Although a capital account deficit has happened before, this number adds to the confirmation to what we have been observing: there is some sort of capital outflow happening since late last year. Capital account deficit in the second quarter was the highest on record.
The chart below shows the different major components of the balance of payment (reserve account as a separate item). As a reminder, all components should add up roughly to zero, allowing for statistics discrepancies. Thus what you see is a more or less symmetrical chart.
Perhaps the most striking thing about these numbers for Q2, however, is not so much that the capital & financial account has turned negative. Rather, the sum of current account and capital & financial account (ex. reserve account) has turned negative, which necessitated a positive number for the reserve account. A positive number for the reserve account means that China is selling off reserve assets, which means foreign exchange reserve. This is the first balance of payments (ex. reserve account) deficit since 1998.
SAFE has not yet disclosed what exactly caused the large deficit for the capital & financial account, except that foreign direct investment came in at a US$38.6 billion surplus, which could mean deficits for other items, such as portfolio investments.
The implication of this is serious. As we have mentioned many times, the accumulation of FX reserve by China is necessitated by the desire to keep Chinese Yuan from appreciating to quickly, and this foreign exchange intervention means the China has to create more Chinese Yuan to keep exchange rate low. At the same time, this action has been creating a lot of liquidity within the Chinese banking system which the People’s Bank of China has always been struggling to sterilise.
Now the situation has been totally reversed, and if this continues, it will mean that the People’s Bank of China will be extinguishing Chinese Yuan, not creating, so to speak. That means should capital outflow continue, the liquidity condition will be tightened within the banking sector. That will limit the ability for the People’s Bank of China to ease monetary and liquidity condition going forward.
This article originally appeared here: China’s balance of payments (ex. reserve account) turned negative in Q2
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