China Research

Analysts do not watch balances on current account (c/a) very carefully these days – possibly apart from countries with major deficits and high or rising foreign debt at the same time (as, for example, currently in the case of Turkey). In terms of definitions, the c/a balance summarizes exports minus imports of goods and services and also factor income and transfer payments to and from other countries such as payments for interest rates and dividends, foreign aid, payments to and from international entities/organizations like the EU, the UN or the IMF/World Bank.

There are two reasons behind this development of very limited c/a analysis. One reason is – compared to the 1980s and 1990s – a substantially decreasing number of countries with burdening c/a deficits during the past decades; problems are mostly in smaller emerging or developing countries without (attractive) capital markets. The second may be – linked to the first – that financial analysts usually do not study c/a developments very carefully and, consequently, provide the press with less illuminating and/or less frequent interpretations of c/a numbers.

Clear downward trend for China’s current account balance

This phenomenon of c/a neglect is also – surprisingly – to a high extent true of China despite the fact that the c/a trend already has been turning around very visibly and quite large capital markets indeed exist, for foreigners as well. The highest quarterly Chinese c/a numbers in modern times came in at around +10 % of GDP in 2007 – and the lowest only recently at -1.1 % or -34 USD bn in q1 this year (q2 2018:+5 USD bn and q3 2018:+16 USD bn; BNP2017: 12 238 USD bn, gross foreign debt q2 2018: 187 USD bn, total foreign currency reserves Oct 2018:3053 USD bn). The c/a deficit in q1 this year was the first in 17 years.

Original Chinese time series for the current account with its aggregates are difficult or impossible to find and not very transparent; they also have qualitative shortcomings (which – on the other side – is the case in many other countries, too). But it should be mentioned that c/a numbers in USD can be found on the homepage of SAFE (State Administration of Foreign Exchange, a bureau under China’s central bank, The People’s Bank of China). They are published quarterly.

Two important questions

Two important questions follow from the still ongoing downward trend of the c/a balance:

First, is there a concrete risk that China more permanently can become a country without surpluses or even deficits in the current account?

Second, what could be the (theoretical) consequences of such a development?

Considering the probability of continuous weakening of the c/a balance including also red figures over time, there is an obvious risk of drawing premature conclusions. This whole future is very complex. Regarding future needs of imports, the objectives of more private consumption and of an expanding service sector may provoke considerable increases of imports in the medium run.

On the other hand, there is also an ambitious strategy called “Made in China 2025”, issued by Prime Minister Li Keqiang in 2015. According to this plan, Chinese political leadership urges strongly to move up China’s manufacturing industries in the global value chain and, thus, to become real competitors to companies in advanced industrial countries. In this context, digitalization and AI are assumed to play a particularly important role. But how successfully can China meet these ambitious plans? This question is certainly impossible to answer – but Chinese ambitions are obviously very large. What about the impact of possibly bursting credit bubbles on future imports?

Nobody is able to answer all these questions in the near future. Consequently, forecasts on the future development of Chinese imports – an important part of the c/a – cannot be made with reasonably accuracy any time soon.

And what about exports – the other major component of a c/a balance? Uncertainty is large for exports as well. How will “Made in China 2025” work out? To what extent can China meet its ambitions to clearly advance in the global product and production chain? Where and what are the mid- and high-tech products of the future? Can China’s financial system develop in line with the ambitions to become a really strong economic and global superpower? When can China introduce a fully convertible currency that can be traded anywhere on this globe? What about U.S. protectionism a couple of years ahead?

China’s future exports and imports contain oodles of conundrums. For this reason, it seems to be impossible to make a well-based forecast for the trend of the Chinese c/a balance some years from now. In the shorter run, however, a return to sustainable major surpluses does not seem to be in the cards. In the longer run, quite a number of scenarios can be found for the Chinese c/a balance. The positive ones are strongly linked to a strong position of “Made in China” and successful moves to new and advanced products for global demand – possible but not predictable!

Consequences of possibly ending c/a surpluses

During the past ten years, analysts could note a clearly declining trend for China’s c/a surpluses from around 10 % of GDP about ten years ago to a slight minus during q1 this year – the first deficit for almost two decades. Theoretically, the consequences of disappearing c/a surpluses and even deficits are obvious. But let us instead start the analysis from a situation with current account surpluses!

C/a surpluses mean that a country is saving more money than it needs for its domestic purposes or – somewhat roughly expressed – that exports are higher than imports. If this is the case, foreign money is coming into the country – a net currency inflow is noted that by definition can be used in the following four different ways:

• Foreign direct investments (FDI) in other countries (more long-term),
• portfolio investments in stocks, bonds, etc. (more short-term),
• credits to abroad,
• further accumulation of the currency reserve.

In times of large c/a surpluses, China applied all four options. In recent years, however, China refrained from further increases of the currency reserves (which indeed were – and still are – high enough for non-emergency conditions). However, if/when (sizeable) c/a surpluses are not achieved anymore or even deficits show up regularly, at least parts of the four above-mentioned investment and lending options need downsizings – unless China wants and can increase its foreign debt.

Currently, China’s existing foreign debt is not a problem at all. This will remain the case as long as China will not be confronted with rapidly increasing c/a deficits. If the latter development should show up at some point in the future, things would change quite visibly or strongly. Chinese dependence from global investors and lenders would increase – and China’s own financial investments abroad and own lending to other countries would need cuts, sooner or later.

This gloomy picture is certainly not a forecast but just one out of a couple of different c/a scenarios. However, it shows that the analysis of China’s balance on current should not be forgotten.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board

 

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