Risk Watch: Declining Export Surplus Will Affect China’s Forex Earnings

The Sino-U.S. trade war and China’s worsening economy have hurt China’s export surplus.

According to official economic figures released near the end of September, China’s export surplus fell by a third in the first eight months of 2018 as compared to the previous year. China’s top three performing provinces by GDP, Guangdong, Jiangsu, and Zhejiang, all saw reduced export surpluses from a year ago. In 2017, exports from the three provinces accounted for 56.2 percent ($2.26 trillion) of the country’s total exports.

China’s declining export surplus has affected foreign exchange earning ability. According to official data, China’s foreign exchange reserves fell by $51.741 billion and $74.432 billion in August and September respectively.

The economic situation in Guangdong, Jiangsu, and Zhejiang is a bellwether of China’s economy on the whole. If current trends hold, China will not be able to withstand a trade war with the United States. (see here, here, and here)

The backdrop:
Oct. 8:

  • China’s State Council increased the export tax rebates for hundreds of items to 16 percent (up by as much as 5 percent for some items). This is the second time this year that China has raised the export tax rebate rate.
  • According to data released by China’s State Administration of Foreign Exchange, China’s forex reserves totaled $3.087 trillion in September, a decrease of $22.7 billion from a year ago and a drop of $74.457 billion from January 2018.

Oct. 10:
China sells $3 billion worth of U.S. dollar bonds, including securities maturing in five, 10, and 30 years.

Oct. 11:
In an interview with Fox News, President Donald Trump said that U.S. tariffs on Chinese products “had a big impact,” and that the Chinese economy “has gone down very substantially and I have a lot more to do if I want to do it.”

Our take:
1. From January to August this year, China’s total export surplus fell 33.4 percent (624.3 billion yuan) as compared to a year ago. The top three exporting provinces, Guangdong (-25.3 percent), Jiangsu (-3.3 percent), and Zhejiang (0.4 percent), saw their export surplus either shrink or drop.

The export surplus drop in Guangdong, one of China’s most economically developed province, is particularly severe and revealing of the country’s economic woes. In 2017, Guangdong was the province with the highest GDP (10.9 percent of China’s total GDP). Meanwhile, Guangdong’s exports made up a third of China’s total exports.

China’s economic situation could be worse than appearances suggest.

A closer examination of official data reveals that the Chinese authorities are likely distorting its economic figures. According to Guangdong’s statistics bureau, the province’s exports grew by 0.4 percent year-on-year in the first eight months of 2018. However, comparing the official figure with that of the previous year shows a drop, and not growth, of 0.7 percent.

Also, the export surplus of Guangdong, Jiangsu, and Zhejiang makes up 181.3 percent of China’s total, an increase of 46.5 percent from the same period in 2017. This means that most provinces have an export deficit, while China’s forex earnings are highly dependant on the three provinces above.

2. The creditworthiness of the renminbi is tied with the U.S. dollar; when China’s U.S. forex earnings is reduced, the value of the RMB also goes down. Reduced money supply will aggravate credit contraction, but not cutting the money supply will cause the RMB to depreciate greatly. Presently, Chinese companies are facing a credit crisis as China’s economy continues to worsen. To avert the credit crisis, the Chinese authorities have adopted monetary easing policies, which have in turn led to RMB depreciation.

Thus far, the RMB has already devalued by nearly 10 percent, a depreciation that has somewhat offset the impact of the U.S. tariffs. The Chinese authorities, however, cannot rely on RMB depreciation to weather the trade war because tariff rates are increasing in 2019 (from 10 percent to 25 percent) and the Trump administration could later label the People’s Republic of China as a currency manipulator to justify imposing even higher tariff rates. In taking the long view, RMB devaluation will not help Chinese exports, but will instead increase the cost of imported goods and drain China’s forex reserves quicker.

China’s recent sale of U.S. dollar bonds, when viewed in the context above, suggests that the CCP is pessimistic about the prospects of boosting its forex reserves.

3. The sharp drop in China’s export surplus also partially reflects the country’s issues with manufacturing and unemployment. Again, we will look at Guangdong, Jiangsu, and Zhejiang.

According to Guangdong’s statistics bureau, more than a fifth of industrial enterprises in the province suffered losses between January to July 2018. Most of the industrial firms that sustained losses were from the private sector, and state-owned enterprises (SOE) were making fewer losses. On the contrary, SOEs saw profits rise by 14.6 percent; private enterprises saw their earnings decline by 5.3 percent while foreign firms saw profits fall by 12.2 percent.

SOEs in Guangdong may have seen increased profits, but they did not provide new employment opportunities and instead slashed 20,000 jobs. Private and foreign enterprises in Guangdong cut employment by 1.6 percent and 8.6 percent from a year ago respectively.

Meanwhile, the real economy in Jiangsu and Zhejiang appears to have shrunk significantly. Per official figures from the Jiangsu local government, the number of industrial firms above designated size in Jiangsu decreased by 2,461 (-5 percent) compared to the same period from a year ago, while profits fell from 613.4 billion yuan to 466.4 billion yuan (-24 percent) year-on-year. In Zhejiang, industrial enterprises saw 5.7 percent fewer profits from 2017, while companies which suffered losses surged by 30 percent.

4. Guangdong, Jiangsu, and Zhejiang, the top three Chinese provinces by GDP, are “barometers” of the Chinese economy. The inability of the three provinces to see healthy export surpluses will affect China’s forex earnings, and forex earnings are a cornerstone of China’s economy.

What’s next:
Businesses in China that are considering shifting supply chains due to the Sino-U.S. trade war might need at least half a year (or much longer) to prepare and make a move. If many companies move part or most of their supply chains outside the country, then the trade war negative impact on the Chinese economy would become more obvious in 2019.

As China economy continues to worsen and the country makes less revenue, local governments with massive debt liabilities will likely come under serious pressure. Social problems (protests by military veterans, financial victims, and other petitioners, etc.) are likely to escalate as the debt crisis becomes more severe. Mounting social tensions will in turn affect consumer and investor confidence, creating a negative spiral. The combination of economic and social problems will significantly raise the already high levels of political risk faced by individual Chinese officials and the CCP regime in general.

Get smart:
SinoInsider predicted the outbreak of the Sino-U.S. trade war in our 2018 outlook in January. With advance and accurate insights into the direction of China’s economy and politics, businesses and investors in China will have sufficient time to prepare for major developments and minimize political risk.

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