Net Errors and Omissions —Do They Explain Capital Flight?

The "net errors and omissions" in China's balance of payments data have long exhibited two traits - being large and largely negative. In the past this has often been interpreted as a sign of a serious problem with capital flight. Now，it is attracting market attention once again. Some economists downplay the significance of a reduction in the nation's official foreign exchange reserves in recent years，insisting it is the result of "foreign exchange now held by the people." However，the argument over whether net errors and omissions reflect capital flight has little practical significance. It is more important to reduce the ratio of net errors and omissions and improve the quality of statistics on the balance of payments in order to better serve the market analysis and macroeconomic decision-making ability of the nation's policy makers.

Over an extended period，there is a correlation between capital flight and negative net errors and omissions. Every country deals with net errors and omissions items in its balance of payments data，and in accordance with global standards，the international balance of payments is prepared using the principles of double entry bookkeeping. In order to strike a balance in the balance sheet in both directions of debits and credits，the net errors and omissions item is set in the balance sheet. However，net errors and omissions are not calculated from statistics. They are merely a category used to reach a balance in international payments and receipts.

Net errors and omissions may be due either to statistical or economic factors. China¡¯' balance of payments figures are based on statistical data from the Customs Administration，the Ministry of Commerce，the People's Bank of China，the China National Tourism Administration and other departments. The data from these diverse arms of the government are compiled from different statistical systems which differ in terms of concept，scope，dimension and recording principles. It is difficult to record all transactions in each sector. Therefore，when the data are aggregated，there may be errors and omissions. As for economic factors，net errors and omissions may reflect unrecognized cross-border capital flows，commonly known as "hot money inflows" or "capital flight."

Theoretically speaking，if the net errors and omissions are mainly due to statistical factors，there should be a stochastic distribution of negative and positive tallies. The quarterly net errors and omissions in the balance of payments statistics of the United States are usually larger than China's，but the annual frequency is smaller due to frequent shifts from positive to negative over the year. For example，in 2000 the ratio of the US net errors and omissions to the total value of US imports and exports was +12.7% in the first quarter，- 8.1% in the second，- 10.4% in the third and -6.7% in the fourth，but the annual ratio was  -3. 3%. In 2005 the quarterly ratios were +10.8%，+15.1%，- 7.6% and -12.0%，but the annual figure was + 1.2%. Of 68 quarters from the first quarter of 2000 to the fourth quarter of 2016，there were 40 quarters with ratios exceeding + 5% or -5% in the US. But in the 17 years from 2000 to 2016，there was only one year where the ratio exceeded 5%，and that was + 5.8% in 2009.

If the net errors and omissions remain positive or negative for a prolonged period，it may reflect a serious problem of unrecorded hot money inflows or capital flight. Judging from the fact that since 2009 the annual value of the net errors and omissions in China's international payments position has been negative (the category was continuously positive between 2002 and 2008)，there is reason to suspect that some capital outflows were not recorded and these were then labeled as "capital flight." In 2015 and in 2016，every quarter showed a negative value and this looked particularly suspicious. In 2015，the ratio of net errors and omissions to the total of imports and exports was -7.5% in the first quarter，- 1.4% in the second，- 9.5% in the third and -5.0% in the fourth，with an annual ratio of - 4.9%. In 2016，the quarterly ratios were -5.6%，- 5.5%，- 8.2% and -6.0% respectively，with an annual ratio of -5.4%.

Whether negative net errors and omissions reflect capital flight does not affect policy judgments and responses. There are many who argue that based on either statistical data or economic analysis，net errors and omissions should not be equated with capital flight. At the same time，it is difficult to say which components of the net errors and omissions should be attributed to statistical reasons as opposed to economic reasons. Looking at economic reasons，it is difficult to say how many should be attributed to the overestimation of the earnings on the current account or be attributed to the underestimation of capital outflows. The lack of a uniform standard makes it hard to give any justifiable explanation for capital flight. This is of some academic significance though it lacks practical value.

First，regardless of whether the negative net errors and omissions reflect capital flight，it is undeniable that China's capital outflow situation has been severe in recent years. To