The Drivers, Implications and Outlook for China’s Shrinking Current Account Surplus1
China’s current account surplus has declined significantly from its peak in 2008 and the external position is now in line with medium-term fundamentals and desirable policies. While cyclical factors helped in 2018, the trend decline has been largely structural, driven by rebalancing, appreciation of the REER towards equilibrium, increase in outbound tourism, and moderation in goods surplus reflecting market saturation and China’s faster growth compared with trading partners. Policies should focus on continued rebalancing and opening up to ensure excessive surpluses do not return; and to prepare the economy and the financial system to handle more volatile capital flows. From a global perspective, the decline in China’s surplus has lowered global imbalances, with different impact across countries, with the trade balances of Korea, Germany, Brazil improving vis-à-vis China, while that of Japan, India, and Indonesia deteriorating.
A. Trends in China’s Current Account
1. China’s current account surplus has declined significantly from its peak in 2008. While part of the sharp decline in 2018 is cyclical, the trend over the past decade is largely structural, driven by a widening of the services deficit and a moderation of the surplus in goods trade (Figure 1). Even at the bilateral level, the trend has been towards a greater balance, with declining goods trade surpluses with the US and the EU; and declining deficits with Japan, Korea and Taiwan, Province of China. With China’s growth model moving from exports towards consumption, the trend toward a smaller surplus or even a small deficit is likely to stay, with far reaching implications for China and the rest of the world.
Figure 1.China’s Current Account
2. Massive increase in outbound tourism and associated overseas spending has led to a surge in the services deficit. China’s tourism balance, mostly on account of outbound tourism, has swung from a small surplus of around 5bn USD in 2008 to a deficit of nearly 250bn USD in 2018, driven by the increasing purchasing power of the middle class and an appreciating currency. While there is some controversy regarding the measurement of the tourism balance, with some observers opining that Chinese tourist spending is overestimated and reflects disguised capital outflows, the trend is undeniable. It is also borne out by an almost 4 times increase in the number of Chinese outbound visitors – from 46mn in 2008 to 162mn in 2018. While other items such as transport services and royalty payments for intellectual property use have also increased, their contribution and size has been much smaller.
Components of Service Account
Sources: CEIC; and IMF staff calculations.
3. Import of raw materials and commodities have increased, but the surplus in manufacturing remains strong. The trend in the goods balance is more volatile, affected by changes in commodity prices, government policy and stimulus measures – particularly through infrastructure investments – and broader Chinese and global growth prospects. While China has boosted imports of raw materials such as oil and iron ore to feed its domestic economy, its surplus in manufacturing, although sizeable, has plateaued as dividends from joining the World Trade Organization in 2001 have diminished and China already occupies dominant position in many markets. After significantly appreciating for much of this period, the REER has stabilized since 2016, though the relationship between REER and the goods balance is difficult to establish, with other factors such as domestic and external demand playing a more dominant role. The importance of processing trade (see below) and exporters adjustment of costs and profits to offset the impact of changes in REER further diminishes its effect.
Sources: China Customs; Haver Analytics; and IMF staff calculations.
4. Technological upgrade in China and a small share of consumer imports have kept import growth below overall growth. China’s domestic share in final demand (as a share of total value added) has increased through a combination of increased domestic capabilities in manufacturing, partcularly in high-tech sectors, and a desire for self-reliance and import substitution (Figure 2, top panel). In addition to its impact on final demand, it has also resulted in a decline in the share of re-exports as Chinease firms have increasingly been able to move up the value chain and replace imported intermediate goods. While ongoing rebalancing and higher demand for more-expensive consumer goods by the country’s growing middle classes is expected to increase demand for consumer imports, household consumption remains a small part of the overall import basket (Figure 2, bottom panel).
Figure 2.Structure of Imports
5. Although China’s export embody value-added by several countries, the domestic share is increasing as China moves up the value chain. OECD data from 2015 shows that over 80 percent of value-added (VA) in total gross exports is due to China, with Korea and United States accounting for around 2 percent of VA in Chinese exports (Figure 3). In addition, China’s share in VA has been increasing over time as it moves up the value chain, with the increase being particulary rapid for high tech sectors. The gaps in VA shares differ by countries, with the gap between gross and VA exports relatively wider for EU28 compared to that of the United States. Focusing on the United States-China bilateral trade balance, the VA trade balance in 2015, at USD219 billion, was 13 percent lower than the trade balance in gross terms (USD 251 billion). Taking the average of the available years (2005–2015), the value added trade balance is 19 percent lower than the corresponding gross numbers.
Figure 3.Trade in Value Added Terms
B. Drivers Behind the Decline in the Current Account Surplus
6. The fall in China’s current account surplus primarily reflects normalization of domestic saving rate. From a broad macroeconomic perspective, the decline in Chinese current account surplus reflects a gradual and still ongoing normalization of the domestic saving rate, which surged to an extraordinarily high level between 2000 and 2008. Since the peak, a weaker national saving rate, in part due to an ageing population, has decreased the savings-investment gap. While both savings and investment have declined, savings declined at a faster pace than investment, resulting in a fall in the current account surplus from its peak in 2008 to near balance in 2018.
China’s Gross Saving and Investment
Sources: National authorities; and IMF World Economic Outlook.
7. China’s saving rate is expected to continue its downward trajectory as it remains an outlier in terms of the household savings ratio. Despite the decline from its peak in 2008, China’s national saving rate remains much higher than the global average and other countries with similar income levels, creating room for further declines. Much of this is due to very high levels of household savings, resulting from demographic changes induced by the one-child policy; the transformation of the social safety net and job security that occurred during the transition from planned to market economy; and housing reforms and rising income inequality. Corporate and government savings are largely in line with global norms, despite the significant widening of the augmented deficit since the global financial crisis (see Zhang et al, 2018). While adverse demographics and ageing will play a role in bringing household savings down, savings behavior is a slow-moving event and normalization will take time and would depend on the pace and success of rebalancing towards a consumption driven economy. In addition, improving the social safety net and reducing income inequality will be critical to continued decline in saving rate (Figure 4).
Figure 4.Household Savings are Expected to Fall National Saving Rate
Sources: World Economic Outlook; and IMF staff calculations.
8. While policies will play a key role, investment has likely peaked and is expected to decline, albeit at a slower pace than savings. Fixed assets investment in China has been falling as rebalancing continues and the economy slowly switches from investment to consumption (Figure 5). Real estate investment, in particular, has declined from its nearly two decades of above 20 percent growth. It is expected to continue moderating given high vacancy ratios, declining working age population, and slowing migration to cities. As investment growth moderates, Chinese imports for commodities should also decline. However, this decline is expected to be offset by the decline in household savings ratio and the associated demand for consumption imports. Furthermore, continuing reforms and liberalization measures, specifically the lowering of tariffs on imports – according to government estimates, the average tariff ratio has fallen from 9.8 percent in 2017 to 7.5 percent after cuts in November 2018 – will encourage imports and is expected to keep the current account surplus in check.
Figure 5.Investment Has Likely Peaked
9. China’s export market share is already large, making it difficult to continue increasing market share. Historically, Chinese exports have grown faster than trading partner GDP as China has gained market share globally. In 2001, when China joined the WTO, the share of Chinese exports to total world exports was around 4 percent. This more than tripled to 13 percent in 2017. In the case of manufacturing, the corresponding figures are 5 and 17 percent respectively (Figure 6). China is now the largest goods exporter in the world and its share of world exports declined in 2016 and 2017. Exports are therefore likely to grow at the same pace as trading pattern growth, with a slowdown in global trade providing additional headwinds.
Figure 6.China Exports Have Slowed and are Likely to be Outpaced by Imports
10. Given China’s faster growth compared to its trading partners, imports are expected to outpace exports. As the economy rebalances towards greater consumption, as opposed to being export driven, demand for consumer imports and intermediate goods are expected to increase. A part of this can already be seen in the decline in the share of China’s exports and imports as a share of GDP. Although this partly reflects the global trade slowdown, the trend is more pronounced in China relative to other large economies. Taken together, these trends would result in a smaller current account surplus and an overall shift towards a more balanced external position.
Sources: World Bank, WDI.
11. With the declining importance of processing trade and the increasing share of commodities and tourism, China’s current account is likely to be more volatile. Processing trade is a customs arrangement that exempts from tariffs raw and auxiliary materials, parts and components, accessories, and packaging materials imported from abroad with the express intention of re-exporting the finished products after processing or assembly. The share of processing trade has declined significantly as manufactures have shifted towards more local components and flexible trading arrangements, raising the volatility of the current account. For processing trade, exports automatically determine imports as a decline in exports would result in a corresponding decline in imports, leaving the current account largely unaffected. In contrast, the share of primary products, around half of it fuel and petroleum, has increased, which tend to be more volatile and driven by global commodity price cycles. Furthermore, the increase in share of outbound tourism is likely to make the current account more sensitive to currency fluctuations.
China’s Goods Imports
Sources: CEIC; and IMF staff calculations.
12. The sharp decline in current account surplus in 2018 was in part driven by cyclical factors. After recording a deficit in the first half of the year, China’s current account surplus came in at 0.4 percent of GDP in 2018 (down from 1.4 percent of GDP in 2017). The 1 percentage drop in current account surplus was mostly due to a decline in the goods trade balance. In particular, the rise in imports of crude and refined petroleum and integrated circuits can explain close to half of the increase in 2018 imports, which increased by around 0.7 percent of GDP. The rest is mostly explained by lower exports due to trade tensions and weak global demand.
China Imports: Petroleum and Integrated Circuits
Sources: China Customs; Haver Analytics; and IMF staff calculations.
13. The rise in imports was driven by an increase in oil and integrated circuit prices. Oil prices spent much of 2018 in the range of US$70–85/bbl, up from US$55–65 range in 2017. The price increase accounted for close to 80 percent of the increase in petroleum imports, which increased by $80bn or around 50 percent from 2017. Similarly, after years of price declines, the prices of semiconductors surged, pushing up imports by around $50bn compared with 2017, with increase in prices accounting for around 60 percent of the increase in integrated circuit imports in 2018 (Figure 7).
Figure 7.Rise in 2018 Imports Driven by Prices
14. Summary. Since its peak, China’s current account surplus has been declining due to structural factors, namely,
- increase in outbound tourism; and
- moderation in goods surplus due to market saturation and growth diffrentials with trading partners.
But the 1 percent decline in 2018 was in part driven by cyclical factors.
- Price impact of oil and semiconductor prices on import is estimated to be 0.4 and 0.2 percent of GDP respectively.
- Impact on CA likely to be smaller (due to higher export prices) and is estimated at around 0.4 percent of GDP.
China’s Current Account
Sources: CEIC; and IMF staff calculations.
C. The Current Account in China—Looking Ahead
15. Over the medium term, under the baseline of continued rebalancing, the current account is expected to remain close to balance. Going forward, the small current account surplus recorded in 2018 is expected to turn into a small deficit as the structural factors outlined above continue to drive up imports and moderate exports. Specifically, the baseline assumes:
- Import demand increases as savings fall faster than investment – a rise in share of private consumption
- Export growth slows due to market saturation and continued higher growth in China relative to trading partners
- Benign outlook for commodity prices
- Tourism deficit increases in line with GDP
- No significant change in income account and the structure of assets
- Unless trade tensions escalate markedly, they are not expected to have a large impact on CA with offsetting effects on exports and imports. The impact of tensions in the area of high-tech exports is beyond the scope of this paper and is not taken into account in the baseline.
China’s Current Account Projections
Sources: CEIC; and IMF staff calculations.
16. Despite sizeable foreign assets, China’s income account remains in deficit. This is because less than 30 percent of China’s external assets consist of higher yielding risky assets such as direct and equity portfolio investment. Most assets comprise of lower-yielding investments such as international reserve assets, trade credit, and foreign currency deposits. In contrast, 70 percent of China’s external liabilities comprise of riskier and therefore higher (expected) return instruments such as direct and portfolio equity investments. While this has been a long-standing feature of China’s International Investment Position, a significant shift in the asset composition can lead to a higher return on assets and push up the current account surplus via the income account. Some of this is already underway, with the share of direct investment abroad in total assets increasing steadily from less than 5 percent in 2007 to around 26 percent in 2018.
|USD bn||%||USD bn||%|
|International assets||7,324||International liabilities||5,194|
|Reserve assets||3,168||43.3%||Direct investment in China||2,762||53.2%|
|Equity portfolio investment||684||13.2%|
|Debt portfolio investment||228||3.1%||Debt portfolio investment||412||7.9%|
|Trade credit||597||8.2%||Trade credit||393||7.6%|
|Currency and deposits||394||5.4%||Currency and deposits||483||9.3%|
|Equity portfolio investment||270||3.7%|
|Net international assets||2,130|
17. Current account deficits could emerge if growth surprises on the upside. Commodity prices, particularly oil prices, are expected to remain moderate in the baseline. However, if they turn out to be higher than projected, it can materially shrink the goods surplus and lead to higher current account deficits. At the same time, higher than projected growth – via domestic demand or credit – would increase imports and push up the current account deficit. Complicating the analysis is the fact that China is not a price taker in commodities market – higher Chinese growth would push up commodity prices, further pushing up imports. Furthermore, although the tourism deficit has been stable as a percentage of GDP over the last few years, and there is some evidence of a slowdown, it is nevertheless plausible that tourism may pick up further as per capita incomes rise and grow faster than GDP. Real appreciation, beyond those warranted by fundamentals, can boost imports and increase the current account deficit, as can higher than projected IP payments.
18. Lower growth or a slowdown in rebalancing can lead to higher current account surpluses and a return of external imbalances. Lower growth can decrease import demand and increase the current account surplus. This is particularly the case if, unlike in the past, offsetting stimulus is via tax cuts, which are likely to have lower import intensity compared with higher public and quasi-public investment in infrastructure. A slowdown or reversal in rebalancing and a return to high savings and less consumption has the potential to undo the progress made in correcting external imbalances. Finally, faster progress in import substitution through initiatives like Made in China 2025 or technology upgradation – e.g. semiconductors – can lower import demand and increase global market share, increasing the current account surplus. In addition, greater availability of high-end and luxury products in the domestic market can diminish overseas spending by Chinese tourists, thereby moderating the services deficit and pushing up the overall current account.
19. Policies should focus on continuing rebalancing and accelerating opening up to ensure excessive surpluses do not return. On the domestic front, rebalancing efforts should continue and be accelerated to increase consumption demand. Regulatory and supervisory reforms should continue to stabilize leverage and pursue “debt neutrality” with SOEs. Made in China should focus on “comparative advantage” and not “import substitution”. At the same time, China should deepen and accelerate opening up and continue to support the international trading system that has benefitted China and the world. Concretely, this would involve further reduction in import tariffs and increased trade openness; further opening up of the service sector; liberalization of restrictions to trade and investment regime; and addressing structural issues such as intellectual property enforcement
20. While the end of large current account surplus has moved the Chinese economy towards equilibrium, it has also diminished a source of global savings, with implications for the Chinese and global economy and internationalization of the RMB. The large current account surplus in China contributed to the global savings glut, pushing down long-term yields. With an end to large surpluses, less global capital will likely to be available for US debtors and other ODI, which can contribute to higher long-term yields. At the same time, the large current account surpluses have meant a steady flow of capital into China, providing a large cushion of foreign exchange reserves and the countercyclical tools to offset any slowdown or shocks. Going forward, without this backstop, more volatile components of the financial account, such as portfolio capital flows are likely to have a much larger impact, particularly as FDI becomes less important. This would likely mean less flexibility for economic and currency management in China and the Renminbi exchange rate may become more volatile and sensitive to capital flows. China, however, could support more stable capital inflows by encouraging the internationalization of the RMB. For example, China might sell more bonds to foreign investors – including to long term investors such as pension funds – or settle transactions in RMB (instead of USD). This would increase the availability of RMB assets for foreigners and make it available and used more widely, but would also require more flexibility and transparency in the management of the RMB.
RMB Volatility vs Current Account
Sources: National authorities; CEIC; and IMF staff calculations.
21. The financial system needs to prepare to handle greater volatility and larger capital inflows. The authorities should continue with financial de-risking and associated micro and macro-prudential reforms. At the same time, policy should focus on encouraging higher quality, stable and diversified inflows by further opening up of the capital account; transparency and regulatory reforms to adhere to international standards and encourage investment by institutional and long-term investors – e.g. reforms to the ratings industry; increase availability of internationally traded instruments; continued RMB internationalization; and a more diversified external asset portfolio to generate higher returns. The currency should also be allowed to respond more to short-term moves and allow for greater two-way flexibility of the exchange rate.
D. International Impact of China’s Declining Current Account Surplus
The Global Perspective
22. As a share of global GDP, China’s current account imbalance has declined and is expected to continue to shrink. Peaking at 0.66 percent of global GDP in 2008, China’s current account surplus has declined to 0.06 percent of global GDP in 2018 and is currently lower than other major surplus countries like Japan and Germany. Going forward, the current account is expected to continue to decline, reaching about -0.01 percent of global GDP in 2024.
Current Account Balances, 2000–2024
Source: IMF, World Economic Outlook.
23. Further declines in the current account surplus will reduce excess global imbalances—a positive development for global stability. China has historically run an excessive current account surplus, with the actual (cyclically-adjusted) current account deemed to be higher than its underlying norm—the level consistent with the country’s fundamentals and desired medium-term policies. As the second largest economy of the world, the country’s excess current account surplus was one of the highest contributors to global excess current account surplus, reaching a peak of around 0.3 percent of global GDP in 2015. The projected decline in China’s current account surplus should narrow global excess imbalances (Figure 8). To the extent that large and sustained excess external imbalances in the world’s key economies pose risks to global stability, a continued decline in China’s excess external imbalances will thus be a positive step towards reducing global imbalances and strengthening the international monetary system.
Figure 8.China’s Current Account from a Global Perspective
The Individual Country Perspective
24. Some Asian economies have benefitted from China’s current account decline… In line with China’s rapid increase in imports of computers, electronics, and electrical equipment, the trade balance vis-à-vis China—in both gross and value-added terms—has improved the most for Asian economies exporting those items to China (Taiwan Province of China, Singapore, and Korea). The rise in Korea’s trade balance—supported by the depreciation of the currency vis-à-vis renminbi towards end of 2007—has been predominantly due to electronics exports, which constituted 41 percent of total exports to China in 2017, up from 28 percent in 2008.
Change in Gross and Value Added Trade Balances vis-à-vis China
Sources: OECD TiVA; IMF, World Economic Outlook; and IMF staff calculations.
25. …while the trade balance of others (e.g. Japan, India, Indonesia) deteriorated. Notably, Japan’s trade balance with China, though improving in recent years, deteriorated by around USD 33bn in the period 2008–2015—equivalent to a decline of 0.7 percentage points, when expressed as a share of Japan’s GDP. Japan’s imports from China, owing to items like electronics and textiles, outpaced exports, where the sales of electronics—the country’s top exports to China—slowed down possibly due to China’s own increase in high-tech electronics production.
26. Outside Asia, Germany’s trade balance with China improved markedly, predominantly due to the rise in exports of motor vehicles and machinery. The share of vehicles—Germany’s top exports to China in 2017—increased to 24 percent of Germany’s total exports to China from 15 percent in 2008. In addition, the commodity exporters (Brazil, Australia) witnessed higher trade balances with China. For the U.S. and Canada, gross trade balance with China improved marginally while the value-added trade balance deteriorated moderately.
27. Advanced economies (e.g. U.S., New Zealand, Japan) have the potential to increase exports to China. The two sectors that have contributed towards China’s import growth are electronics and services (to be more precise, distributive trade, transport, accommodation, and food services). The combination of the revealed comparative advantage of economies in these sectors (economies have an edge on exporting these products compared to others) and the current exposure to China in these sectors (economies have an existing relationship) provides a simple metrics of gauging which economies can benefit from China’s rising imports (Figure 9).
- Focusing on electronics, some Asian economies (Taiwan Province of China, Korea, Malaysia, Philippines) have both high revealed comparative advantages and significant exposure to China. Hence, these economies are likely to benefit if China’s import growth in electronics continues. However, the exposure to China’s final demand for these products is less than exposure to China’s imports—hence, the benefits may not be as high as the gross numbers indicate.
- Some Asian economies (Hong Kong SAR, Singapore, Thailand) have high comparative advantages and high exposure, while some of the advanced economies (U.S., New Zealand, Australia, Japan) have comparative advantages as well as decent exposure to China’s growing imports in services. To the extent that the advanced economies have some existing relationship but relatively low exposure, there is potential for these countries to increase exports in this area.
Figure 9.Exposure to China’s Growing Import Industries
28. Potential to increase exports may not necessarily translate into higher trade balance—some economies may have strong imports from China, which would act as an offsetting force. Countries like India and Philippines are expected to have strong domestic demand growth in the medium-term, while Hong Kong SAR, Korea, and Thailand have significant import exposure as well as domestic demand increase in the medium-term. Outside Asia, the expected domestic demand growth of advanced economies like Germany, Canada, and the U.S. could also translate into high import growth from China.
Domestic Demand Growth (2020–2024) vs. Import Exposure to China
Sources: OECD TiVA; and IMF staff calculations.