Opinion

Expect a U-shape for China’s current account

As the US aims to reduce it's bilateral trade deficit, China's current-account surplus is back in the headlines. However, in reality China’s current-account surplus has significantly dropped since the 2007-08 global financial crisis. In this opinion piece, Alicia García-Herrero discusses whether we should expect a structural deficit or a renewed surplus for China's current-account.

By: and Date: May 28, 2019 Topic: Global Economics & Governance

This opinion piece was first published in Asia Times.

China’s current-account surplus is back in the spotlight amid the US quest to reduce its bilateral trade deficit with the Asian country. However, the reality is that China’s current-account surplus has dropped significantly from its peak during the 2007-08 global financial crisis.

From China’s perspective, a narrower current-account balance may be helpful as it could ease the concerns of the rest of the world about China’s export machine. But it also has disadvantages, namely reducing China’s ability to respond to unexpected shocks, as the accumulation of foreign-exchange reserves from a trade surplus would in principle stop, if not retract. While most Western economists would argue that China’s external buffer, namely Forex reserves, are excessive, this might not be the view of China’s leadership, especially after the recent experiences with US-led disruptions and other types of tail risks.

Over and above the ongoing reduction of China’s current-account surplus, the US push for China to reduce its bilateral trade surplus puts even more weight on the – by now consensus – view that China’s current-account surplus is an issue of the past and that we should expect a structural deficit down the road.

This prediction might not come true, however. The most obvious reason, at least in the short term, is the breakdown of trade negotiations between the US and China, but this is not the whole story. There are other important reasons, related to the very nature of China’s reduced current-account surplus, that lead us to expect a reversal of the current trend, back toward a renewed surplus.

There are other important reasons, related to the very nature of China’s reduced current-account surplus, that lead us to expect a reversal of the current trend, back toward a renewed surplus.

In fact, trade in goods contributed to less than one-third of the shrinking current-account surplus, with services (especially tourism) explaining the rest. The rising tourism deficit appears to be easily explained by the large number of Chinese tourists overseas, but that too is not the full story. A comparison of China’s reported tourism deficit with its key trading partners’ reported tourism trade surplus shows that the former is significantly bigger than the latter, reflecting the reality that China’s reported tourism expenditure is not actually fully on the usual tourism-related means but actually has other objectives.

In fact, a large bulk of the deficit might be outright capital flight to circumvent capital-account restrictions. As such, measures to clamp down on tourism expenditure could eventually be taken if China did not manage to attract enough capital to counter the reduction in the current-account balance. This is especially so under the current managed exchange-rate mechanism, which requires enough Forex reserves to buffer 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 its current account in surplus. But in recent years, China’s domestic savings rate has been on a downward trajectory. Corporate saving has slowed because of the leverage binge that Chinese companies have experienced since the massive stimulus Beijing has carried out since the global financial crisis. More recently, slower household income growth, the transformation toward a consumption-driven growth model and the strengthened social-security system have contributed to a decline in household savings as well. Finally, 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, all of the above structural factors are to remain, which should in principle push the current account toward a deficit. This consensus view, though, assumes that investment will remain high in China, and this is where we tend to disagree. In fact, investment has remained high artificially as a consequence of consecutive stimulus plans.

Public investment has played an important buffering role every time private investment decelerated because of the worsening economic outlook. This has again been the case since the beginning of 2019, which explains the correction in the current-account surplus toward a deficit but, structurally, investment in China can only go down as the return on assets continues to fall. In other words, expect a smaller – if not negative – current-account balance in 2019, but not later, as investment cannot be maintained artificially high for ever.

The clampdown on tourism expenditure may be the trigger to turn the current-account deficit back to positive, which can only reflect a lower investment ratio down the road, even lower than the reduction in the savings ratio. This, of course, does not bode well for China’s potential but it does explain why China’s widely expected current-account deficit might be short-lived. It might, thus, be wiser to expect a U-shaped current-account balance for China down the road. The US negotiators dealing with China now might not like this, though.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More on this topic
 

Blog Post

A world divided: global vaccine trade and production

COVID-19 has reinforced traditional vaccine production patterns, but the global vaccine trade has changed considerably.

By: Lionel Guetta-Jeanrenaud, Niclas Poitiers and Reinhilde Veugelers Topic: Global Economics & Governance Date: July 20, 2021
Read article More by this author
 

Blog Post

The European Union’s carbon border mechanism and the WTO

To avoid any backlash, the European Union should work with other World Trade Organisation members to define basic principles of carbon border adjustment mechanisms.

By: André Sapir Topic: Energy & Climate, Global Economics & Governance Date: July 19, 2021
Read article More on this topic More by this author
 

Opinion

Could the RMB dislodge the dollar as a reserve currency?

The dollar remains the world’s largest reserve currency, but it is facing both domestic and external risks.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: July 14, 2021
Read about event More on this topic
 

Upcoming Event

Sep
3
09:00

The role of the EU's trade strategy for an inclusive and sustainable recovery

Bruegel Annual Meetings, Day 3 - We are delighted to welcome Valdis Dombrovskis, Executive Vice President of the European Commission for An Economy that Works for People to talk about Europe's trade strategy.

Speakers: Valdis Dombrovskis and Alicia García-Herrero Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read about event More on this topic
 

Past Event

Past Event

Strengthening the weak links: future of supply chains

What new supply chains trends will we see in the post-pandemic era?

Speakers: Ebru Özdemir, André Sapir and Guntram B. Wolff Topic: Global Economics & Governance Date: July 7, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

CCP's 100th Anniversary: Reflecting and looking forward

As the Chinese Communist Party celebrates its 100th anniversary, we looked into the past, future and present of the country's economic development.

By: The Sound of Economics Topic: Global Economics & Governance Date: July 7, 2021
Read article Download PDF More on this topic
 

Policy Contribution

Commercialisation contracts: European support for low-carbon technology deployment

To cut the cost of decarbonisation significantly, the best solution would be to provide investors with a predictable carbon price that corresponds to the envisaged decarbonisation pathway.

By: Ben McWilliams and Georg Zachmann Topic: Energy & Climate Date: July 1, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

Avoiding a requiem for the WTO

The WTO has been 'missing in action': how can we restore the organisation's role as a global forum for cooperation on trade?

By: The Sound of Economics Topic: Global Economics & Governance Date: June 16, 2021
Read article
 

Opinion

Relaunching transatlantic cooperation with a carbon border adjustment mechanism

The best way for the EU and the US to jointly introduce carbon border adjustment would be to form a ‘climate club’.

By: Simone Tagliapietra and Guntram B. Wolff Topic: Energy & Climate, Global Economics & Governance Date: June 11, 2021
Read article More by this author
 

Podcast

Podcast

A transatlantic climate alliance

When Joe Biden visits Europe for the first time as US president, he should begin forging a transatlantic green deal.

By: The Sound of Economics Topic: Energy & Climate, Global Economics & Governance Date: June 11, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

Challenges and growth of China's private sector

Is the dynamic role of the private sector in China under threat by its economic model and the United States?

By: The Sound of Economics Topic: Global Economics & Governance Date: June 9, 2021
Read article
 

Blog Post

For the climate, Asia-Pacific must phase out fossil-fuel subsidies

An exit from coal in the Asia-Pacific region is a global decarbonisation priority.

By: Alicia García-Herrero and Simone Tagliapietra Topic: Energy & Climate, Global Economics & Governance Date: May 31, 2021
Load more posts