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A healthy international balance of payments is now a significant aspect of macroeconomic management. It is becoming increasingly important for keeping the Chinese economy on the track of rapid and sustained growth.
The surplus in China's international payments is caused by many complex reasons.
Internationally, globalization is the main reason. A new round of structural reforms started in industrial nations in the 1990s. China's opening-up made it a major destination for industrial manufacturing transferred from these countries. As a result, foreign-funded enterprises, many of them engaged in processing trade, became the main force in China's export growth. During the 1993-2002 period, these firms' exports grew by an average 23.6 percent annually, as compared with the national average of 15.1 percent. During the first nine months of this year, foreign-funded companies accounted for 54.1 percent of exports.
Processed goods accounted for 78.8 percent of their exports.
This situation explains China's surplus in both foreign direct investments and trade.
If the volume of processed goods is included, China's trade surplus is US$61.8 billion from January 2000 to September 2003. But if it is excluded, China ran a US$102.9 billion trade deficit during the same period.
Some developed countries' restrictions on exports to China have further expanded the nation's trade surplus. China has a huge demand for technology-intensive products. But some developed countries create many obstacles for domestic companies that export to China, citing national security concerns as an excuse.
The unreasonable international financial system is also a reason for the growth of China's foreign exchange reserves. There is no last creditor in the current international currency system. This means that a big developing country like China will not be able to look to anybody for help in a financial crisis. So developing countries, including China, have accumulated huge foreign exchange reserves to safeguard against financial risks.
Domestically, China's international balance of payments surplus reflects the imbalance between fast economic growth and lagging structural reform. In some sectors, China is producing too few goods to meet market demand, while in other areas there is an oversupply of products, insufficient demand and employment problems.
If a country has abundant savings but relatively low effective investment and consumption, the surplus in its savings will certainly transfer out of the country. This will further enlarge its international balance of payments surplus.
China's long-term aim is to have a balance in international payments, with a small surplus. It was not China's intention to accumulate its current big surplus. This issue cannot be resolved by China alone.
Downside of surplus
The surplus can be an advantage for the Chinese economy, but it can also cause trouble. When there is a difference between interest rates of local and foreign currencies or when the value of local currency is anticipated to fall, a significant exodus of funds can occur and bring about a financial crisis.
The surplus can also affect the management of the domestic economy. The central bank's purchase of foreign exchange with renminbi has become a major source of money supply. This will narrow the room for the central bank to use monetary policy as a tool. Relaxed currency supply will result in inflation or economic bubbles.
Developing countries with large foreign exchange reserves, including China, find that these reserves flow back to developed nations.
This can be seen as an inefficient use of the funds. The big volume of foreign exchange also means big risks and difficulties in management of this money.
In addition, Chinese enterprises' over-reliance on price competitiveness will affect their process of product and technological upgrades, branding and the improvement of other non-price factors.
The result is developed countries can enjoy cheap Chinese products while using measures such as anti-dumping taxes to create troubles for Chinese exporters.
China's international balance of payments will eventually change.
It is likely the country will register a deficit under the current account. Observers should look not just at China's trade relations with one or two other countries but with multiple countries. The probability of a deficit is growing as the country's foreign trade sector develops. China has already seen a few month's trade deficit, in the first half of 2003.
For a developing country with a rapidly growing economy and huge foreign direct investment, the emergence of a trade deficit is possible. It is even necessary. As long as the capital influx under the capital account is maintained, an appropriate level of trade deficit is beneficial to better resources allocation. But the preconditions are that economic structures must be adjusted, domestic demand stimulated and foreign countries lift their restrictions on exports to China.
However, the fast growth of foreign direct investment will not continue forever. This year the investment growth rate has declined. We are still not sure whether it is a temporary phenomenon or the start of a long-term trend. But the transfer of manufacturing capabilities will slow down some time in the future. So in the long term, foreign investment in manufacturing could fall. Although China has a promising service sector, the funds this sector needs is limited. In addition, foreign companies now have a growing opportunity to raise money within China. And possible fluctuations in the US dollar's interest rate could raise expectations of exchange rate changes and lead to fund outflows.
Policy options
China needs a balanced economy, both internally and externally. If China continues to have trade surpluses in the future, the country will need to take adjustment measures. Theoretically, five options are available. But in practice, the outcome of these choices will differ greatly. Some have major defects, so not all are applicable.
Increasing imports
Increases in imports can accelerate technical upgrades and introduce talent and management expertise. But this should not be achieved through administrative orders. Instead, it should flow from structural reforms and the expansion of domestic demand. It should be decided by businesses and the market. As the country's surplus is smaller now, a moderate increase in imports cannot solve the problem fundamentally.
Suppression of exports
Some experts suggest artificially imposing obstacles on exports. But this defies the principle of a market economy and free trade. As a big economy, China should rely mainly on domestic demand. The ratio of exports to the economy will decline, but the sheer volume of China's exports means they will remain a major economic driver. Furthermore, China's exports are closely related to its imports. Suppression of exports will also dampen import growth.
Reducing capital inflow
The key to capital inflow management should be the control of short-term capital flow and the prevention of money flow for speculative profits. But the reduction of direct investment is not advisable. China is not short of funds, but foreign direct investment can bring in technology and market opportunities and can facilitate structural reforms. We should continue to use these investments. In the meantime, we should help create more channels for foreign companies to raise funds in China to alleviate the pressure from huge capital inflow.
Encouraging capital outflow
China has been encouraging the influx of capital. This, along with rapid growth of domestic deposits, has resulted in capital redundancy. International experience indicates that encouraging capital inflow while discouraging capital outflow can increase the risk of economic bubbles. China is relaxing capital outflow restrictions. But these control should not be annulled completely. An active and prudent attitude is needed in taking such measures.
Increasing exchange rate flexibility
Some countries have urged China to revalue the renminbi, citing China's surplus as a reason. There are lots of misunderstandings on this issue. In theory, the appreciation of a currency will suppress exports and capital inflow, and stimulate imports and capital outflow. But in reality, an exchange rate's influence is determined by different factors. It has been said that China's surplus arose mainly because labor-intensive industries moved to China. This trend is not likely to change due to the movement in renminbi's exchange rate. On the trade front, our observation is that, in China, the relationship between the development of the trade sector and the exchange rate is not close. Export growth is mainly affected by the global economic environment and import growth is mainly affected by domestic demand.
The adjustment of the yuan's value cannot solve developed countries' trade imbalances and their domestic economic problems.
The United States' deficit in trade is mainly caused by domestic structural problems such as a low savings rate. The International Labor Organization estimated that China's labor cost is equivalent to 3 percent of the US figure. So even if China's labor costs double as the result of renminbi revaluation, the US high labor costs will still be an obstacle.
Another factor that needs attention is the exchange rate's impact on the economy. If the renminbi appreciates drastically, China's trade surplus will drop greatly. But the huge change in exchange rate could have very negative effects for a country with an incomplete market mechanism. It could also have a negative impact on the regional economy and the global economy. No country can benefit from a chaotic or stagnant Chinese economy.
So the stability of renminbi's value should be maintained.
On the other hand, artificially low prices of land and labor do exist in some regions of China due to illegal practices by some companies. These problems will be rectified.
The most feasible policy option for the Chinese Government in addressing the surplus in international balance of payments is to support exports while encouraging imports; increase channels for capital outflow in a prudent manner; perfect the mechanism for setting the renminbi's exchange rate and maintain the stability of the currency in a reasonable and balanced manner.
To conclude, the improvement of China's international balance of payments relies not only on economic sectors that have transactions or direct relations with the outside world. It also relies on domestic structural adjustments and expansion of domestic demand. In addition, it depends on international economic and financial developments and foreign countries' economic policies toward China. Such improvements should also be compatible with other domestic reforms and adapt to changing circumstances.
The author Guo Shuqing is director-general of the State Administration of Foreign Exchange and vice-governor of the central People's Bank of China
(China Daily November 17, 2003)
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