Trade Woes and the Current Account — Don't Panic Yet

The current account is an important indicator of a country's external equilibrium，and it plays a role in shaping exchange rate expectations. In the first quarter and first half of this year，China suffered its first deficit on the current account since 2001. Although the latest data show that China had a surplus in the second quarter alone of US$5.8 billion，there is much concern over the potential for further weakening amid the growing Sino-US trade friction. This has implications for China's economy and the renminbi exchange rate.

The proportion of China's current account surplus to the gross domestic product fell from 1.8% in 2016 to 1.3% in 2017. It had a deficit equal to 1.09% of GDP in the first quarter of this year and approximately 0.43% in the first half of the year. (The current account consists of trade in goods，services，income and current transfers. In essence，due to the relatively modest amounts of income and current transfer projects，changes in the current account are essentially determined by goods and services.)

The Near Term Perspective

At present，the overseas economic prosperity is still at a high level of volatility，and there is a lagging effect from renminbi depreciation in the previous period. The export fundamentals in the second half of the year were not cause for pessimism. Merchandise exports were affected mainly by overseas demand. The latest data showed that  US economic growth in the second quarter exceeded expectations，with GDP quarter on quarter growth of 4.1%，the highest since 2014. Although economic growth in Europe and Japan has slowed，the performance of the US economy means that any slowdown in global economic growth will be delayed. The depreciation of the renminbi will promote China's export expansion in future.

In the context of a slowdown of the domestic economy，import demand may weaken. Tighter financial regulation aimed at promoting deleveraging in the domestic economy will eventually lead to a contraction of credit. That in turn will have an impact on the real economy. As China's domestic demand growth slows in the second half of the year，import demand may weaken.

Slower household income growth and the depreciation of the currency will make it difficult to record a trade deficit that is bigger in terms of GDP. China's deficit in the services trade is mainly from travel though transportation and "other areas" also are factors. In recent years，rising living standards in China due to economic growth and a stronger currency have brought about a boom in outbound tourism. Spending on overseas tourism has increased year by year. However，with the gradual slowdown in economic growth and the depreciation of the renminbi，the service deficit may not expand at a rapid pace.

Although the United States has imposed new tariffs on China，Chinese counter-measures will largely offset the negative impact on the current account. On the export side，China's export price elasticity is -1.16. The second round of the new US punitive tariffs covers a total of US$250 billion worth of goods. The situation remains unclear but in the worst case scenario，a 25% tariff on Chinese goods，China's exports could be reduced by US$72.5 billion. On the import side，China's import price elasticity is -1.03. China's counter-measures involve a total of US$110 billion worth of goods. If we calculate the impact using the weighted average tariff of 20%，China's imports would be reduced by US$22.7 billion. The impact of the trade war on China's trade surplus could be a total of US$49.8 billion，putting the current account surplus at about 0.4% of GDP.

Oil prices are another key uncertainty. Prices of other commodities have been weak，and the price of crude oil may follow suit. That would improve China's current account. The July Commodity Index declined 2.22% year-on-year，the first negative reading since September 2016. According to the latest forecast of the World Bank，international oil prices will rise 32.6% this year，though price growth will ease in the second half of the year. It is estimated that China's import price index will fall from an average of 102 in the first half of the year to 100，and the total value of imports will decline 3.92%