Trade Surplus Attracts Foreign Investment

Foreign investors are bullish on China and continue to increase their investment there. The trade surplus is an important reason.

People’s Bank of China (PBOC) published the Financial Statistic Data Report of the First Half of 2011 on July 12, showing that the foreign exchange reserves of China had amounted to 3197.5 billion U.S. dollars by the end of June 2011, up 30.3% year on year. Experts say that the foreign exchange reserves of China have exceeded the “critical value”. This is very risky, which may cause pressure over economic structure. Meanwhile, they point out that the continuous trade surplus of China is an important reason for foreign investors to invest.

Double surplus attracts foreign investment

One day before PBOC publishing the report, the State Administration of Foreign Exchange published the revised data about the international balance of payments in the first quarter of 2011, showing that the current account, as well as capital and financial account both saw surplus. Among them, the trade surplus in current account amounted to 28.8 billion U.S. dollars, down 21% from the same period of last year; the capital and financial account had the surplus of 86.1 billion U.S. dollars, with a 41% year-on-year increase.

Dr. Du Zhengzheng from the Financial Institution of the Chinese Academy of Social Sciences says that the surging price of bulk commodities and the rising enthusiasm of domestic investors pushed the increase in the amount and price of imported goods in the first quarter, which reduced the surplus of current account. However, despite the reduced surplus of current account, foreign investors are still bullish on China because it still enjoys higher GDP growth rate and lower inflation compared with other emerging countries. According to the data from customs, China still had the surplus of 22.2 billion U.S. dollars in June, which was the highest in 2011. This resulted in the stress of capital inflow and increased the stress of RMB appreciation.

Zhao Qingming, an economic researcher from the Bank of Construction, says that tight credit policies and the strong anticipation of RMB appreciation force the companies to choose low-cost overseas financing.

“Apart from existing factors, the fast development of RMB cross-border settlement in the first half of this year also pushed up the foreign exchange reserves,” says Liu Yuhui, director of the Chinese Economy Evaluation Center, Financial Institution, Chinese Academy of Social Sciences. “The import-oriented enterprises could use RMB as the tool for cross-border settlement, which reduced the consumption of foreign exchange and increased the foreign exchange reserves in an indirect way.”

Confronted with risk of depreciating dollar

The great amount of foreign exchange reserves of China is a proof of national power of this country and has profound influence upon China’ economic position in the world. It can prevent the inflow of a large amount of capital, stabilize exchange rate and resist the impact from international financial crisis. However, against the current complicated environment of world economy, the depreciation of U.S. dollar and the sovereign debt crisis in some European countries require China to lower the exchange rate risk to keep the value of its foreign exchange reserves.

“The U.S. dollar assets take a large proportion of our country’s foreign exchange reserves,” Bank of China’s vice president Yang Zaiping says. Now the U.S. dollar assets are exposed to great risk. The financial deficit of the U.S. has already taken 10% of its GDP and the national debt has already exceeded 11 trillion U.S. dollars long before.

Zheng Xinli, vice president of China Center for International Economic Exchanges, says that China’s economy is closely related with the U.S. economy. In the following period, the U.S. dollar crisis is the major financial risk that China has to face. In addition, the excessive foreign exchange reserves will bring negative influences upon China’s macro economy. Experts think the straight accumulation of foreign exchange reserves may lead to tighter regulation and control policies – the PBOC may further improve the deposit-reserve ratio to reduce the fluidity of the capital market.

E Yongjian from Bank of Communications thinks that the deposit-reserve ratio will be further increased in the second half of 2011 if the foreign exchange reserves of China keep increasing.

Increase to be continued in H2

“The structures of debt, creditor’s right and currency of China needs to be changed to diversify the 3-trillion-USD foreign exchange reserves,” says Yu Yongding from the Chinese Academy of Social Sciences. Diversifying foreign exchange reserves means to increase the proportion the assets of other currencies except U.S dollars based on the economic and monetary situation of different countries. It is of use to resist the global debt crisis and is an important method to avoid foreign exchange reserve risk.

Zheng Xinli thinks that increasing the investment into foreign countries and turning some foreign exchange reserves and U.S. national debts into the real materials such as resources and energy. This is also an effective method to lower the risk brought by depreciation of U.S. dollars.

In addition, experts think that the internationalization of RMB is the best solution to foreign exchange reserves risk. But now, developing RMB cross-border settlement is an efficient method, which can both reduce the risk of foreign exchange reserves and promote the internationalization of RMB. And the capital market will be further improved, providing diversified financial products for the domestic and foreign investors.”

“The root of solving the problem of foreign exchange reserves lies in the change of economic structure of China. But it cannot be realized in a short while,” says Chen Daofu, head of the Financial Institution of State Council’s Research and Development Center. In his opinion, the increase of foreign exchange reserves of China will last for a while.

Liu Dongliang, financial analyst from Merchant Bank forecasts that the anticipation for RMB appreciation will not be changed and FDI and trade surplus will not see drastic decrease in the future. Meanwhile, the RMB cross-border settlement will take a higher proportion, pushing the new foreign exchange counterpart to a higher level.