial products at lower costs. For example, the Chinese mainland and Hong Kong can mutually recognize each other's mutual funds, and such recognition can be gradually extended between the mainland and other countries and regions. Moreover, more competition should be introduced to the fund management industry in order to lower the costs of many investment products.

The author is chief economist with the Research Bureau of People's Bank of China.

(China Daily USA 11/27/2014 page12)