March 23,2009

Huge Capital Outflow Likely in 2008 Second Half

By Xu Yisheng, Beijing
"China maintained double surplus in balance of payments in 2008," claims the People’s Bank of China, China’s central bank, in a report on the 2008 international financial market, but there may be strong disagreements surfacing over that judgment in the coming months. The details will only become clear after the State Administration of Foreign Exchange (SAFE) releases balance of payments statements for 2008 as a whole.
 
Disputes are rising over whether China has maintained surpluses under capital and financial accounts during the global financial crisis. The crisis has seriously influenced China’s international payments, and this influence will continue through 2009. We may even see negative growth in foreign exchange reserve in the first two months of this year.
 
Capital and financial accounts consists of capital account, direct investment, portfolio investment, other investment, etc. These, together with current account, are the core of balance of payments.
 
Possible disputes come from two figures. In 2008, China’s surplus under current account totaled about $440 billion, but in the same year China’s foreign exchange reserve grew $417.8 billion. These two numbers were revealed by SAFE Vice Director Deng Xianhong and the central bank, respectively.
 
According to the calculation principle of balance of international payments, annual foreign exchange reserve growth equals the sum of the balance of current account, balance of capital and financial account, net errors and omissions. If net errors and omissions are positive, as happened in the first half of 2007 and 2008, or neglected, about a $22.2 billion deficit will appear in the capital and financial account in 2008.
 
If the deficit really occurred, this would be the largest change in China’s balance payments in the past ten years, particularly since 2003, when pressure for RMB appreciation began to grow heavy. The last deficit in the capital and financial account occurred in 1998.
 
The balance of payments statements released by SAFE for the first half of 2008 hint that great change in the capital and financial account occurred in the second half of 2008, as the global financial crisis broke out.
 
In the first half of the year, China’s surplus under current account totaled $191.7 billion, and for capital and financial account $71.9 billion and net errors and omissions totaled $17.1 billion. At that time, the foreign exchange reserve rose by $280.7 billion. According to existing figures, surplus under current account in the second half of last year totaled about $243.8 billion ($440 billion minus $191.7 billion), and foreign exchange reserve in the second half of last year grew $131.7 billion, meaning putting aside net errors and omissions, the deficit under capital and financial account in the second half of 2008 reached $111.2 billion.
 
$111.2 is net outflow under capital and financial account. Taking the $40 billion foreign direct investment in the second half of 2008 into account, foreign exchange outflow will be even larger.
 
Therefore a deficit is very likely to appear under capital and financial account for 2008 as a whole, though a surplus may appear if net errors and omissions are negative and quite high. But deficit under capital and financial account is certain to emerge in the second half of 2008.
 
China has tried to be cautious of capital outflow, especially since the outbreak of the financial crisis. The change in capital and financial account in 2008, especially the second half of 2008, will be a crucial sign. What is worth more attention is that the deficit may worsen in 2009. As is happening in many emerging markets, capital outflow during the financial crisis will put heavy pressure on China’s asset prices and RMB rate.
 
Although China recently increased its holding of US national debt by $12.2 billion, because of the capital outflow and the book loss led by Euro depreciation and the fall in US bond prices, we will not be surprised to see a negative growth in China’s foreign exchange reserve in the first two months of 2009. Negative foreign exchange reserve growth can be a sign of danger, and proof of capital outflow.
 
All of which casts great uncertainty on the prospects for China’s economy in the near future.
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