Alicia Garcia Herrero, Natixis Asia Pacific Chief Economist, Bruegel Senior Fellow
Since the start of the US–China trade war, the market has seen no shortage of trade measures engineered to reduce China’s bilateral trade surplus with the United States. With renewed trade tensions, China’s current account surplus is back in the spotlight, despite the surplus dropping significantly from its peak during the 2007–2008 global financial crisis (GFC). A narrower current account balance may ease global concerns about China’s export machine, but with less foreign reserves it also means that China will have less room to respond to unexpected external shocks.
In addition to the US push for China to reduce its bilateral trade surplus with the United States, China’s current account is also generally expected to continue declining towards deficit as Beijing rebalances towards a consumption-oriented economy. But this prediction may turn out to be inaccurate.
The most obvious reason, at least in the short term, is the prolonged trade war between the United States and China. But there are several other important factors — related to the nature of China’s reduced current account surplus — which lead to an expectation of a renewed current account surplus.
Trade in goods contributed to less than one third of the shrinking current account surplus with services (especially tourism) accounting for the rest. The rising tourism deficit appears to be easily explained by the large number of Chinese tourists overseas, but it is not the full story. China’s reported tourism trade deficit is significantly larger than its key trading partners’ reported tourism trade surplus. This reflects the reality that China’s reported tourism expenditure is not entirely spent on usual tourism-related activities, but has other objectives. In fact, a large bulk of the deficit might be outright capital flight to circumvent capital account restrictions.
Measures to clamp down on tourism expenditure could eventually be taken if China does not manage to attract enough capital to counter the reduction in the current account balance. This is especially likely under the current managed exchange rate mechanism which requires enough foreign exchange reserves to buffer renminbi (RMB) depreciation pressure. In other words, tourism is an obvious source of unrecorded capital outflows — equivalent to more than half of the goods trade surplus — and may be restricted to push up the current account surplus.
From a long-term domestic perspective, a high savings rate is the key for China to keep a current account surplus. But China’s domestic savings rate is on a downward trajectory.
Corporate saving is slowing down due to the leverage binge that Chinese companies are experiencing because of the massive stimulus China has carried out during the GFC until today. More recently, slower household income growth, the transformation towards a consumption driven growth model and the strengthened social security system are also contributing to a decline in household savings. The decline in China’s government savings is due to the slower growth in fiscal revenues and the frequent need to stimulate the economy on the back of increasingly lower potential growth.
Down the road, these structural factors are likely to remain, which should — in principle — push the current account towards a deficit. But this consensus view assumes that investment will remain high in China. In fact, investment has remained high artificially as a consequence of consecutive stimulus plans. Public investment plays an important buffering role every time private investment decelerates due to the worsening economic outlook. This was the case again for the end of 2018 while it turned again to a surplus in the first quarter of 2019, and when the surplus was maintained in the second quarter. It seems as if continued trade tension with the United States could be related to this development.
In the long run investment in China can only go down as the return on assets continues to fall, which points to a structural current account surplus rather than a deficit. This is because investment cannot remain artificially high forever.
The clamp-down on tourism expenditure may be the trigger to see the current account deficit turn back positive, which can only reflect a lower investment ratio down the road — even lower than the reduction in the saving ratio. This, of course, does not bode well for China’s future but it does explain why China’s widely expected current account deficit might be short-lived. It might be wise to expect a U-shaped current account balance for China down the road. The US negotiators dealing with China now might not like this.
This article was first published by East Asia Forum at: https://www.eastasiaforum.org/2019/10/11/u-turning-chinas-current-account-balance/