Reasons for Decline in Trade Surplus and Future Prospects for China

In 2009, China's trade surplus was 196.1 billion dollars (in this article, all statistics are CEIC-based), an enormous decline of about 100 billion, as compared to 2008. This trend has continued in 2010, with the trade surplus for January and February standing at 21.8 billion, i.e., one-half of the surplus in the same period in 2009. Although predicting that the figures for the first two months of this year are a signal as to the trend for the rest of the year would be premature, most economists agree that the trend, of declines in the trade surplus, will continue throughout this year. Macroeconomic policymakers in the Chinese government regard this decline in trade surplus as a welcome change, because of the rapid increase in recent years of foreign currency reserves, as well as mounting pressure from Europe and the United States to appreciate the Yuan. It is easy to understand their line of thinking when you look at the size of the current trade surplus and the accumulation of foreign currency reserves, at 2.4 trillion dollars at the end of the last year (Japan's trade surplus for the calendar year 2009 was 40.6 billion, calculated at the customs official exchange rate of 1 dollar to 93.52 yen, foreign currency reserve at 1.0 trillion dollars.) Considering the reasons for the declines in the trade surplus and looking a few years down the road, however, a risk lies ahead.

The major reason for the last year's decline in trade surplus was the decrease in international demand due to the economic slowdown caused by the global financial crisis. China's export, on a dollar basis, had continued to grow at over 20% during the six years from the third quarter of 2002 to the third quarter of 2008. It declined drastically, however, after the fourth quarter of 2008 - immediately after the Lehman Shock - and it was followed by a sharp decline of 16% in 2009. In the meantime, the import also had continued to grow at around 20% except for 2003 and 2004 when it exceeded 30% growth. It declined dramatically by over 20% until the end of the first half of 2009. Since the last half of 2009, however, the growth rate of imports has started to recover faster than that of exports. In the fourth quarter of 2009, exports grew by only 0.2%, as compared to the previous year, while imports grew by 22.3%. This has resulted in a sharp decline in China's trade surplus.

Until recently, China's imports had grown approximately in proportion to its exports, which avoided such a drastic decline in the trade surplus that China is now facing. Recently, this trend has changed. Since 2005, the Chinese government had promoted to change its model for economic growth from a model led by export investment to one spurred by domestic demand, by implementing such policy measures as appreciating the Yuan, raising the minimum wage, and increasing tax incentives for exports. After the financial crisis, in the autumn of 2008, exports declined sharply, while domestic demand grew due to fiscal and monetary stimulus packages implemented in order to ensure economic growth, which resulted in a more rapid change in the economy. This change became increasingly apparent in the trade arena after the latter half of 2009, with exports stagnating, while imports started to pick up, reflecting increases in domestic demand. Since December 2009, exports have recovered with a double-digit growth. The overall growth of imports, however, is substantially bigger.

Looking into the future with these changes in mind, mid- to long term risks for the Chinese economy are perceivable. If the European and the American economies stagnate longer than expected, the growth of China's exports is likely to be smaller than previously. At the same time, in order to stabilize its domestic economy, China will continue its policy of increasing domestic demand to maintain high economic growth. This policy will result in an increase in imports, and, consequently, a decline in the trade surplus. If this decline is only moderate and China can keep the trade surplus stably, then the change for China will be desirable. If China can no longer sustain a trade surplus and, instead, ends up with trade deficit, especially over a period of several years, then China's macroeconomic policies will be constrained, resulting in the need to control the expansion of its domestic demand. This is one of the risks to keep in mind.

In order to prevent these risks, Chinese corporations need to improve their international competitiveness in the mid- to long-term, ascertain the growth in exports, while restricting the growth of imports to a certain band. If China is to achieve the same results by depreciating the Yuan, import inflation is a risk. To achieve a trade account balance without manipulating the exchange rate, Chinese corporations need to improve their international competitiveness.

How can this be achieved? China has strengthened its export competitiveness by its policy of reform and opening-up policy, and this policy has been a great success. It is desirable for China to aim for economic growth based on continued its policies of attracting foreign currencies, and of promoting cooperation between its own, domestic corporations with foreign corporations that possess advanced technologies. To continue to invite stable investment by respected international corporations, China must maintain a favorable climate for foreign direct investment. The most important element of this investment climate is expanding the domestic market by policies that result in growth in domestic demand. At the same time, China needs to improve its market infrastructure, such as intellectual property protection, smooth and seamless financial transactions, and the increased reliability of commercial transactions based on regulation. If China continues to strive in these areas, foreign companies continue to expand their investment in Chinese market, and Chinese corporations improve their international competitiveness, then it will be possible for China to maintain a trade surplus over the mid- to long-term. In order for China to side-step the risk of ending up with a future trade deficit, such policies - based on mid- to long-term views - will be necessary.