Information about Asia and the Pacific Asia y el Pacífico

Chapter 1. An End to China’s Imbalances?

Anoop Singh, Malhar Nabar, and Papa N'Diaye
Published Date:
November 2013
  • ShareShare
Information about Asia and the Pacific Asia y el Pacífico
Show Summary Details
Ashvin Ahuja, Nigel Chalk, Malhar Nabar, Papa N’Diaye and Nathan Porter 

Global imbalances have been a central theme of the international economic policy debate for much of the last decade, prompted by large and sustained current account deficits in the United States and counterpart surpluses in China, Germany, and many of the oil-producing economies. This chapter focuses on the external imbalance in China, examining the factors underlying the post-2008 drop in China’s current account surplus and analyzing the prospects for the external surplus going forward. It finds that China’s current account surplus should remain modest in the coming years. However, despite the likelihood that China’s medium-term current account will stay below its precrisis range, it is too early to conclude that “rebalancing” has truly been achieved in China. Although imbalances do not currently seem to be manifesting themselves as a feature of China’s external accounts, the evidence points to a domestic imbalance because the economy continues to rely on high levels of investment.


As early as 2005, analysts and academics became concerned about the prospects for, and sustainability of, growing current account imbalances in the world’s largest economies (see, for example, Obstfeld and Rogoff, 2005). In the United States, low saving rates and growing household consumption—fueled in part by what later turned out to be a bubble in the property market—sucked in imports from abroad, causing the trade and current account deficits to balloon. Of course, this deficit had a counterpart in the United States’ principal trading partners. Among the oil producers, strong demand and rising prices resulted in growing trade surpluses and rising net foreign asset positions. In Germany and Japan, external surpluses rose steadily throughout the early part of the 2000s, mainly on account of rising trade surpluses but also, in Japan’s case, because of rapidly growing income flows accruing on Japan’s significant stock of foreign assets. Finally, beginning in 2004, the trade surplus in China took an unprecedented turn upward, which, in turn, created significant pressure for the renminbi to strengthen.1

Researchers viewed this system of growing global surpluses and deficits as a renewed “Bretton Woods II” system (Dooley, Folkerts-Landau, and Garber, 2003, 2004; Roubini and Setser, 2005). The principal concern among commentators was that, at some point, the global system would be unwilling to continue to finance the growing imbalances in the United States (particularly in financing the U.S. fiscal position), which would lead to a sudden stop in capital flows to the United States, a spike in U.S. treasury yields, a weaker U.S. dollar, and a collapse in both external deficits and surpluses. This disorderly unwinding was predicted to be painful, creating macroeconomic and financial instability and a collapse of global growth.

The global economy did fall into a crisis—the worst tailspin since the Great Depression—but in a manner that was far from what was predicted by Bretton Woods II proponents (see Delong, 2008; and Dooley, Folkerts-Landau, and Garber, 2009). Catastrophic failures of risk management and financial regulation were exposed—spilling out from the U.S. real estate market—culminating in the startling failure of Lehman Brothers, the near-collapse of the international financial system, and a sharp global recession. All of this occurred with relatively modest movements in the real exchange rates of both the deficit and the surplus economies (Figure 1.1).

Figure 1.1Real Effective Exchange Rate

(Index, 2000 = 100)

Source: IMF INS database and staff calculations.

As a by-product of the Great Recession, current account surpluses and deficits across the globe contracted. The U.S. saving rate moved sharply upward, and external demand collapsed. Japan’s current account surplus fell from 4.8 percent of GDP in 2007 to 2.8 percent of GDP in 2010. Germany’s current account surplus fell from 7½ percent of GDP to 5¾ percent of GDP during the same period. Despite relatively high oil prices, the current account surpluses of the oil exporters were cut in half, to about ½ percent of global GDP (Figure 1.2).

Figure 1.2Global Imbalances

Sources: IMF, World Economic Outlook; and IMF staff calculations.

And then there was China. In the world’s second-largest economy, the current account surplus was cut in half from 2007 to 2009, amounting to a US$150 billion swing in the current account surplus. The surplus leveled off in 2010 as the global economy recovered, but then in 2011 the current account surplus was cut almost in half once again (Figure 1.3). Forecasting China’s external accounts has always been challenging, in part reflecting rapid structural change, uncertainties surrounding China’s terms of trade, and difficulty predicting the path of the global recovery—but the scale of this current account reversal has been far sharper and more durable than expected.

Figure 1.3China’s Current Account and Its Components

Sources: IMF, World Economic Outlook; and IMF staff calculations.

This chapter focuses on describing the dynamics behind the fall in China’s external surplus since 2007. It aims to assess what has driven the external imbalance to shrink and provides a revised outlook for the current account in the medium term.

The Recent Path of China’s External Imbalance

Until 2004, China’s external imbalances were relatively small with the trade surplus averaging only 3 percent of GDP during the period 1994–2003 (Figure 1.4). At a more disaggregated level, the trade surplus or deficit for various product components was also very small, although the trade surplus for textiles grew steadily during the period. Starting in 2004, the size of China’s imbalance accelerated, most notably as the result of an upswing in net exports of machinery and mechanical devices. This upswing was offset, in part, by a significant expansion of China’s trade deficit in minerals (largely metals and energy products). Despite these equalizing factors, as a share of GDP, China’s current account was able to rise to double digits by the eve of the global financial crisis, and at the time, few signs indicated that the pace of growth of the imbalance was set to slow down anytime soon.

Figure 1.4Trade Balance

(12-month moving average)

Sources: CEIC Data; and IMF staff calculations.

However, what happened next was an extraordinary set of global circumstances that combined to set off the worst global financial crisis in the post–World War II period. Against this external backdrop, China’s current account surplus was cut in half between 2007 and 2009 and, by 2011, had fallen to 1.9 percent of GDP. This compression in the external surplus was largely a result of a falling trade balance (which went from 9 percent of GDP in 2007 to 3.3 percent of GDP in 2011).

Certainly the drop in the trade balance has a cyclical component. After all, growth and demand in the global economy were damaged by the global financial crisis, and balance sheet repair and ongoing deleveraging were expected to weigh on growth well into the medium term. At the same time, the significantly higher demand for imported minerals (Figure 1.4) and energy was a side effect of China’s policy response to the global financial crisis—to put in place a significant infrastructure-driven stimulus funded by high credit growth.

Nevertheless, more lasting forces have also been at work, affecting the trade surplus in both directions. Domestic costs are rising, the costs of imported inputs (particularly commodities) have risen, and the stimulative effects on trade that were created by China’s accession to the World Trade Organization (WTO) may be waning. However, the relocation of global manufacturing capacity to China (financed by significant foreign direct investment [FDI] inflows) continues and capacity is being built in new industries as China moves rapidly up the quality ladder. The following discussion aims to weigh these various competing factors first by analyzing the main forces behind the recent decline in the surplus and then by drawing ideas together to summarize what this all means for China’s external imbalance going forward.

What is Driving the Declining Surplus?

The Collapse in Global Demand

Since 2008, the global environment that China faces has changed radically. It has become clear that the path the advanced economies were on during the “Great Moderation” was unsustainable and built on excessive consumption and leverage. As a result, in 2008, the level of GDP in the advanced economies took a large step down. In addition, future growth is likely to struggle as balance sheet excesses are worked through. This will certainly prove to be a headwind for China’s trade performance. Part of this is cyclical; eventually the output gap in advanced economies is expected to close. However, the advanced economies are expected to endure lower potential growth in the medium term. The direct impact on China’s export sector has been visible. For example, exports of machinery and equipment to the United States—which contributed between 10 and 15 percent of China’s overall export growth early in the first decade of the 2000s—look unlikely to recover as long as the U.S. housing market remains subdued. Indeed, the contribution of these items to export growth has declined to about 5 percent in the postcrisis period.

One additional aspect of China’s export performance worth highlighting is that, although overall external demand has suffered as a result of the global financial crisis, China’s ability to gain a larger share of those external markets appears to have been relatively unaffected. Even in 2008, when global trade collapsed, China was still able to gain market share, and since then, the pace of China’s market share gains has broadly returned to the level prevailing before the global crisis. At an aggregate level, China has, since 2003, managed to increase its share of world exports by an average of about ¾ percentage point per year.

While maintaining its foothold in traditional areas, China has also started to make a concerted push into industries typically dominated by more advanced economies. Prominent examples of these new growth areas include wind turbines, solar panels, automobiles, and semiconductor devices. In the wind energy industry, for example, China increased its share of global capacity from 16½ percent in 2009 to 22¾ percent in 2010, overtaking the United States as a world leader in wind energy capacity. Thus, China has increased its global market share in exports of wind energy equipment to about 6 percent (as of September 2011) from almost zero five years earlier. Similarly, China has moved rapidly to build production facilities in solar panels, and the upswing in China’s global export share in this industry has come at the expense of Japan and Germany (in part, as multinationals from those countries move their production facilities into China).

A Step Increase in Investment

In 2008, as the global financial system melted down, China responded early and resolutely with a large stimulus package that was designed to prop up domestic demand and offset the large shock emanating from the coming collapse in external demand. This stimulus created the conditions for a dramatic step-up in investment, to 47 percent of GDP from 42 percent (Figure 1.5). Much of that investment was concentrated in transportation, utilities, and housing construction. A direct consequence of this investment has been to remove many of the infrastructure bottlenecks that existed and to increase the connectivity between provinces. Ultimately, these advances will serve to improve the competitiveness of China’s industry, in part as it facilitates industrial relocation to lower-cost areas within China (particularly the central and western provinces).

Figure 1.5Domestic Demand

Sources: CEIC Data; and IMF staff calculations.

As the global economy started to recover, China’s spending on infrastructure began to wane, which created a hole in aggregate demand that was quickly filled by an upswing in private sector manufacturing investment. It appears this manufacturing capacity is being built predominantly in a range of relatively higher-end manufacturing industries. In the coming years, this growth in manufacturing capacity could potentially lead to future increases in exports (as China sells these goods onto global markets). Alternatively, this capacity could be deployed domestically through sales to Chinese industries and households. Finally, there is a chance that it could remain underutilized (which would open up the question of how and whether the financing for these investments will be serviced). At this point, the purpose for which this new capacity will be used remains an important question but very difficult to predict.

The Role of Commodities and Capital Goods

As discussed, one of the by-products of the step increase in fixed investment has been a significant increase in China’s demand for commodities. This growth in demand took off first in metals followed by strong import growth in machinery and energy products. Both private and public investment projects have proved to be very import intensive. Some opportunistic cyclical stockpiling of commodities has occurred, and inventory data show stockbuilding in upstream industries such as ferrous metal mining (about 15 percent year-over-year growth in 2011) and nonferrous metal mining (about 25 percent year over year). Overall, however, little evidence points to a secular rise in inventories, which would suggest that this import demand is largely being used as an input to domestic production (see Ahuja and others, 2012, for more details).

The Terms of Trade

The sustained strength in imports of commodities and minerals has reinforced a dynamic that has been at work for several years now, going back to well before the global financial crisis. During the past several years, imports have become more linked to commodities and minerals, for which supply is relatively inelastic and global prices have been rising. At the same time, exports have become increasingly tilted toward machinery and equipment, for which supply is relatively elastic, competition is significant, and relative prices have been falling.

As a result, aside from 2009 and 2012, China’s terms of trade have been steadily worsening. This result may not be surprising from a historical standpoint. Several other economies that have witnessed export-oriented growth (notably Japan and the newly industrialized economies) were affected by similar terms of trade declines along their development paths (Figure 1.6). In China’s case, this dynamic is further fueled by the fact that, in both export and import markets, the country has become so large as to no longer be a price taker. As a result, to some modest degree, China may well be generating a decline in its own terms of trade, creating a self-equilibrating mechanism that drives China’s terms of trade and creates countervailing downward pressures on China’s external surplus, through global prices.2

Figure 1.6Terms of Trade of Selected Economies since Growth Take-Off

Sources: IMF, World Economic Outlook; and IMF staff calculations.

Note: NIE = Newly Industrialized Asian Economies.

Exchange Rate Appreciation

The exchange rate appreciated 14¾ percent in real terms during April 2008–December 2011, but as mentioned above, this change masks considerable variation within the interval. A significant portion of this appreciation took place in 2008, after which the pace slowed markedly through the crisis and recovery (and has included intervals of real depreciation). Most of the real appreciation was due to movements in nominal exchange rates relative to major trading partner currencies, whereas the portion of the real appreciation accounted for by inflation differentials relative to trading partners has been relatively minor (Table 1.1).

Table 1.1Decomposition of China’s Exchange Rate
Percent change April 2008–December 2011
REER appreciation14.7
Contribution from
Inflation differential1.6
NEER appreciation13.0
of which, contribution from
Appreciation against U.S.$2.4
Appreciation against other partner currencies10.6
Memo item:
Bilateral appreciation against U.S. dollar10.6
Source: IMF staff estimates.Note: NEER = nominal effective exchange rate; REER = real effective exchange rate.
Source: IMF staff estimates.Note: NEER = nominal effective exchange rate; REER = real effective exchange rate.

Net Income Flows

Finally, a few words on net income flows are warranted. It is something of a puzzle that, as China’s net foreign asset position has accelerated, net income flows have not increased correspondingly. Looking first at the asset side, the rise in foreign assets in China has largely tracked the evolution of the central bank’s reserve portfolio and China Investment Corporation’s investment position. Liabilities, however, have mirrored the growing stock of FDI flowing into China. The low net income flow numbers suggest a significant differential between the return on FDI into China versus the returns on the reserve holdings of the central bank. Indeed, it would appear that the return differential has been on the order of 3–4 percentage points for much of the past several years, resulting in net income flows that are close to zero despite a growing net foreign asset position (Ahuja and others, 2012).

Putting It All Together

Even as China’s growth has moderated compared with before the crisis, import volumes have continued their upward trajectory as output has become more capital goods and commodity intensive. The step increase in investment spending and the associated sustained strength in import volumes (particularly of key commodities) have reinforced an ongoing secular deterioration in China’s terms of trade. To attach some quantitative importance to these effects, actual developments during 2007–11 were compared with a counterfactual scenario based on both a reduced-form model of the current account and separate trade regressions (details are in the Annex 1A to this chapter). The counterfactual scenario is based on decomposing the change in the current account surplus since 2007, assuming that (1) partner country output was at potential from 2007 to 2011, (2) the real exchange rate had stayed constant, and (3) the terms of trade and investment-to GDP ratio had remained at their 2007 levels.

The calculations suggest that the terms of trade decline contributed between one-fifth and two-fifths of the decline in the current account surplus during 2007–11 (Table 1.2). The acceleration in investment accounted for one-quarter to one-third of the decline, whereas the appreciation of the currency contributed between one-fifth and one-third. Below-potential growth in partner countries had a slightly smaller effect. Overall, the conclusion is that growing domestic investment, worsening terms of trade, weakening external demand, and appreciation of the REER explain a large share of the postcrisis decline in the current account surplus. That said, it should be noted that these calculations are based on a partial equilibrium approach and have to be interpreted with some caution. For example, they do not account for feedback effects between these various factors (such as the linkages between high investment in China and rising global commodity prices).

Table 1.2Estimated Contributions to the Decline in China's Current Account Surplus, 2007–11(percent of GDP)
Estimated Trade Elasticities1Reduced-Form Current Account Equation
Actual 200710.110.1
Actual 201122.82.8
Contributing factors:
Terms of trade−1.6−3.6
Foreign demand−1.1−1.4
Source: IMF staff calculations.Note: REER = real effective exchange rate.

Elasticities based on estimated calculations for exports and imports of goods and services.

Preliminary actual.

Source: IMF staff calculations.Note: REER = real effective exchange rate.

Elasticities based on estimated calculations for exports and imports of goods and services.

Preliminary actual.

Policy Reform, Demographics, and Cost Pressures

Policy Reforms

The Chinese government has rightly focused its policy efforts since the global financial crisis on a range of areas designed to accelerate the transformation of the Chinese economic model, improve livelihoods, and raise domestic consumption. Access to primary health care has been improved through the construction of new health care facilities, particularly in previously underserved rural communities. A new government health insurance program has been launched nationwide, and subsidies for a core set of prescription drugs have been introduced. In addition, the existing government pension scheme is being expanded to cover urban unemployed workers across the country and to make those pensions more portable within China. Also, the absolute level of pensions has been increased, particularly for the elderly poor.

In addition to health care and pensions, improving access to affordable housing has been an important policy objective. The 12th Five-Year Plan, launched in 2011, aims to construct 36 million low-income housing units by 2016. The wider availability of low-cost housing has the potential to ease the budget constraints of low-income groups and release savings currently locked up in financing home purchases.

So far, however, it is still too early to conclude that the initiatives to build out the social safety net and increase the provision of social housing have led precautionary saving to decline or have created sufficient momentum for household consumption to durably reverse the secular decline as a share of GDP that has been seen since 2000.

At the same time that these housing and social reforms have been undertaken, greater policy emphasis has been placed on market-based pricing of factor inputs and the scaling back of subsidies. Nevertheless, the low cost of many of China’s factor inputs—including land, water, energy, labor, and capital—still creates incentives for an overly capital-intensive means of production. Factor inputs are priced below prices that would be expected to equilibrate supply and demand and are also low relative to international comparators. For instance, in many cases, industrial land is provided for free to enterprises to attract investment, and the price of water in China is about one-third of that of international comparators. Cross-country data on the cost of energy show that the prices of gasoline and electricity in China are low relative to much of the rest of the world. Studies estimate that the total value of China’s factor market distortions could be almost 10 percent of GDP.3 However, China is making progress in bringing some energy costs in line with international levels: oil product prices have been indexed to a weighted basket of international crude prices. natural gas prices have been steadily increased, and preferential power tariffs for energy-intensive industries have been removed.

Again, so far these rising costs, along with higher wages and the more appreciated currency, appear to have had little effect on corporate saving. Geographical relocation, strong productivity, and modest increases in export prices are helping to defray cost pressures that firms may be facing.

Overall, although the policy reforms that have been undertaken are valuable and necessary, and structural forces are at work that should help redistribute resources and shift behaviors, little evidence indicates that these efforts have created a decisive turnaround in national saving behavior, either at the corporate or the household level. However, many of these policies are likely to have long lags before their impact on saving behavior is clearly seen. It may well be that an effect on household income and consumption will become steadily more discernible in the coming years.


In addition to the policy efforts taken by the government to lessen its external imbalances, raise household income, expand the services sector, and boost consumption, some important underlying structural changes are also under way. Over the decades, urbanization has proceeded steadily and is now at the point that half of the Chinese population is living in urban areas. This process has tended to be commodity intensive; new housing and infrastructure built to accommodate this growing urban citizenry has put downward pressure on the trade surplus. At the same time, this shift has raised the standard of living for many Chinese, lifting millions out of poverty and creating a vibrant urban middle class. This process undoubtedly has been associated with growing consumption of tradable goods, some imported from abroad but the majority produced within China. Thus, while manufacturing capacity has been expanding at a breathtaking pace, a large share of this capacity has been deployed to provide goods to the domestic market. That fact is becoming increasingly evident as the domestic economy—particularly the interior of the country—develops and companies relocate production facilities out of the coastal areas and closer to these fast-growing local markets.4

Demographic Change

A second important structural factor has been China’s unique demographics. China is fast approaching the point at which its labor force will start to shrink; already, the size of the cohorts that are younger than 24 years old has begun to decline. This change is naturally going to tighten labor markets and put upward pressure on wages as the labor-supply curve moves from perfectly elastic to moderately upward sloping, as is now happening. Although China is not yet at the so-called Lewis Turning Point, it has entered a period in which real wages are going to continue to rise and increasingly at a rate that is faster than productivity.5 These ongoing shifts in factor markets—both labor and other inputs—are clearly important and, over time, should lead to rising cost pressures. This will also have implications for the external imbalance. Nonetheless, it is still too early to conclude that rising cost pressures have been responsible, in a meaningful way, for China’s shrinking external surplus. As seen in the decomposition of the REER appreciation in Table 1.1, the contribution of the inflation differential (which reflects, in part, the influence of factor cost differences) has been relatively minor.

The Outlook for China’s External Surplus

As discussed above, prospects for China’s external surplus are closely linked to the outlook for the principal drivers of the recent decline—external demand, the level of investment, and the future trends for China’s terms of trade and domestic costs. The outlook draws on the conclusions of the various modeling approaches described in Annex 1A but also imposes some degree of judgment given the uncertainties. Therefore, these projections are predicated on the assumption that many of the recent shifts underpinning the surplus reversal will be persistent, in particular,

  • China continues to gain global market share at the average pace seen during the past decade, but in an environment of generally weak growth in China’s main trading partners (as described in the April 2012 World Economic Outlook).
  • The elevated level of investment spending continues, keeping the investment-to-GDP ratio close to current levels and well above the precrisis average.
  • China’s terms of trade continue to steadily deteriorate (by ½ percent per year).
  • The usual World Economic Outlook assumption that China’s REER remains constant continues to be true.
  • As the global recovery gathers momentum in the medium term, the rates of return on China’s reserve portfolio increase, leading to a growing surplus on the income account.
  • Under these conditions, net exports will likely improve in real terms as global demand slowly recovers, but the current account surplus will not rise to anywhere near the levels seen before the global financial crisis. Instead, the current account surplus is expected to stay close to current levels in the near term and rise in the medium term but only to about 4 to 4½ percent of GDP by 2017 (Figure 1.7).

Figure 1.7Projection to 2016 of China’s Current Account and Its Components

Source: IMF, World Economic Outlook.

The downside risks to the outlook for the current account are considerable. They are partly tied to the global outlook, but the pace of continued structural change in China’s economy is also subject to uncertainty. For example, various factors—including the beneficial impact of WTO accession in 2001, strong growth in manufacturing productivity, a relocation of global production facilities to China, and low-cost factors of production—created the conditions for the country’s export market share to rise rapidly since the early 2000s. China is expected to continue building its export market share and to rotate its product mix toward higher-end manufacturing. This process may, however, face headwinds from the slow recovery in global demand. It is also possible that market share gains will moderate relative to the rate experienced since early in the 2000s as China’s export mix gets closer to the technology frontier and opportunities for technology transfer and the relocation of overseas production facilities diminish. Finally, if past experience can be extrapolated, China’s real exchange rate may continue to appreciate, which, again, will diminish the size of the external surplus.

What Does This Revised Outlook for China’s Current Account Imply for the Path of Global Imbalances?

The implications of changes in China’s current account for global imbalances is a big question that does not lend itself to a neatly wrapped answer. The issue also goes well beyond China and requires that the imbalances in many other large economies be examined. However, there are three major points:

  • First, the Chinese economy is growing rapidly, so even though the increase in the size of the imbalance in the medium term is relatively modest, it would still translate into a growing share of the aggregate external balance of surplus economies in the future. Furthermore, relative to the size of the world economy, the rapid growth in the Chinese economy would indicate an increase in the current account to 0.6 percent of global GDP in the medium term from 0.2 percent in 2012 (high growth ensures that China’s economy becomes a larger and larger share of global output through time). By this metric, the current account surplus is far from negligible, albeit well below the share of global GDP that China’s current account surplus reached in 2007–08.
  • Second, the fading of China’s external surplus does not mean global imbalances are solved. Rather, these global imbalances may be rearranging themselves into a different geographical constellation. China’s external surplus may well have migrated elsewhere, aided, in part, by the impact China is having on global prices and its own terms of trade.
  • Third, unless consumption can soon be catalyzed, the decline in the external surplus will have come at the expense of a widening imbalance in China’s domestic economy. However, such an imbalance is not merely a domestic issue. If left unresolved, it has the potential to generate macroeconomic and financial instability in China’s economy, which, because of China’s size and systemic importance, will undoubtedly have consequences for global macroeconomic and financial stability.


The decline in China’s external surplus has been impressive and should be welcomed. However, this adjustment has largely been the result of very high levels of investment, a weak global environment, and an increased pace of commodity prices that outstrips the rising price of Chinese manufactured goods. Although all three of these factors are likely to continue to put downward pressure on the external imbalance, the “rebalancing” in China advocated by the IMF over the past several years is not occurring.6 Certainly, the policy thrust of the 12th Five-Year Plan is very much focused on raising household income, boosting consumption, and facilitating expansion of the service sector. In the coming years, if these ongoing structural reforms continue to be implemented, China does have the potential to evolve from a largely investment-based to a more consumption-based decline in its external imbalance. If successful, this would ultimately prove to be a more lasting shift that would increase the welfare of the Chinese people and contribute significantly to strong, sustained, and balanced global growth.

Annex 1A. Empirical Analysis

A number of different models have been estimated to explain the external surplus—see, for example, Aziz and Li (2007), Cheung, Chinn, and Qian (2012), or Mann and Pluck (2007). The analysis in this annex looks at four different approaches—a structural dynamic stochastic general equilibrium model, a multivariate Bayesian vector autoregression (BVAR) model, a reduced-form time series model of the current account, and an approach using simpler trade equations—and examines their predictions for the future path of China’s current account surplus.

In most cases, these forecasts assume a constant real effective exchange rate (REER); the World Economic Outlook (WEO) projections for global demand; and a path of steady, medium-term fiscal consolidation in China. If the exchange rate appreciates in real terms (because of either faster nominal appreciation or a sustained increase in domestic cost pressures that translates into larger inflation differentials relative to trading partners) or external demand is weaker, the current account will undoubtedly be below these projected ranges.

  • Global Integrated Monetary and Fiscal Model (GIMF). The first approach uses the IMF’s multicountry dynamic general equilibrium model.7 The model captures the vertical trade structure and other key features of trade between China, advanced economies, emerging economies, and the rest of the world. Simulations using the GIMF show that a combination of stronger global demand and a lower fiscal deficit creates the conditions for a rise in exports and a decline in commodity imports. As a result, the current account surplus would be predicted to increase to about 4 percent in the medium term.
  • Bayesian VAR (BVAR). The second method uses higher-frequency, quarterly data based on the BVAR methodology (Österholm and Zettelmeyer, 2007). The model includes trading partners’ demand, domestic demand, property prices, consumer price index inflation, commodity price changes, interest rates, the fiscal balance (as a percentage of GDP), the current account balance (as a percentage of GDP), the money supply, and the REER. Similarly to the GIMF approach, the out-of-sample forecasts assume a steady path of fiscal consolidation and a global recovery as projected by the WEO. Simulations using the BVAR model show a much stronger and earlier rise in the trade surplus. The model forecasts that the current account surplus would rise to about 5 percent of GDP by 2014 (Figure 1A.1).
  • Reduced-form current account model. A third approach uses a set of variables similar to those in the BVAR. Specifically, the reduced-form model relates China’s current account share of GDP to real GDP growth, China’s trading partners’ real GDP growth, the REER, the terms of trade, and ratio of the lagged current account to GDP.
  • The model was estimated for 1986–2011 using the generalized method of moments approach. All parameters are significant and with signs consistent with economic theory (Table 1A.1).
  • In the short term, a 1 percentage point increase in China’s real GDP growth reduces the current account surplus by 1/3 percent of GDP; a 1 percentage point increase in trading partners’ growth increases China’s current account surplus by about ½ percent of GDP; a 10 percent real effective exchange rate appreciation would lower the surplus by 1 percent of GDP; an improvement in the terms of trade up to a threshold would improve China’s current account surplus. Above that threshold, the income effect from the improvement in the terms of trade would start to dominate, leading to a reduction in the current account surplus as the terms of trade improve. In the longer term, the effects of these variables are about 2¾ times larger.
  • The model predicts that a gradual strengthening of demand for China’s exports, steady annual GDP growth in China, a slight deterioration in the terms of trade, and a constant REER would leave China’s current account surplus at less than 4 percent of GDP by 2017 (Figure 1A.2). This prediction is despite an in-sample overestimation of the 2011 current account surplus by 2¼ percent of GDP (i.e., in 2011 the model predicts a current account surplus of 4¼ percent of GDP versus the 1.9 percent of GDP outturn).
  • Trade equations. One recurrent theme in estimating trade equations for China is that the estimated elasticity of exports to external demand is very large.8 At the same time, on the import side, an important driver of imports has been the level of exports (about ½ of imports in some way or another are destined as inputs for goods that are processed and then eventually exported to third countries). To take into account these two features of China’s trade, a simple modified trade model is used.9 In particular, FDI is included in the export equation as a proxy for the expansion of China’s tradables production and increased involvement in cross-border production sharing. On the import side, the effect of processing trade is captured by including exports in the import equation. With FDI in the export regression, the elasticity of exports to foreign demand falls from 5 to 2, whereas including exports in the import equation reduces the elasticity of imports to domestic demand from 1.4 to 0.6 (Table 1A.2). Using these models to forecast, and assuming a modest decline in inward FDI as a share of GDP, the trade surplus falls to about 3 percent of GDP in the medium term. However, the forecast is subject to significant uncertainty and is highly sensitive to the path of future FDI inflows; if FDI stays about the same share of GDP as in 2011, the model would forecast the trade surplus to be some 6 percentage points of GDP higher in the medium term.

Figure 1A.1Current Account Balance Projections Using Different Models

Source: IMF staff calculations.

Note: GIMF = Global Integrated Monetary and Fixed Model; VAR = vector autoregression; WEO = IMF World Economic Outlook.

Table 1A.1Generalized Method of Moments Estimate of Current Account Balance(Percent of GDP)
Parameter Estimates
Real GDP growth−0.30 [.001]
Trading partners, real GDP growth0.43 [.000]
REER−0.09 [.006]
Terms of trade (lagged 1 year)0.42 [.000]
Terms of trade squared (lagged 1 year)−2.8E-03 [.000]
Current account balance (lagged 1 year)0.64 [.000]
Dummy 2009–11−2.99 [.000]
Source: IMF staff calculations.Note: Generalized method of moments estimates over the sample 1986–2011. Figures in brackets are p-values.REER = real effective exchange rate.
Source: IMF staff calculations.Note: Generalized method of moments estimates over the sample 1986–2011. Figures in brackets are p-values.REER = real effective exchange rate.

Figure 1A.2Current Account Forecast Based on Time Series Model

Sources: IMF, World Economic Outlook; and IMF staff calculations.

Note: WEO = World Economic Outlook.

Table 1A.2Trade Elasticities
Export ElasticitiesImport Elasticities
with respect to:Standard ModelAugmented ModelStandard ModelAugmented Model
Foreign demand

Domestic demand

Source: IMF staff calculations.Note: *significant at 10%; **significant at 5%; ***significant at 1%.FDI/GDP = Foreign direct investment divided by GDP; REER = Real effective exchange rate.
Source: IMF staff calculations.Note: *significant at 10%; **significant at 5%; ***significant at 1%.FDI/GDP = Foreign direct investment divided by GDP; REER = Real effective exchange rate.

    Acharya, Viral V., and PhilippSchnabl,2010, “Do Global Banks Spread Global Imbalances? The Case of Asset-Backed Commercial Paper during the Financial Crisis of 2007–09,” IMF Economic Review, Vol. 58, No. 1, pp. 37–73.

    • Search Google Scholar
    • Export Citation

    Ahuja, Ashvin, NigelChalk, MalharNabar, PapaN’Diaye, and NathanPorter,2012, “An End to China’s Imbalances,” IMF Working Paper 12/100 (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation

    Aziz, Jahangir, and XiangmingLi,2007, “China’s Changing Trade Elasticities,” IMF Working Paper 07/266 (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation

    Bems, Rudolfs, JoshuaFelman, DavidReichsfeld, and ShaunRoache, forthcoming, “Why Has China’s Current Account Surplus Declined?” IMF Working Paper (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation

    Caballero, Ricardo, EmmanuelFarhi, and Pierre-OlivierGourinchas,2008, “An Equilibrium Model of ‘Global Imbalances’ and Low Interest Rates,” American Economic Review, Vol. 98, No. 1, pp. 358–93.

    • Search Google Scholar
    • Export Citation

    Cheung, Yin-Wong, MenzieChinn, and XingWangQian,2012, “Are Chinese Trade Flows Different?” Journal of International Money and Finance, Vol. 31, No. 8, pp. 2127–46.

    • Search Google Scholar
    • Export Citation

    Cooper, Richard N.,2007, “Living with Global Imbalances,” Brookings Papers on Economic Activity, Vol. 2, pp. 91–110.

    De Long, J. Bradford,2008, “The Wrong Financial Crisis,” VOX.

    Dooley, Michael P., DavidFolkerts-Landau, and PeterGarber,2003, “An Essay on the Revived Bretton Woods System,” NBER Working Paper No. 9971 (Cambridge, Massachusetts: National Bureau of Economic Research).

    • Search Google Scholar
    • Export Citation

    Dooley, Michael P., DavidFolkerts-Landau, and PeterGarber,2004, “The Revived Bretton Woods System: The Effects of Periphery Intervention and Reserve Management on Interest Rates and Exchange Rates in Center Countries,” NBER Working Paper No. 10332 (Cambridge, Massachusetts: National Bureau of Economic Research).

    • Search Google Scholar
    • Export Citation

    Dooley, Michael P., DavidFolkerts-Landau, and PeterGarber,2009, “Bretton Woods II Still Defines the International Monetary System,” Pacific Economic Review, Vol. 14, No. 3, pp. 297–311.

    • Search Google Scholar
    • Export Citation

    The Economist, 2012, “Changing Migration Patterns: Welcome Home,” February25.

    Gruber, Joseph W., and Steven B.Kamin,2008, “Do Differences in Financial Development Explain the Global Pattern of Current Account Imbalances?” International Finance Discussion Paper No. 923 (Washington: Board of Governors of the Federal Reserve System).

    • Search Google Scholar
    • Export Citation

    Guo, Kai, and PapaN’Diaye,2009, “Is China’s Export-Oriented Growth Sustainable?” IMF Working Paper 09/172 (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation

    Huang, Yiping,2010, “Krugman’s Chinese Renminbi Fallacy,”, March26.

    Huang, Yiping, and KunyuTao,2010, “Causes and Remedies of China’s External Imbalances,” China Center for Economic Research Working Paper No. E2010002 (Beijing: Peking University).

    • Search Google Scholar
    • Export Citation

    International Monetary Fund (IMF), 2010, “People’s Republic of China Article IV Consultation—Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion,” IMF Country Report 10/238 (Washington).

    • Search Google Scholar
    • Export Citation

    International Monetary Fund (IMF), 2011, “People’s Republic of China Article IV Consultation—Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion,” IMF Country Report 11/192 (Washington).

    • Search Google Scholar
    • Export Citation

    Kumhof, Michael, DouglasLaxton, DirkMuir, and SusannaMursula,2010, “The Global Integrated Monetary and Fiscal Model—Theoretical Structure,” IMF Working Paper 10/34 (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation

    Mann, Catherine L., and KatharinaPlück,2007, “Understanding the U.S. Trade Deficit: A Disaggregated Perspective,” in G-7 Current Account Imbalances: Sustainability and Adjustment, ed. by RichardClarida (Chicago: University of Chicago Press) pp. 247–82.

    • Search Google Scholar
    • Export Citation

    Obstfeld, M., and K.Rogoff,2005, “Global Current Account Imbalances and Exchange Rate Adjustments,” Brookings Papers on Economic Activity, 2005, Vol. 1, pp. 67–123.

    • Search Google Scholar
    • Export Citation

    Obstfeld, M., and K.Rogoff,2010, “Global Imbalances and the Financial Crisis: Products of Common Causes,” in Asia and the Global Financial Crisis, ed. by ReuvenGlick and Mark M.Spiegel (San Francisco: Federal Reserve Bank of San Francisco).

    • Search Google Scholar
    • Export Citation

    Österholm, P., and J.Zettelmeyer,2007, “The Effect of External Conditions on Growth in Latin America,” IMF Working Paper 07/176 (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation

    Roubini, Nouriel, and BradSetser,2005, “Will the Bretton Woods 2 Regime Unravel Soon? The Risk of a Hard Landing in 2005–2006,” Paper presented at the Symposium on the “Revived Bretton Woods System: A New Paradigm for Asian Development?” organized by the Federal Reserve Bank of San Francisco and the University of California Berkeley, San Francisco, February4.

    • Search Google Scholar
    • Export Citation

An alternative view was that global imbalances had emerged as a by-product of underdeveloped financial markets in emerging economies (for example, Cooper 2007; and Caballero, Farhi, and Gourinchas, 2008). In this interpretation, savings from emerging economies were channeled uphill to advanced economies, particularly the United States, in search of safe and liquid assets (as the result of a lack of such assets in these countries’ domestic economies). But as Obstfeld and Rogoff (2010) argue, based on the findings of Gruber and Kamin (2008) and Acharya and Schnabl (2010), little evidence suggests that capital flows from emerging to advanced economies were systematically related to the state of financial development, or that it was principally emerging economies’ demand for risk-free assets that was financing the U.S. current account deficit.


The deteriorating terms of trade could also generate negative income effects as prices of imported goods rise, which would lower domestic demand and partly offset the narrowing of the external surplus. But this offset so far appears to be relatively muted in China’s case, with domestic spending (particularly investment) continuing to rise rapidly even as import prices have risen.


See Huang and Tao (2010) or Huang (2010). Also see IMF (2011) for more discussion on relative factor costs comparing China with other economies.


The process has been facilitated by the loosening of restrictions on household registration requirements in certain interior urban areas such as Chongqing. For more details, see The Economist (2012).


See Chapter 9 for a detailed analysis of this issue.


See, for example, IMF (2010, 2011).


See Kumhof and others (2010) for a description of the model.


For example, in Aziz and Li (2007), a 1 percent increase in external demand is associated with a 5 or 6 percent increase in China’s exports. This far outstrips the typical elasticity in other countries and is the counterpart of China’s rapid growth in global export market share. Such a large export response is clearly unsustainable and should eventually decline, although the timing of that decline is highly uncertain (Guo and N’Diaye, 2009).


See Bems and others (forthcoming) for details.

    Other Resources Citing This Publication