Opinion leader 丨Guan Tao Liu Lipin
Excerpt
In the second quarter, China's balance of payments continued to show a balance pattern of current account surplus and capital account deficit, the valuation effect of RMB appreciation pushed up foreign financial liabilities, short-term foreign debt increased but the risk was generally controllable, and it is expected that the Fed Taper will have a limited impact on China's foreign economic sector.
In the second quarter, the current account surplus continued to decrease sequentially, and its share of GDP remained in a reasonable range, of which the trade surplus in goods changed less, and the trade in services deficit and the primary income deficit widened.
In the second quarter, the capital account deficit narrowed significantly, mainly because his investment turned from a deficit to a surplus; net errors and omissions turned negative again, and the online capital account after excluding the item was a surplus.
In the second quarter, the basic balance of payments surplus led to an increase in reserve assets, and the short-term capital deficit accounted for the basic balance of payments surplus fell in the first quarter compared with the first quarter, indicating that the impact of the "shrinkage panic" caused by the surge in US Treasury yields in the first quarter was alleviated.
As of the end of June, China's foreign financial assets and liabilities have increased, and foreign net assets have decreased, mainly affected by non-transaction factors. Among them, the valuation effect of RMB appreciation contributed more than 80% of the increase in external liabilities caused by non-transaction factors in the same period.
In the second quarter, the rate of return on China's foreign investment and the cost ratio of foreign capital increased relatively smallly from the previous quarter, but both increased significantly compared with the first quarter of last year, mainly because the proportion of securities investment and other investment in foreign financial assets increased, reflecting the relatively abundant domestic foreign exchange liquidity and the increase in the demand for diversified allocation of domestic main assets; the proportion of securities investment in foreign financial liabilities increased, reflecting that China's economy took the lead in recovering after the outbreak of the epidemic, and the return on RMB assets was better.
In the second quarter, China's external debt balance increased. In terms of term structure, short-term external debt is the main contributor; short-term external debt as a proportion of foreign exchange reserves has risen, continuing to hit a new high since 1994, but still below the international warning line of 100%, indicating that external debt serviceability is still sufficient. From the perspective of currency structure, the contribution rate of foreign currency and local currency foreign debt to the increase in external debt balances is roughly equal, and the valuation effect of RMB appreciation contributes 23% to the increase in local currency foreign debt balances.
In the second quarter, the scale of private sector net external liabilities further increased, but non-transaction adjustments contributed 69%. Considering that the current private sector currency mismatch has improved significantly, and the market's tolerance and adaptability to exchange rate fluctuations has increased significantly, it is expected that the Fed Taper will have a limited impact on China's foreign economic sector.
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On September 30, the State Administration of Foreign Exchange (SAFE) announced the official figures of the balance of payments for the second quarter of 2021 and the international investment position statement at the end of June 2021. Combined with the existing data, the analysis of China's balance of payments in the second quarter is as follows.
The current account surplus continued to narrow, mainly due to trade in services and widening primary income deficits
In the second quarter, China's balance of payments continued to show an independent balance pattern of current account surplus and capital account deficit. Among them, the current account surplus was US$53.3 billion, the capital account (including net errors and omissions) deficit was US$3.3 billion (below, if not specifically referred to below, the capital account differences include net errors and omissions), and foreign exchange reserve assets increased by US$49.9 billion (see Chart 1).
The current account surplus continued to decline sequentially, and its share of GDP remained within a reasonable range. In the second quarter, the current account surplus was $53.3 billion, continuing the downward trend in the first quarter (see Chart 2). From the perspective of the expenditure method, the pulling effect of external demand on economic growth is tending to weaken. In the second quarter, the current account balance as a proportion of nominal GDP in the quarter was 1.2%, down 0.6 percentage points from the previous quarter; the annualized current account balance as a proportion of the annualized nominal GDP was 2.1%, down 0.4 percentage points from the previous quarter; and the two remained in a reasonable range of ±4%, indicating that the RMB exchange rate was at a balanced and reasonable level (see Chart 3).
The surplus of trade in goods changed less sequentially, and the drivers of import and export growth were different. In the second quarter, the balance of payments surplus in trade in goods was US$119.5 billion, an increase of only US$800 million from the previous quarter. Among them, the export of goods was 762.2 billion US dollars, an increase of 9.8% month-on-month, an increase of 26.8% year-on-year; the import of goods was 642.7 billion US dollars, an increase of 11.7% month-on-month, an increase of 43.6% year-on-year (see Chart 4). According to the import and export price index and quantity index published by the General Administration of Customs, we can calculate the contribution rate of quantity and price changes to the year-on-year increase in import and export value. The results show that in the second quarter, the average contribution rate of export quantity and price to the growth of export volume was 108% and -8%, respectively, reflecting that exports mainly benefited from the recovery of overseas demand and the continuation of export order transfer dividends; but the average contribution rate of import quantity and price to the growth of import volume in the second quarter was -106% and 206%, respectively, reflecting that imports were mainly affected by the rise in international commodity prices (see Figure 5).
The trade deficit in services widened sequentially, with transport services being the main contributor. In the second quarter, the services trade deficit was $28.3 billion, up $6.1 billion sequentially. Among them, the travel deficit of US$20.2 billion, a decrease of US$4 billion (travel expenditure decreased by US$3.6 billion), has been reduced for three consecutive quarters, hitting a new low since 2014, mainly due to the significant increase in new confirmed cases worldwide (excluding China) caused by delta virus mutation since April, which further restricts residents' overseas travel (see Charts 6 and 7). In the quarter, the transport services deficit of US$10.2 billion, an increase of US$6.7 billion sequentially, was the main reason for the widening of the trade in services deficit, with transport revenue and expenditure of US$26.1 and US$36.3 billion respectively, both of which hit new highs since the data was published and may reflect the impact of rising international transport costs (see Charts 7 and 8).
The primary income deficit widened sequentially, mainly due to the widening of the investment income deficit. In the second quarter, the initial revenue deficit was $42.2 billion, an increase of $12.8 billion sequentially. Among them, the difference between employee compensation and other primary income was smaller, increasing by only 980 million and US$570 million respectively, and the investment income deficit widened from US$28.6 billion in the first quarter to US$43 billion, contributing 112% of the increase in the primary income deficit (see Chart 9). In the second quarter, the income from foreign investment and the income from foreign investment were 83.7 billion yuan and 126.7 billion US dollars, respectively, both of which hit a new high since the data was released (see Chart 10).
The capital account deficit has narrowed significantly, and the conversion of other investments into surpluses is the main contribution
The capital account deficit narrowed significantly, and the online capital account turned into a surplus. In the second quarter, the capital account (net errors and omissions) deficit was US$3.3 billion, a decrease of US$31.1 billion sequentially (see Chart 11); the surplus of non-reserve capital accounts (i.e., online capital accounts) excluding net errors and omissions was US$63.3 billion, meaning that the current account and online capital account had a "double surplus" in the second quarter. This is the fourth time since 2018 that there has been a "double surplus", the first three times being the third quarter of 2018 and the first and fourth quarters of 2019 (see Chart 12).
The direct investment surplus narrowed and the securities investment surplus widened. In the second quarter, the direct investment surplus was US$45.6 billion, down US$30.1 billion sequentially. Among them, of which OFDI increased by US$11.9 billion and FDI decreased by US$18.2 billion, both of which are seasonal fluctuations, in line with historical laws, and the scale of FDI in the first and second quarters is significantly higher than in previous years, reflecting the continued confidence of foreign enterprises in China's economy (see Chart 13). In the quarter, the securities investment surplus was $16.2 billion, an increase of $12.7 billion sequentially, but the increase was smaller than the narrowing of the direct investment surplus. Among them, foreign securities investment decreased by US$44.7 billion (including equity investment decreased by US$46.9 billion and bond investment increased by US$2.2 billion), mainly reflecting the impact of the correction of Hong Kong stocks and the decrease in net purchase transactions of Hong Kong Stock Connect; foreign securities investment decreased by US$32 billion (including us$18.4 billion in equity investment and US$50.4 billion in bond investment[1]), reflecting that China's stock market inflows remained strong, but the attractiveness of the bond market for foreign investment weakened (see Chart 14).
The slowdown in the net increase in foreign holdings of RMB bonds is mainly related to the continued narrowing of domestic and foreign interest rate differentials. In the second quarter, the 10-year U.S.-China Treasury yield spread of 154 basis points per day narrowed by 33 basis points (see Chart 15) from a 50 basis point decline in the previous quarter, and foreign investors increased their holdings of domestic RMB bonds by 185.5 billion yuan through Bond Connect, a further decrease of 117.9 billion yuan on the basis of a decrease of 10.9 billion yuan in the previous quarter (see Chart 16).
Other investments turned into surpluses, which were related to a decrease in net outflows of foreign currencies and deposits and loans (i.e., net access to assets). In the second quarter, other investments turned from a deficit of US$115.5 billion in the previous quarter to a surplus of US$1.7 billion, which was the main reason for the narrowing of the capital account deficit. Among them, the currency and deposit deficit turned from a deficit of US$30.5 billion to a surplus of US$24.4 billion (of which the net outflow of foreign currencies and deposits decreased by US$49.8 billion), and the loan deficit narrowed from US$82.5 billion to US$21.9 billion (of which the net outflow of foreign loans decreased by US$53.8 billion), which is the main contribution of other investment balance changes (see Chart 17). The direction of change in China's foreign currency, deposits and net outflows of loans is consistent with the direction of change in the balance of deposits and loans in banks' foreign financial assets in the same period, mainly due to the narrowing of the current account surplus that has improved the balance of domestic foreign exchange liquidity (see Chart 18). In addition, there have been significant changes in the asset side and liability side of trade credit in other investments: the asset side has converted from a net inflow of $12.2 billion in the first quarter to a net outflow of $16.3 billion, and the liability side has converted from a net outflow of $2.8 billion in the first quarter to a net inflow of $17.2 billion, mainly reflecting the increase in export receivables/import payables due to the increase in export/import size from the previous quarter (see Chart 19).
Net errors and omissions have turned negative again, and the proportion of imports and exports is still reasonable. In the second quarter, net errors and omissions turned from +$100 million in the previous quarter to -$66.6 billion. This is related to the widening of the trade surplus gap in the same period: in the second quarter, the customs comparable caliber of the bank's foreign-related goods trade surplus of 63 billion US dollars, compared with the customs statistics of the import and export surplus of goods trade of 137.7 billion US dollars less than the customs statistics of the import and export surplus of goods trade of 14.7 billion US dollars, while the first quarter of the goods trade only received 13.3 billion US dollars less; the negative trade surplus surplus accounted for -5.0% of the total import and export volume of customs statistics, and only -1.0% in the first quarter (see Chart 20). Although the negative value of net errors and omissions is large, its proportion of imports and exports of trade in goods in the current quarter (balance of payments caliber, the same below) is -4.7%, and the proportion of annualized net errors and omissions in annualized imports and exports is -4.0%, which has continued to be within the reasonable standard of ±5% since the second quarter of 2018 (see Figure 21).
The basic income and expenditure surplus led to an increase in reserve assets, and the impact of the "reduction panic" in the first quarter eased
The surplus of basic income and expenditure has led to an increase in reserve assets, and the short-term capital deficit has narrowed. In the second quarter, transaction-induced reserve assets increased by $50 billion. Among them, the short-term capital (including net errors and omissions) deficit of $48.9 billion, the underlying balance of payments surplus of $98.9 billion, the latter is the main reason for the increase in reserve assets. The short-term capital deficit as a percentage of the underlying balance of payments surplus was -49%, compared to -76% in the first quarter (see Chart 22).
The increase in the balance of foreign exchange reserves is mainly caused by transactions, and the impact of non-transaction factors is less. As of the end of June 2021, the balance of foreign exchange reserves calculated by the central bank was $3.2 trillion, an increase of $44 billion from the end of March. Over the same period, transaction-induced foreign exchange reserve assets increased by US$49.9 billion, representing a change in the value of foreign exchange reserves due to non-trading factors such as exchange rates and asset prices (for details, see "Second Quarter Balance of Payments Analysis Report: Reduced Trade in Goods Surplus, Weakened Short-term Capital Flow Shock", August 8, 2021).
Foreign exchange accounts increased month-on-month, but the increase was much smaller than the bank balance on foreign exchange settlements. In the second quarter, foreign exchange accounted for an increase of 57.7 billion yuan, equivalent to US$8.9 billion, far less than the bank's forward (including options) foreign exchange surplus of US$60.3 billion in the same period. Since 2017, the central bank has basically withdrawn from the normal intervention of the foreign exchange market, and the change in foreign exchange account has been very small. In this case, the surplus of foreign exchange settlement and sales of banks mainly changes to the use of external assets of banks. In the second quarter, the banking sector's external financial assets increased by US$60.2 billion, of which foreign currency assets increased by US$32.4 billion (see Chart 23).
External net assets decreased sequentially, and the valuation effect of RMB appreciation was obvious
The decrease in net external assets was mainly affected by non-transactional factors. As of the end of June 2021, foreign financial assets were US$9,027.8 billion, foreign financial liabilities were US$7,041.8 billion, and net positions were US$1,986 billion in net external assets, a decrease of US$154 billion from the previous quarter. Combined with the balance of payments data, it can be seen that transaction-induced changes (including the difference in financial accounts of reserve assets are reversed) contributed 9% of the change in external net assets, while changes in exchange rates, changes in non-transactional factors such as asset price revaluation and statistical adjustments contributed 91% (see Figure 24).
The appreciation of the renminbi led to an increase in external liabilities due to non-transactions. In the changes caused by non-transaction factors, external assets decreased by US$47.1 billion, less than the increase in external liabilities of US$93.7 billion, which was mainly affected by the appreciation of the renminbi. In the second quarter, the median value of the RMB exchange rate appreciated by 1.7%. This resulted in exchange gains of US$51.6 billion for foreign equity investments, US$9.4 billion on RMB equity assets held by foreign institutions and individuals, and US$19.4 billion for local currency external debt[2], all three of which totaled US$80.5 billion, contributing 86% of the increase in external liabilities caused by non-transactions in the same period.
The rate of return on foreign investment and the cost ratio of utilizing foreign capital have increased significantly compared with the first quarter of last year
In the second quarter, the return on outward investment measured by the proportion of annualized foreign investment income to foreign financial assets was 3.2%, and the cost of utilizing foreign capital, measured by the proportion of annualized foreign investment income to foreign financial liabilities, was 6.3%. Compared with the first quarter of 2021, the two only increased by 0.05 and 0.07 percentage points respectively; but compared with the first quarter of last year, the yield of China's foreign investment increased by 0.4 percentage points, and the cost rate of using foreign capital increased by 1.2 percentage points (see Figure 25).
This is mainly due to the changes in the structure of China's external financial assets and liabilities since the first quarter of last year. Among the foreign financial assets, the proportion of reserve assets and direct investment has declined, but the proportion of securities investment and other investments has increased by 2.8 and 2.3 percentage points respectively, reflecting the relatively abundant domestic foreign exchange liquidity and the increase in the demand for diversified allocation of domestic main assets (see Figure 26). Among the foreign financial liabilities, the proportion of direct investment and other investments declined, but the proportion of securities investment increased by 5.4 percentage points (the proportion of equity and bond investment increased by 3.9 and 1.5 percentage points respectively), reflecting that China's economy took the lead in recovering after the outbreak of the epidemic, and the return on RMB assets was better (see Chart 27).
In addition, the increase in the rate of return on foreign investment and the cost ratio of foreign capital utilization is also related to the base effect. In the first quarter of last year, due to the impact of the epidemic, a huge earthquake occurred in the overseas financial market, and the foreign investment income of domestic entities fell to US$23 billion, a new low since 2013 (see Chart 10); the epidemic led to the suspension of production work of domestic enterprises and the decline in profits of foreign-invested enterprises, which was reflected in the reduction of profit remittances of foreign-invested enterprises, which fell to US$35.6 billion in the first quarter of last year, a new low since the second quarter of 2010 (see Chart 10).
Short-term external debt as a share of foreign exchange reserves has reached a record high, but the risk of external debt remains manageable
As of the end of June 2021, the balance of China's external debt with contractual repayment obligations was 2,679.8 billion US dollars, an increase of 153.2 billion US dollars from the previous month. From the perspective of term structure, the balances of medium- and long-term external debt and short-term foreign debt increased by 44 billion and 109.2 billion US dollars respectively from the end of March, contributing 29% and 71% of the overall external debt balance increase respectively. Short-term external debt as a percentage of foreign exchange reserves, at 47 percent, rose 2.8 percentage points from the end of March and continued to hit a new high since 1994, but remained below the international warning line of 100 percent, indicating that external debt service remains sufficient (see Chart 28). From the perspective of currency structure, foreign currency external debt (including SDR distribution) and local currency external debt balances increased by 69.2 billion and US$84 billion respectively from the end of March, contributing 45% and 55% of the increase in external debt balances respectively (see Chart 29). As mentioned earlier, the appreciation of the renminbi led to an increase of US$19.4 billion in the balance of local currency external debt, which contributed 23% of the increase in the balance of local currency external debt.
Private sector currency mismatches have improved significantly, and fed taper influence is expected to be limited
Although China's foreign net position has been positive for a long time, after excluding the reserve assets in foreign assets, the private sector's external net position is negative. As of the end of June 2021, external net debt (excluding reserve assets, the same below) was US$1,359.9 billion, an increase of US$202.8 billion sequentially; as a percentage point of annualized nominal GDP was 8.0%, up 0.8 percentage points sequentially (see Chart 30). Although the size and proportion of private sector net debt increased, the increase in external net debt caused by transactions contributed only 31%, and non-transaction adjustment contributed 69%. Among them, the appreciation of the renminbi led to a total increase of US$80.5 billion in renminbi-denominated foreign direct investment, equities and local currency external debt, contributing 40% of the increase in external net debt.
At the beginning of the "8.11" exchange rate reform in 2015, the depreciation of the renminbi and the expectation of depreciation strengthened each other, mainly because the private sector accumulated a large-scale currency mismatch before the exchange reform, and the market was very sensitive to the depreciation of the local currency. However, after the concentrated adjustment of tibetan remittances to the people and debt repayment in 2015 and 2016, the mismatch of private currencies has improved significantly. At present, both the size of the private sector's external net debt and its share of GDP are much lower than at the end of June 2015 (see Chart 30), with the result that the market's tolerance and adaptability to exchange rate fluctuations has increased significantly. Therefore, even if the Fed officially launches taper in 2021, the RMB exchange rate may be under short-term pressure, but it is expected to have a limited impact on China's foreign economic sector.
exegesis:
[1] The main channels for overseas investment in China's securities include overseas institutions' investment in the domestic bond market (including "Bond Connect" and direct entry into the interbank bond market) and bonds issued overseas by Chinese institutions (including RMB central bank bills issued by the central bank in Hong Kong), "Shanghai Stock Connect" and "Hong Kong Stock Connect" channels, and qualified foreign investors (QFII/RQFII, etc.). [2] The average of equity investments in foreign direct investment at the end of March and June 2021, the balance of domestic RMB stock assets held by foreign institutions and individuals, and the local currency foreign debt balance denominated in US dollars is calculated by multiplying the mid-price change in the RMB exchange rate in the second quarter, respectively.
(About the author: Global Chief Economist of BOC Securities)