China posted a trade deficit – no, that’s not a typo, I did mean deficit – in March, of $7.2 billion. That’s the first monthly deficit since 2004. It couldn’t come at a more auspicious time, for China that is. Beijing is in the middle of a tug-of-war with Washington over the value of its currency, and the deficit takes a bit of steam out of the American position that the yuan is grossly undervalued. Politicians in Washington (and many economists) have insisted that China purposely keeps the yuan (also known as the renminbi) at an artificially cheap level, giving its exports an unfair cost advantage in global markets and fueling China’s persistent trade surpluses. If those surpluses were to vanish, so does the American argument.
But that’s not likely to be the case. The March trade deficit does not settle the controversy about China’s currency regime.
The reason is there is widespread agreement among economists that the March deficit is not an indication that Chinese exports are becoming less competitive. The March figure could well be a one-off event, or at best a sign of a very temporary phenomenon. The deficit was caused by an unusually large level of imports (up 66% year-on-year), especially of the raw materials needed to fuel China’s recession-busting infrastructure binge. However, investment in those infrastructure programs is expected to taper off as 2010 progresses, while recovering demand in the U.S. will likely lead to healthier Chinese exports – meaning China’s trade balance will quickly return to a surplus.
With that expectation, economists are not changing their view that China will need to allow the yuan to appreciate to fight inflationary pressures and slow down a potentially overheating economy. Here’s what Jun Ma, chief China economist at Deutsche Bank, had to say on the matter in a note to investors:
Many people wonder whether (the March deficit) would become a meaningful argument for China to avoid or delay its exchange rate reform. Our answer is no, as this monthly deficit is a symptom of economic overheating and a few other one-off factors and is thus tentative in nature. We expect China’s trade balance to return to surplus a few months later, and the outlook for the RMB to resume flexibility should not be affected.
Yet there’s another way of looking at this picture. (We are, after all, dealing with economics!) HSBC economists, in a recent report, noted that the March deficit points to a much larger historical trend – China’s surpluses have been decreasing (relative to the size of the economy), and will likely continue to do so:
March’s trade deficit is likely to be temporary, but it reveals an underlying trend that the market has overlooked; that is, China’s trade (and current account) surplus has already been falling at a rapid pace since 2007…China’s trade surplus to GDP ratio had reached a historical peak of 7.5% in 2007, then it dropped to 6.5% in 2008 and further to only 4% in 2009. Meanwhile, China’s current account surplus to GDP ratio had almost halved to 5.9% in 2009 from the spike of 10.6% in 2007. We expect this trend to continue with the trade surplus to GDP ratio falling below 3% and the current account surplus to below 4% by 2011. This is mainly because growth in China’s imports is likely to continue to outperform exports growth in the coming years.
The shrinking surplus, HSBC says, “is likely to substantially weaken the case for renminbi undervaluation.”
Whatever the value of the yuan should or should not be, the March figures from China are also symbolic of another major trend taking place in the world economy, one that bodes well for future global economic growth – the increasing importance of China and emerging markets in general as importers, and the beneficial impact that’s having on trade. Goldman Sachs chief economist Jim O’Neill and his team pointed this out in a very interesting recent study. Here’s what he said:
Emerging markets have not only helped to drive the rebound in global trade in growth terms, but have also contributed towards bringing back world imports to 2007 levels in U.S. dollar terms. World imports have already recovered almost 50% of its fall during crisis…Looking over a longer period, the gain in EM (emerging market) imports since June 2007 is more than the loss in DM (developed markets) imports over the same period, indicating that EM acted as a good cushion during the crisis period. In particular, the gain in China imports is more than the loss in the U.S. imports during crisis… The share of EM in world imports has risen significantly from 30% in the late 1990s to 45% towards the end of 2009. In particular, China’s share of world imports has more than doubled in the past decade.
Getting past the highly politicized back-and-forth on the value of the yuan, we should see China’s March trade deficit as a potentially positive development for the world economy. A China that buys more from the world is a China that is eradicating the dangerous imbalances in its economy and adding to the health of the global economy.