The size and destination of China’s portfolio outflows

Abstract

ABSTRACT China’s large financial system is relatively closed, raising concerns that liberalization of China’s capital account could have disruptive effects on the global financial system. We estimate a portfolio allocation model to estimate an economy’s foreign portfolio investment, using panel data for 39 economies. We estimate the model separately for equity and debt securities holdings. We find that portfolio allocation to a foreign economy depends on the destination economy’s market size, gravity variables, governance indicators and capital controls in source and destination economies. We then construct a counterfactual scenario of China’s overseas portfolio investment allocations in 2015 if China had liberalized capital outflows. The analysis indicates that China’s holdings of overseas portfolio assets would have been large at 13% to 29% of Chinese GDP, or 5 to 12 times its actual levels. These asset holdings would have been predominantly from the world’s deepest financial markets: the United States, euro area and Japan. Emerging-market economies would have received relatively little additional portfolio inflows from China, suggesting that liberalization of China’s portfolio outflows may not prove disruptive to the global financial system.