Back in August 2018 we observed a historic event for China's economy: for the first time in its modern history, China's current account balance for the first half of the year had turned into a deficit. And while the full year amount reverted back to a modest surplus, it was only a matter of time before one of the most unique features of China's economy - its chronic current account surplus - was gone for good.
Then, a few months later also in 2018, UBS wrote that the upcoming loss of China's current account cushion would soften domestic activity, which coupled with the emerging US-China trade war, would mean that "for the first time in 25 years, China would have to make a choice between external stability and growth." This was followed by the Wall Street's Journal bringing attention to this topic, calling it a "tectonic shift" in China's economy, which has largely gone unnoticed by investors, and which is "quietly beginning to upend the global financial system."
And yet, a few years later such predictions of a "tectonic shift" in both China's economy and in global fund flows have yet to materlialize for the simple reason that thanks to covid, China's current account which was on the cusp of turning into a deficit, exploded into a massive surplus the likes of which China had not seen since 2016 thanks to the breakout of the oh-so-convenient-for-Beijing covid pandemic, which crippled global economies and sparked a Chinese export boom (mostly related to items linked to Covid which the world couldn't find anywhere else).
Yet while covid proved to be the capital "Hail Mary" Beijing urgently needed, China's resurgent economy (and current account) brought with it a fresh headache, namely massive capital
outflows inflows as a result of global investors flocking into local capital markets as China emerged an island of stability in a world crippled by the pandemic. The result: a unprecedented surge in the Yuan, which reached a level just shy of where it was in 2015 when Beijing was forced to devalue the currency.
But more importantly, it's why as Caixing reports, in 2020 China reported its first annual deficit on the financial account in its balance of payments in four years as regulators allowed more money to flow out of the country to ease appreciation pressure on the yuan stemming from rising foreign investment in the country’s capital markets.
The 2020 deficit, excluding reserve assets held by the central bank, amounted to $77.8 billion, although that’s down from an initial estimate of $175.9 billion given in February, according to revised figures for the balance of payments released by the State Administration of Foreign Exchange (SAFE) on Friday. It’s the first shortfall since 2016 when the country had a financial account deficit for the year, excluding reserve assets, of $416.1 billion. The financial account includes domestic ownership of foreign assets –– such as deposits, loans, securities, commodities and direct investment –– and foreign ownership of domestic assets.
"The deficit on the financial account excluding reserve assets shows that the accumulation of overseas assets by China’s private sector is continuing,” the administration said in a report (link in Chinese) accompanying the data. “First, domestic residents have increased their investment in overseas securities, which shows that demand to diversify assets (in investment portfolios) is strong. Second, outbound direct investment has been rational and orderly. Third, banks have increased their deposits and loans overseas, as the current account surplus has provided relatively abundant foreign currency liquidity."
Meanwhile, as shown in the chart above, the yuan appreciated 8.8% against the U.S. dollar in the second half of 2020, ending the year at 6.50 per dollar, up from 7.13 per dollar at the end of May.
“Amid the continued appreciation of the yuan since June 2020, China’s foreign exchange policies have focused on increasing the flexibility of the exchange rate, expanding capital outflows and controlling capital inflows,” Guan Tao, chief global economist at BOC International Co. Ltd. wrote in a Feb. 23 report (link in Chinese) on the preliminary balance of payments data. He said he expected this foreign-exchange policy mix to continue as the “orderly expansion of capital outflows is an important policy tool to cope with the appreciation pressure on the yuan."
In other words, don't be surprised to see a fresh flood of Chinese real-estate buyers in Vancouver, California and the Tri-State area. Also, don't be surprised to see a reversal in China's long-running feud with Bitcoin as Beijing realizes that there is no better way to send money offshore than using crypto.
Until then, Chinese investors are making do with foreign bonds: according to data from China Central Depository and Clearing Co. Ltd. and the Shanghai Clearing House, outstanding overseas holdings of bonds traded in the onshore interbank market rose to 3.25 trillion yuan ($495 billion) at the end of December, a net increase of 1.1 trillion yuan from a year earlier.
In an interview with Caixin, Guan said that foreign exchange in the onshore market was abundant in 2020, allowing banks to absorb domestic deposits in foreign currency and then deposit or lend them abroad.
Growing confidence in China’s recovery from the Covid-19 pandemic as other major economies continued to suffer, and higher yields on Chinese government bonds compared with U.S. Treasuries also contributed to an increase in inflows of foreign capital last year.
Ironically, three years after fears of a current account deficit sparked worries on Wall Street about how China would fund itself in the global capital markets, the abundance of foreign currency liquidity, especially the U.S. dollar, led to a decrease in the cost of financing in foreign currency which led to an increase in domestic loans made in foreign currency, said Wang Youxin, a senior researcher at a research institute backed by Bank of China.
Overall, China had a balance of payments surplus of $168.1 billion in 2020, comprising a current account surplus of $274 billion, and a combined capital and financial account deficit of $105.8 billion, the latest data show. That compares with $129.2 billion in 2019 and $177.4 billion in 2018, according to revised SAFE figures.
The financial account involves equity investment and debt financing, while the current account measures a country’s total trade in goods and services plus earnings on cross-border investments. Under the financial account, direct investment and portfolio investment had a surplus of $102.6 billion and $87.3 billion, respectively, while other investment had a deficit of $256.2 billion, up 160% from 2019, the data show. Other investment includes all financial transactions not considered direct investment, portfolio investment, financial derivatives, employee stock options, or reserve assets.
In 2020, net outflows in other investment amounted to $314.2 billion, the highest since a deficit of $349.9 billion in 2016. This mainly comprised greater net outflow of deposits of $130.4 billion, 28% higher than in 2019, and a net jump in cross-border loans of $128.2 billion which reversed a net decline of $26 billion in 2019, as banks increased their overseas lending and companies added to their overseas deposits amid ample liquidity, according to the SAFE report.
Domestic deposits in foreign currency jumped by $131.6 billion in 2020, the largest increase since 2014, while loans in foreign currency grew by $80.2 billion, the most since 2013, according to data (link in Chinese) from the People’s Bank of China.
For portfolio investment, cross-border funds flowed actively into and out of the Chinese mainland in 2020, SAFE wrote in its report. Last year, domestic investors bought a net $167.3 billion of overseas stocks and other types of securities, while their overseas counterparts purchased a net $254.7 billion in the Chinese securities markets, both hitting a record high since the data series on international balance of payments began in 1982.