The Future is Now

China’s Q2 2018 Balance of Payments (BOP) figures show important deviations from past patterns, and point the way toward China’s BOP future. This note analyzes the most important data points and discusses the implications amidst US-China tensions and an otherwise deteriorating external environment for China. The key findings are:

A shrinking goods trade surplus is melting China’s current account surplus: Despite frontloading of exports in response to looming US tariffs, China’s goods trade surplus shrank 20% compared to last year to the lowest in five years for a second quarter. The deficit in services trade remains unchanged, driving down China’s quarterly current account surplus to just $5.3 billion. After a deficit of $34.1 billion in Q1 China is on track for the first annual current account deficit in a quarter century.

Strong bond and equity investment inflows sustained the financial account surplus: In Q2, China saw the largest portfolio securities surplus in history at $61 billion, primarily into the government bond market. That was sufficient to offset other outflows in the capital and financial account, as well as capital outflows that might be hidden within the services trade deficit. Last quarter was roughly in line with Beijing’s best-case scenario in the coming years, with stronger portfolio inflows offsetting the inevitable outflows from diversification by Chinese households and corporates.

US-China frictions could disrupt this new equilibrium, paving the way for further yuan depreciation: Despite the relatively healthy conditions in Q2, China’s currency still depreciated by 5.55% during the quarter. If the US-China dispute further erodes China’s current account balance and changes the psychology around further portfolio inflows, China may have to resort to further depreciation of the exchange rate to resolve BOP pressures and re-ignite investor appetite for Chinese securities.

Posted October 19, 2018
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Barbarians Suddenly at the Gate: An Ironic Twist to China’s Fiscal Restraint

China still has considerable fiscal space to expand its government balance sheet to manage long-term debt problems.  That expansion may happen faster than expected, ironically because foreign investors have become a key source of marginal demand in the market for Chinese Government Bonds (CGBs), large enough to have a material impact on CGB yields. Foreign investors’ presence in the CGB market is already roughly equivalent to China’s own presence in the US Treasury market.  China still needs portfolio inflows and Beijing is working to encourage foreign investors to diversify their bond investments beyond CGBs, but more government bond issuance and fiscalization of debt are also likely.

Posted September 18, 2018
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What Happened to China’s Current Account Surplus?

Balance of payments data from the State Administration of Foreign Exchange (SAFE) last week reported a sharp decline in China’s current account surplus, from $74.2 billion in Q3 2016 to only $11.8 billion in Q4. SAFE attributed this change to revised estimates of earnings from foreign companies, which were not repatriated, most likely because of newly imposed capital controls. The data adjustment therefore indirectly boosted foreign direct investment inflows as these profits were reinvested in China. The bottom line is that despite SAFE’s adjustments, China is still posting strong goods surpluses and larger services trade deficits, while foreign investment flows into China are still weakening.

Posted August 1, 2017
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