Reviving China’s Rebalancing

After running massive surpluses for two decades, China’s foreign-exchange reserves are poised to break $4 trillion, with the marginal cost of every dollar accumulated vastly surpassing its benefits. It is clearly in China’s interest to reduce its economic imbalances; the question is whether it has the policy space to do so.

BEIJING – China is at a crossroads. After experiencing three decades of unprecedentedly rapid GDP growth, the country weathered the global economic crisis exceptionally well. But it sustains considerable economic imbalances, which are undermining its ability to achieve high-income status. The question is whether China’s leaders – preoccupied with challenges like financial instability stemming from risky shadow-banking activities and a heavy burden of local-government debt – have the policy space to put the economy on a sounder footing.

In the aftermath of the global economic crisis, China appeared to be on track to complete such a rebalancing. Its current-account surplus fell from more than 10% of GDP in 2007 to 2.6% in 2012, and it ran a large capital-account deficit for the first time since 1998. Moreover, China added only $98.7 billion to its foreign-exchange reserves in 2012, compared to an average annual increase of more than $435 billion from 2007 to 2011. That meant diminishing upward pressure on the renminbi’s exchange rate.

But, over the last year, China’s imbalances returned with a vengeance. Its 2013 trade surplus likely exceeded $250 billion; its capital-account surplus exceeded $200 billion in the first three quarters of the year; and its foreign-exchange reserves soared by $509.7 billion. Meanwhile, the lower current-account surplus (as a share of GDP) could be a result of its increased investment-income deficit. And, while recovery in the advanced economies boosted exports, persistent overcapacity, combined with slower household-consumption growth than in 2012, caused investment growth, though still rapid, to decline to its lowest rate in the past 11 years.

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