CHINA’S BALANCE OF PAYMENT

AND EXCHANGE RATE POLICY

Word Count: 1,571

Table of Contents

Introduction .................................................................................................. 3

China’s balance of payment evolution ............................................................... 3

China’s Exchange-Rate Policy .......................................................................... 6

Implication of the Demand and Supply on China’s Policy ..................................... 8

Future implications of China’s Foreign Exchange Policy ..................................... 10

Domestic Implications ................................................................................ 10

Global Implications .................................................................................... 10

Conclusion .................................................................................................. 11

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Introduction
China, in recent years, has grown to be a global economic powerhouse as it has
become the country with the largest global foreign reserve (Zhang, 2021). In the
past decade, China has made progress in economic reforms, which has led to the
drastic development of trade in the Asian country (Wu & Mao, 1993). This economic
growth has mainly been attributed to China making use of a different system for its
balance of payment than the rest of the world (Wafik & Tharwat, 2020). This has
therefore attracted much attention and a closer look by the public.

This report will examine China’s balance of payments system, the impact on China,
and the future projections of the balance of payment. This report will also take a
closer look at the country’s exchange rate policy.

China’s balance of payment evolution

The rise of China from a developing economy to a major global economic stalwart is
something of a spectacle. The economic reform of this Asian country started in
1979. It has since been grown over four decades. As of 2017, it was reported that
China’s Gross Domestic Product grew annually at a constant rate of 10%
(Congressional Research Service, 2019).

The economic success of China is primarily attributed to two main factors. These
factors are the large-scale capital investment, funded mainly by foreign
investments, and increased growth in production (Congressional Research Service,
2019). These measures have been coherent over the years, which has boosted the
country’s economic prosperity. This policy put forth by the Chinese government has
led to an increase in the current account surplus and a reduction in the capital
surplus (Wafik & Tharwat, 2020).

China’s balance of payment, which is one of the significant factors for the economic
development of the country, has also gone through a series of stages ever since the
start of the economic reformation in 1979 (Wafik & Tharwat, 2020). The first stage
occurred between 1982 and 1989 and is regarded as the opening up of the reform.
This phase saw an increase in debts measured in bonds and loans. The second
stage occurred between 1990 to 1993. This stage is characterized by a more

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openness of China’s economy and the progression in the foreign trade activities
undertaken in the country. The third and most crucial stage of China’s balance of
payments occurred between 1994 and 2011. This phase brought about
unprecedented economic growth as the economy achieved a double surplus. This
third stage saw the entry of China into the World Trade Organization in 2001. The
inclusion of China in the WTO saw a massive decline in barriers to trade between
China and the rest of the world which also led to the jump in the current and
financial account of the country (OECD, 2011). In 2008, China’s current account
reached $402.6 billion, which has since been the account’s peak. This is illustrated
in Figure 1. The fourth and present stage of the evolution of China’s balance of
payments started in 2012. This phase has brought in the attraction of foreign direct
investment (Wafik & Tharwat, 2020).

Figure 1: China’s Current Account Balance, 1982 - 2016

Source: World Bank1

1
World Bank statistics of China’s Current Account Balance. Obtained from
https://www.stlouisfed.org//media/project/frbstl/stlouisfed/blog/2017/october/blogimage_c
hinacurrentaccountbalance_100217.png

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Figure 2. shows the annual GDP growth of China from 2007 to 2024.

Figure 2. China’s Real Annual GDP Growth: 2007-2018 and Projections

through 2024

Source: IMF, World Economic Outlook Database, April 2019 2.

Figure 3. shows China’s balance of payment trends from 2011 to 2022.

2
International Monetary Fund, World Economic Outlook Database. Obtained from
https://www.imf.org/en/Publications/WEO/weo-database/2019/April

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 Figure 3: China’s Balance of Payment Trends from 2011 to 2022

Source: CEIC Data (2021)3

China’s Exchange-Rate Policy

According to the annual report published by (IMF, 2016), there have been some
changes in the exchange rate policy laid down by China in the past ten years. China
has since pegged the Renminbi to the Dollar from 2005. Between 2006 and 2008,
the Bank of China allowed the Renminbi (RMB) to gradually appreciate by 2.1%
against the US dollar (Congressional Research Service, 2019).

The currency intervention taken by the Chinese government has been primarily
cited as an indicator for the vast trade surpluses and foreign exchange reserve
accumulation the country has witnessed over the years. Aside from the policy
discussed above, China loosened its capital controls in a bid to make the currency-
peg Renminbi more attractive for inclusion in the IMF’s Special Drawing Rights. This
caused a sharp depreciation of the RMB against the US Dollar. However, this step
ensured that China could achieve trade leverages and increased production of
export materials leading to economic growth (Mertens & Shultz, 2017).

Furthermore, the People’s Bank of China in 2015 published an exchange rate index
that consisted of 13 currencies. This action minimized the contention driven by the

3
Ceic China’s Balance of Payments curve from 2011 to 2022. Obtained from
https://www.ceicdata.com/en/china/balance-of-payments-bpm6

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RMB and Dollar’s supposed connection. This ensured that the RMB could be
recognized as a flexible exchange among other global currencies (Mertens & Shultz,
2017).

To guide against the situation whereby the RMB would be pushed to a higher
valuation than required due to market forces during global demand excesses, the
People’s Bank of China made a series of interventions in the foreign exchange
markets. The intervention involved selling RMB for US Dollars, which prevented the
RMB’s appreciation and ensured excess demands were satisfied (Mertens & Shultz,
2017).

Figure 4. shows the average monthly rates of RMB to the Dollar taken between
January 2015 and May 2019.

Figure 4: Monthly RMB-Dollar Reference Rates (Yuan per Dollar)

Source: Bank of China4

4
Bank of China’s datafor China’s monthly RMB-Dollar rates. Data obtained from
https://www.ceicdata.com/en/china/balance-of-payments-bpm6

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The implication of Demand and Supply on China’s Policy
The Demand and Supply Curve is a graph revealing the connection between the
price of a good and the quantity of the good demanded for a given period.
According to Zhang (2021), demand and supply significantly affect the Double
Surplus reserve and the Balance of Payment of China. China has grown to become
a significant player in the global demand and supply of some key sectors of global
trade (Francis, 2007). With the increasing demand and supply of China’s consumer
goods, the prices of such goods changed over time consistently, thereby affecting
the consumer price index of goods, most especially durable and semi-durable
goods.

The increase in the income of the populace leads to an increase in the demand for
goods and services. China has become the world’s largest manufacturer of
consumer goods, having more than 60% of its production globally, and this has
increased the average income of the populace. This appreciation in the nation’s
currency, RMB, has reduced prices and housing expenditure, increasing demand for
these products (Fu & Li, 2014). Therefore, this culminated in a surplus of both the
current account and the capital and financial account of the country (Zhang, 2017).

Figure 5. is a curve explaining the demand and supply characteristics of goods in

China.

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 Figure 5: China’s Demand and Supply Curve

P2

P1

Q1 Q2

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From Figure 5, we can see that China has an increased supply, mainly attributed to
the country’s increased exportation rate. The increased supply also affects the
demand as there is an increase in the amount of goods demand due to an increase
in average income. Therefore, this demand and supply behavior explains the
increase in China’s current account and financial account, contributing to the
country’s economic progress.

Future implications of China’s Foreign Exchange Policy

Domestic Implications
The view of financial analysts and scholars that the double surplus structure being
put up by China is an overall measure that defines the strength and resistance of
the country’s economy against shock caused by a variety of factors (Zhang, 2017).
It is believed that if China sustains its policy of balance of payments, the country’s
foreign exchange reserve (FER) will be increased. This increase in the FER will
ensure China has the financial edge to meet global trade requirements, minimize
the risks of incurring foreign debts, and maintain its position as a major financial
powerhouse.

However, the effect of double surplus on the economy is not too sustainable in the
long run, coupled with the fact that international reserves accumulation cost is
high. Economists and analysts consider that it can thwart the healthy growth of the
Chinese economy (Zhang, 2017).

Global Implications
The current foreign exchange policy undertaken by China is predicted to reduce the
exportation rate in China. Many other countries might want to lean with other
conventional exchange systems rather than commit to the Chinese balance of
payment system (Zhang, 2017). Furthermore, China’s double surplus has caused
the nation’s trade wars with other countries such as the United States and the UK.
This has caused China to become the country with the most trade frictions in over a
decade (Zhang, 2017).

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Conclusion
This report has explored the balance of payments being put to use in China. It can
be deduced from the report that the economic policy put on by China has both its
pros and cons on both the domestic and international trade of the country.

Primarily, the conventional balance of payments deals with disequilibrium of the

balance of payments, whereby the idea is to focus on correcting the extent of trade
deficits in the current and financial accounts. However, this is not so with the
balance of payment system put forth by China, as there is a double surplus in the
balance of payments, as seen in this report.

A recommendation for China is to improve its investment environment and

strategize how to attract more foreign investments to attract and maintain foreign
stock. This will ensure that there will not be a far-reaching long-term consequence
on the country’s economy.

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