China China’s huge trade surplus counteracts outflow pressure from Fed

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China’s huge trade surplus counteracts outflow pressure from Fed​

By: Bloomberg News | Aug 01 2022 at 11:38 AM | International Trade

China’s massive trade surplus helped to offset capital outflows in the first half of the year, anchoring its balance of payments even as the Federal Reserve’s aggressive interest rate hikes fuel outflows from developed and emerging markets alike.

The country’s net foreign exchange settlement, which measures onshore conversion of foreign currencies into yuan, stood at $85.2 billion for the first half of the year, extending gains over the past two years. Cross-border receipts and payment, another gauge of flows, also recorded a surplus of $83.4 billion, according to data from the State Administration of Foreign Exchange.

A breakdown of the figures show that strong inflows from goods trade and foreign direct investment have offset outflows via investment in securities, corporate remittances and the services trade, which has shrunk since 2020 as few Chinese can travel abroad during the pandemic. As a result, the currency has held up relatively well -- the offshore yuan’s 5.7% fall against the dollar this year makes it the fourth best-performer among 12 Asian currencies this year.

“Foreign exchange outflow pressure certainly is smaller this time” compared with previous Fed tightening cycles, said Wang Ju, head of foreign exchange and rates strategy for Greater China at BNP Paribas SA. “In contrast to the 2015-2016 and 2018-2019 periods of renminbi depreciation, non-bank clients have been a net supplier of dollars.”

China’s trade surplus hit a record $98 billion in June as exports surged after Shanghai emerged from lockdown, while inbound FDI jumped to 723 billion yuan ($112 billion) in the first half of the year. Those inflows gave China enough space to conduct a relatively independent monetary policy, reducing any need for authorities to intervene in the foreign exchange market or tighten policy.

On the other hand, overseas funds cut holdings of China’s bonds by 510 billion yuan in the five months through June, as the US and China’s 10-year government bond yield inverted for the first time since 2010. And while offshore investors sold equities in March and April, they bought more in May and June, leaving the total value of their holdings basically unchanged from the end of January.

Chinese authorities are cautious about outflows, with strict capital controls still in place. High-net worth residents are finding it more difficult to move money outside of China this year as passport processing times have increased and documentation requirements have become more onerous. Regulators have also been asked to exercise greater caution when it comes to reviewing new overseas spending and investment plans.

Last week the State Administration of Foreign Exchange laid out its plans for the rest of the year, with officials saying they will “effectively prevent risks related to cross-border capital flows” and strengthen guidance on expectations.

Whether the massive trade surplus can continue will depend on external demand for Chinese goods, which could start to weaken in the coming months as inflation and recession risks weigh on overseas economies. In addition, a declining share of the trade surplus is being converted into yuan, which tends to happen when the currency weakens and interest rate spreads narrow, according to research from Goldman Sachs Group Inc., and this could undermine the support from trade inflows for the currency.

But capital outflow pressure may also ease as markets are dialing down expectations for how much policy tightening the Federal Reserve will do in the rest of this year.

“Portfolio outflows will slow in the second half because the dollar index likely passed a temporary peak,” said Xing Zhaopeng, senior China strategist at Australia & New Zealand Banking Group Ltd. The current account surplus will remain strong, likely contributing to a positive balance of payments in the second half of the year, he said.

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