China’s current account balance paints a worrying picture. The world’s largest economy, which charted its way to glory through enormous net savings, could soon become a net borrower if its current account surplus continues to fall the way it has since the 2008 global financial crises.
The country’s current account balance, which assesses its net income, international transfers of capital, direct payments, as well as its imports and exports of goods and services, has plummeted from surplus peaks of about $450 billion or 9.9 percent of its GDP in 2008 to about $50 billion or 0.4 percent of its GDP in 2018.
Forecasts from the International Monetary Fund (IMF) are even more ominous. The IMF projects that although the nation’s current account surplus will increase marginally to $60 billion in 2019, it is likely to fall further to $20 billion in 2021, before posting a current account deficit of more than $6 billion in 2022.
“China is changing. Its current account is about to turn negative, meaning its economy will be increasingly dependent on foreign capital to continue growing. This has potentially far-reaching implications, not just for China, but for the U.S. and the rest of the world,” says Tom Elliott, a Senior International Investment Strategist at deVere Group, one of the world’s largest independent financial advisory organizations.
China’s current account surplus is important because, for more than 25 years, the country has been able to use its domestic savings to subsidize export factories and invest in overseas assets including U.S. Treasury bonds and London property in an attempt to improve its export competitiveness. However, with the current account surplus steadily decreasing, the nation doesn’t have this safety net anymore. In fact, President Xi Jinping is attempting to switch to consumption as a means of growth rather than constantly relying on investments and savings when growth weakens.
China’s government, its households, and its corporate sector, which are the prime pillars of China’s economy, are saving much lesser than they used to. Diminishing business profits, losses on foreign exchange reserves, and higher consumer spending aren’t helping. With major projects in the pipeline and big infrastructure goals, China’s investment requirements could soon outweigh its domestic savings. This means that China could soon become a net borrower placing pressure on the yuan and the exchange rate.
“In 2018, Chinese visitors spent $240 billion more abroad than foreign visitors spent in China, thanks in part to their lavish spending habits. China has become wealthier, and a growing middle class has the cash to spend,” Elliott says.
But this isn’t necessarily indicative of a healthy economy.
“First, the growth in the export of goods has not kept pace with the growth of consumer imports. China’s deficit in traded goods with Japan and South Korea has grown. Second, a huge increase in Chinese tourism abroad has occurred over the last decade which has increased the persistent deficit in services,” Elliott adds.
Although China has boasted a goods trade surplus of $400 billion its current account balance has been pulled down by a services trade deficit of close to $300 billion.
China's current account surplus in relation to its goods and services trade (Source: Bloomberg)
“Domestically, the Chinese authorities have responded to the change in the current account by opening China’s capital markets to foreign investors, to help boost inflows of foreign capital,” Elliott says.
However, the renewed U.S.-China trade war has only made matters worse. U.S. President Donald Trump’s decision to increase U.S. tariffs on imported Chinese goods is expected to reduce China’s growth rate by 1 percent.
“The 25 percent tariff imposed by the U.S. on $500 billion worth of Chinese imports will accelerate this trend. As China stops being a large buyer of U.S. Treasuries, America’s budget deficit is ballooning and will be just short of $1 trillion this fiscal year. The combination is negative for U.S. Treasuries and may help drive up U.S. and global bond yields. Investors around the world may see higher global borrowing rates, from car loans to mortgages, because of the end of the Chinese savings glut. This could trigger a global economic downturn,” Elliott says.
“China’s – and therefore the world’s – economy is changing. But remember, wherever there is disruption there will be winners. As such, investors should remain diversified, geographically and by asset class – that’s to say, maintaining exposure to equities and bonds, from as many different issuers as possible – in order to protect their savings from this uncertainty and capitalize on the opportunities that will inevitably present themselves,” Elliott concludes.