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China’s dwindling current account surplus received a lot of attention in 2018. In the first quarter, China recorded the first current account deficit in 17 years. The fall in the surplus follows a large capital outflow between 2014 and 2016, stoked by the devaluation of the renminbi (RMB). The threat of a full-blown trade war between the US and China, coupled with a cooling domestic economy, led to renewed weakness in the currency. In the midst of this turbulence, investors are allocating more and more funds to China, especially to China’s onshore bond market. These developments are all, directly or indirectly, related to the balance of payments of China.

In this paper, we look at the key developments in the balance of payments and what effect these developments could have on the value of the RMB. For investors, the inclusion of China in various global benchmark indices means that the currency will not just have a second-round effect on returns through global risk sentiment, but will directly affect the value of RMB denominated assets. Thus, it is important to understand the drivers that could move the currency in either direction. Specifically, we are trying to find the answers to the following questions:

  • What is causing the fall in the current account surplus?
  • What does the falling surplus tell us about China’s economy?
  • Has the capital outflow from China picked up again?
  • How is the composition of the capital account changing?
  • What are the options for the People’s Bank of China (PBoC) to defend the RMB?

The message from the falling current accounts surplus

Fluctuations in China’s current account surplus over the last 20 years have been truly spectacular. The surplus increased from 1.3% of GDP in 2001 to over 10% in 2007 (Figure 1). After a sharp fall following the global financial crisis, the surplus stabilised at around 2%. However, in Q1 2018, the current account fell into deficit for the first time since 2001. While the deficit could have partially been explained by seasonality, the subsequent quarters have shown that this was not a blip. The rolling four-quarter surplus was just 0.4% in Q4 2018.

Figure 1: China’s current account surplus has evaporated

China current account balance, %GDP

Source: Schroders, Thomson Reuters Datastream. Data as at Q4 2018


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