--- Chinese Capital Account and Current Account

Financial Market of China

Introduction

Concept and Relationships between current account, capital account and official reserves

Present Capital Account and Current Account

Reasons, Advantages and Disadvantages from the data

Forecasted Capital Account and Current Account

Reasons, Advantages and Disadvantages

from the Forecasted Results

Conclusion: Good Expectations for the Development of China

Part IPart ICurrent Account: It is the sum of net sales from trade in goods and

services, net factor income (such as interest payments from abroad), and net unilateral transfers from abroad.

Capital Account: (Financial account) It is the net change in foreign ownership of

domestic assets.

Current Account: It is the sum of net sales from trade in goods and

services, net factor income (such as interest payments from abroad), and net unilateral transfers from abroad.

Capital Account: (Financial account) It is the net change in foreign ownership of

domestic assets.

KA account deficit:

domestic ownership of foreign assets has increased more quickly than foreign ownership of domestic assets

KA account surplus:

foreign ownership of domestic assets has increased more quickly than domestic ownership of foreign assets

Official reserve:

It records the government's current stock of reserves. Reserves include official gold reserves, foreign exchange reserves, and IMF Special Drawing Rights (SDRS).

Official reserve:

It records the government's current stock of reserves. Reserves include official gold reserves, foreign exchange reserves, and IMF Special Drawing Rights (SDRS).

Relationships between: current account, capital account and official reserve

Current Account + Capital Account = Change in Official Reserve Account

(Total) Figure 1 Factors that affect Capital Flows

Capital Inflows Capital Outflows

Export and

Import

Export

Import

Labor

Supply Labor to foreign

Foreign supply Labor to domestic

Return of

Investment

Obtain

Offer

Investment

Get foreign capital

Foreign get domestic capital

Loans Foreign in debt Domestic in debt

Official Reserve Decreasing Increasing

Part IIPart II

Present Current account and capital account prevailing in China

Present Current account and capital account prevailing in China

China’s Balance of Payments Components,1994-2004 (USD billion)

1. Current Account Surplus

2005.07.21

Bank of China declared 2% appreciation of RMB

Exchange rate US dollar/ China RMB decreased from 8.27 to 8.10

2001.11.10

China's accession to the World Trade Organization (WTO)

Export is booming faster

2001~2007

The increase rate of current account = (160.6-17.4)/17.4 = 824.1%

Capi tal fl ows (1996-2002)

-600

-400

-200

0

200

400

600

1996 1997 1998 1999 2000 2001 2002

Year

capi

tal

flow

amo

unt

($10

0 mi

llio

n) Capi tali nfl owsCapi taloutfl owsNetdi ff erences

2. Capital Account Surplus

• Figure ２ :

• China’s International Direct investment of capital inflows and outflows (1997-2003) Unit: $100million

Year 1996 1997 1998 1999 2000 2001 2002

Capital Inflows

Capital Outflows

Net Differences

417.3

21.1

-396.1

452.6

2.7

-449.9

454.6

28.2

-426.4

403.2

23.8

-379.4

407.2

22.4

-384.8

468.8

70.9

-397.9

535.05

20.87

-514.18

•Source from: According to 2003 Chinese foreign economical trade yearbook

　　　　　　　　　　　 2004 Chinese commerce yearbook computation

3. Official Reserve

Why this “Double surplus” ?

Why this “Double surplus” ?

1. Increasing in FDI:1. Increasing in FDI:(1)FDI need to balance the resources settles around the globe.

(2) Chinese economic characters strengthen the capability to absorb capital in ：　　 Cheap- Labour => Low Cost

1980 1980 1990 1990 2000 2000 2003 2003In Out In Out In Out In Out

China 1.1 0 20.7 2.5 348.3 25.8 501.5 37Japan 3.3 19.6 9.9 201.4 50.3 278 89.7 336UK 63 80.4 204 229.3 438.6 898 627 1129US 83 215 395 430.5 1214 1293 1554 2069

Cumulative FDICumulative FDI

2. Less domestic invest abroad:2. Less domestic invest abroad:

1. China’s stage of development:

2. China’s macro policy: (1) Aim to enlarge the export, lack of independency.

(2) The examination and approval system is too complex.

3. The enterprises in China have problems themselves.

4. China has a relative higher return of interest on saving.

Figure 3: International Direct Investment flows and its growth rate (1997-2002)

Unit: $100million All country Developed country Developing country

Year Inflows Outflows Inflows Outflows Inflows Outflows

1997 Flows

Growth rate

4819. 11

24. 80

4769. 34

20. 74

2696. 54

22. 62

3960. 57

9. 15

1932. 24

26. 55

766. 62

25. 04

1998 Flows

Growth rate

6860. 28

42. 36

6832. 11

43. 25

722. 65

75. 14

6308. 91

59. 29

912. 84

-1.O

498. 37

-34. 99

1999 Flows

Growth rate

10790. 83

45. 26

10965. 54

44. 31

8246. 42

80. 72

10213. 07

59. 82

2292. 95

-1. 79

727. 86

-32，81

2000 Flows

Growth rate

13929. 57

29. 09

12007. 83

9. 51

11205. 28

35. 88

10977. 96

7. 49

460. 57

7. 31

990. 52

36. 09

2001 Flows

Growth rate

8238. 25

-40. 86

7114. 45

-40. 75

893. 79

-47. 40

6605. 58

-39. 83

2094. 31

-14. 89

473. 82

-52. 16

2002 Flows

Growth rate

6511. 88

-20.96

6473. 63

-9.1

4603. 34

-21. 90

6000. 63

-9. 16

1621. 45

-22. 58

430. 95

-9.05

Source from: According to 2004 Chinese commerce yearbook reorganization

Advantages for this surplus in capital account

Advantages for this surplus in capital account

1. Balance the international profit.

2. Having more money to boost up domestic economy.

3. Lower unemployment Rate

1. Balance the international profit.

2. Having more money to boost up domestic economy.

3. Lower unemployment Rate

Disadvantages for this surplus in capital account

Disadvantages for this surplus in capital account

1. Means that the domestic market is occupied by foreign investors.

2. Since foreign investor will gain from investment, the profit as a financial capital massive will backflow to developed country.

3. The domestic economical industrial structural adjustment may be affected.

4. Financial foreign exchange crisis ：　　 more pressure in appreciation of RMB

1. Means that the domestic market is occupied by foreign investors.

2. Since foreign investor will gain from investment, the profit as a financial capital massive will backflow to developed country.

3. The domestic economical industrial structural adjustment may be affected.

4. Financial foreign exchange crisis ：　　 more pressure in appreciation of RMB

Part IIIPart IIIForecast Capital Account

Reasons for Our Forecasts

Advantages of Our Forecasts Results

Disadvantages of Our Forecasts Results

The Volume of International Trade between China with UK, USA and Mongolia (Source: World Trade Organization)

Import and Export in the 10th Five-year Plan Period

(www.stats.gov.cn/.../ t20060302_402308116.htm)

RMB exchange rate to USD

2005/07/21 to 2007/03/12 Source from: The People’s Bank Of China

From the data and Charts above, there is big pressure for RMB to appreciate, and let’s look at what would happen for the capital account.

The appreciation of Chinese Currency will make investment less attractive because of the speculation reasons.

Adding…

Our Theoretical ProveOur Theoretical Prove

Recall: Current Account + Capital Account = Change in Official Reserve Account

From the data above, China is now experiencing a “Double Surplus” in both current account and capital account.

=>If a government runs a current account surplus and has no change in official reserves, then the current account surplus must be balanced by a capital account deficit.

Recall: Current Account + Capital Account = Change in Official Reserve Account

From the data above, China is now experiencing a “Double Surplus” in both current account and capital account.

=>If a government runs a current account surplus and has no change in official reserves, then the current account surplus must be balanced by a capital account deficit.

As there will be a Capital account deficit…

As there will be a Capital account deficit…Advantages:

1. Avoid Repeat Investment

Advantages: 1. Avoid Repeat Investment

2. Balance the Payment of domestic without increasing Official reserve.

3. Increasing the demand of foreign currency, which will less the pressure of evaluated domestic currency.

Advantages:Advantages:

4. Stop borrowing useless capital from foreign countries and lending to foreign countries.

5. Having more influence in global market.

6. Gain good money from investing abroad.

4. Stop borrowing useless capital from foreign countries and lending to foreign countries.

5. Having more influence in global market.

6. Gain good money from investing abroad.

Explanation I : Solow Model

there is a decrease on saving rate

the saving line shifted from L1 to L2

the capital per worker (k) decreases from K1 to K2

the output decreases from y1 to y2

Worse off

Explanation Ⅱ : Disappear of Speculation

Short Run:

There is a difference between actual exchange rate and market exchange rate

Investors have the motivation to get the profit from speculation

If there is an appreciation on Exchange rate, there will be a decrease on capital inflow

Long-Run:

The attractive points on investing foreign assets still exist

There will be a capital outflow

In total: KA will have a negative sign in the long term.

Explanation Ⅲ : Output Function

Y = C + I + G + Export - Import

d Y/Y = d C / C * C / Y + d I / I * I / Y + d G / G * G / Y + d NX / NX * NX / Y

There will be a decrease on economic growth.

Explanation Ⅳ : Labour Market

the cost of labour will increase.

the opportunities provided will decrease.

the unemployment rate will increase due to the above reasons.

Explanation Ⅴ : Aggregate Demand

Foreign investment decreases

Domestic interest rate decreases

Saving rate decreases

Domestic investment decreases

Less motivation for economic growth

IS1

IS2

LMR

Y

R1

R2

Y1Y2

Nowadays, China runs surplus on both Current Account and Capital Account.

Under the pressure of International Trade Partner, Chinese Currency has the tendency to appreciate.

After the adjustment of Chinese Currency, Speculation Investment will be withdrew.

China now is experiencing the specific development period and there will be some problems.

Group Members: Stella, Xu

Tony, Chen

Lucy, Zhang