China’s current account balance turns around
Authors: Alicia Garcia-Herrero, Natixis and Bruegel
Since the start of the US-China trade war, the market has not lacked trade measures designed to reduce China’s bilateral trade surplus with the United States. With renewed With trade tensions, China’s current account surplus is back in the spotlight, despite the surplus falling significantly from its peak during the 2007-2008 global financial crisis (GFC). A tighter current account balance may allay global concerns about China’s export machine, but with less foreign exchange reserves, it also means China will have less room to respond to unexpected external shocks.
In addition to pressure from the United States for China to reduce its bilateral trade surplus with the United States, China’s current account is also expected to continue declining towards deficit as Beijing rebalances towards a consumer-driven economy. . But this prediction may turn out to be inaccurate.
The most obvious reason, at least in the short term, is the protracted trade war between the United States and China. But there are several other important factors – related to the nature of China’s current account surplus reduction – that lead to expect a further current account surplus.
Trade in goods contributed less than a third of the decline in the current account surplus, with services (particularly tourism) accounting for the remainder. The increase in the tourism deficit seems to be easily explained by the large number of Chinese tourists abroad, but that is not all. China’s reported tourism trade deficit is significantly larger than the reported tourism trade surplus of its major trading partners. This reflects the reality that China’s reported tourism spending is not entirely spent on regular tourism activities, but has other purposes. In fact, much of the deficit could be outright capital flight to bypass capital account restrictions.
Measures to restrict tourism spending could possibly be taken if China fails to attract enough capital to counter the declining current account. This is especially likely under the current managed exchange rate mechanism which requires sufficient foreign exchange reserves to cushion the renminbi (RMB) depreciating pressure. In other words, tourism is a clear source of unrecorded capital outflows – equivalent to more than half of the trade surplus in goods – and may be limited to increasing the current account surplus.
From a long-term domestic perspective, a high savings rate is key for China to maintain a current account surplus. But China’s domestic savings rate is on a downward trajectory.
Corporate savings are slowing due to the debt frenzy Chinese companies are experiencing due to the massive stimulus measures China has carried out during the GFC until today. More recently, the slowdown in household income growth, the transformation to a growth model driven by consumption and the strengthening of the social security system are also contributing to a decline in household savings. The decline in Chinese public savings is due to the slower tax revenue growth and the frequent need to stimulate the economy due to weaker and weaker growth potential.
Over time, these structural factors should persist, which should, in principle, push the current account into a deficit. But this consensus assumes that investment will remain high in China. Indeed, the investment remained high artificially following consecutive stimulus plans. Public investment plays an important buffer role whenever private investment decelerates due to deteriorating economic prospects. This was again the case for the end of 2018 when it returned to surplus in the first quarter of 2019 and when the surplus was maintained in the second quarter. It seems that the continuation of trade tensions with the United States could be linked to this development.
In the long run, investment in China is bound to decline as the return on assets continues to decline, suggesting a structural current account surplus rather than a deficit. Indeed, investment cannot stay artificially high forever.
The reduction in tourism spending may be the trigger for a positive return to the current account deficit, which can only reflect a lower rate of investment over time, or even lower than the reduction in the savings rate. This, of course, doesn’t 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. American negotiators who are dealing with China now might not like this.
Alicia Garcia-Herrero is Chief Economist for Asia-Pacific at NATIXIS and Assistant Professor at Hong Kong University of Science and Technology (HKUST). She is also a Senior Fellow at the Brussels-based think tank Bruegel, a non-resident researcher at the Madrid-based Real Instituto ElCano and a member of the advisory board of the Chinese think tank Merics based in Berlin.