from Follow the Money

It will be difficult to rebalance the global economy if Chinese exports keep growing at 30% …

February 12, 2007

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Evaluating Chinese trade data in January and February is hard, since the timing of the Chinese new year varies.   But the January data didn’t provide much evidence that the pace of China’s export growth is slowing.  With export growth in q4 (and so far in q1) running at around 30% y/y, China’s already large trade surplus looks set to get even bigger in 2007.  

That shouldn’t be a shock.  When China starts to worry about overheating and begins to restrict bank lending, investment growth – which is a big component of domestic demand – slows.  The result is a bigger current account surplus, especially since the RMB remains weak in real terms.  I expect China’s 2006 current account surplus to come in at around $240b – and the 2007 surplus, on current trends, to rise above $300b.

Add in $70-80b of FDI inflows and perhaps a bit of hot money attracted by China’s roaring stock market and expectations of a faster move in the RMB, and well, it is easy to see how China might need to add $400b to its foreign assets next year.  If all those assets showed up on the PBoC’s balance sheet, Chinese reserves would approach $2 trillion by the end of 2008, not in 2010 … 

No wonder there is talk of giving a new state investment company $200b of seed money – and intensive efforts to encourage Chinese state pension and life insurance companies to invest more money abroad. 

Now there is a little bit of a puzzle, since the available data from h2 suggests that hot money moved out of China.   Reserve growth (adjusted for valuation) lagged FDI inflows and the estimated current account surplus (see Florian Gimbel, who cites work by Standard Chartered).  

I don’t buy it.   Not really.   Stephen Green has done the sums correctly.   But a story based on hot money outflows in the second half of 2006 doesn't hold together very well.  

China seems to have had a part time convincing individual investors to participate in the qualified domestic institutional investor program.  And the same factors that made it unattractive for Chinese investors to hold foreing bonds (the booming stock market and RMB appreciation) also made it attractive to move offshore funds back into China.

I would guess that there were hot money inflows, especially in the fourth quarter, but that these inflows were offset by outflows from the state banks, state insurance funds and the like.   The PBoC probably took the sting out of this, at least for the banks, by doing currency swaps.  Swaps allow the state banks to invest abroad without taking the exchange rate risk.   We won’t know for a while, but this is a story that fits reasonably well with the h1 data ($45b in purchases of foreign debt by “private” investors -- likely the state banks and state insuranance funds -- in China) and the anecdotal data from h2 (lots of interest in moving funds into China).

And I don't particularly see what is likely to change this in 2007.  

China’s surplus looks poised to rise.  The oil importing countries are upping the spending, big time – and China is doing very well in most of these markets.  In real terms, the RMB remains very weak, as the dollar’s fall v. the euro in 2006 offset the late 2006 increase in the pace of RMB appreciation.  Chinese exporters are doing very well.

That should encourage China's government to allow a bit more RMB appreciation, which will only pull more funds into China.

And if commodity prices are stable, well, one of the big sources of the recent growth in China’s import bill may dissipate.  That, though, certainly wasn’t apparent in the January data: China seems to have stocked up on oil, big time, in January – with near record oil import volumes offsetting lower prices.   Over time, though, stable oil and commodity prices could slow the pace of China’s import growth.

The same broad story holds for Japan.   With oil rising in dollar term and the yen weakening, oil has soared in yen terms.    I suspect the rising oil import bill explain why Japanese imports growth has been relatively strong over the past few years (data, in yen, here) – offsetting soaring exports.    The November data may provide a hint of what is to come.  Import growth slowed dramatically …  exports, not so much.   Toyota is doing very well in North America – and at the current exchange rate, it doesn’t have much incentive to really push hard to increase its production in the US.      

If oil is stable at around $60 a barrel this year, the surplus of the oil exporters should fall.  But rather than reducing the US deficit, the combination of stable oil prices, rising oil country imports and weak real exchange rates in China and Japan may just shift the world’s current account surplus away from the Middle east and Russia and back toward East Asia.   With Japan, the growing carry trade will bring that surplus over to finance the US deficit – sometimes via Brazil’s central bank (private investors borrow yen to buy real, while Brazil’s central bank buys dollars for real to keep the real from appreciating – leading to an offsetting outflow from Brazil to the US).   With China, there isn’t a well-established carry trade.  Not really.   And I suspect it will be hard to get one started so long as the RMB is rising and expected to rise more.  So a state institution – whether the SAFE, a new State investment authority or various state banks and state pension funds – has to add to its foreign assets.  

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