Rapidly Expanding International Trade And Foreign Exchange Reserves

Economic reforms have made China a major trading power. China's exports grew from $14 billion at the start of the economic reforms in 1979 to $762 billion in 2005 while imports increased from $16 billion to $660 billion. In 2005, the trade surplus was $102 billion. Much of the surplus came from exports to the United States and Europe. Excluding the United States, China actually had a deficit of $12 billion. As is clear from the Table 1.1, China's international trade surpassed $1 trillion in 2004 and continued to increase in subsequent years. China's foreign trade of $1.4 trillion in 2005 made it the third largest foreign trader behind the United States and Germany. If this pace of growth continues, it is likely to overtake the United States as the largest exporter by the end of the decade.

The expansion process has been facilitated by trade reforms and the general opening of the economy that have attracted surging foreign direct investment (see Table 1.2) and increased integration with the global trading system. Given China's size and substantial development potential, it will continue to have a large impact on the global economy. China's top-10 export destinations are the United States, Hong Kong, Japan, South Korea, Germany, the Netherlands, United Kingdom, Taiwan, Singapore, and Italy. Key import suppliers are mostly from Asia. The top import sup-

TABLE 1.1 China's International Trade

Exports

Imports

($ Billions)

($ Billions)

1979

13.7

15.7

1980

18.1

19.5

1981

21.5

21.6

1982

21.9

18.9

1983

22.1

21.3

1984

24.8

26.0

1985

27.3

42.5

1986

31.4

43.2

1987

39.4

43.2

1988

47.6

55.3

1989

52.9

59.1

1990

62.9

53.9

1991

71.9

63.9

1992

85.5

81.8

1993

91.6

103.6

1994

120.8

115.6

1995

148.8

132.1

1996

151.1

138.8

1997

182.7

142.2

1998

183.8

140.2

1999

194.9

165.8

2000

249.2

225.1

2001

266.2

243.6

2002

325.6

295.2

2003

438.4

412.8

2004

593.4

561.4

2005

762.0

660.1

2006

961.1

791.7

Source: (1) International Monetary Fund, "Directions of Trade Statistics"; (2) New York Times, January 11, 2006; (3) News release, Embassy of the People's Republic of China in the United States, January 10, 2007.

Source: (1) International Monetary Fund, "Directions of Trade Statistics"; (2) New York Times, January 11, 2006; (3) News release, Embassy of the People's Republic of China in the United States, January 10, 2007.

pliers are Japan, South Korea, Taiwan, the United States, Germany, Malaysia, Singapore, Australia, Russia, and Thailand.

International Trade

China has emerged as a trade giant for imports and exports. On the export side, China has long claimed success as the world's factory for light industrial goods for export, such as textiles and toys, and continues to enjoy success in this area. At the same

TABLE 1.2 Foreign Direct Investments in China

1990

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

No. of Contracts

7,271

37,01 1

24,556

21,001

19,799

16,918

22,347

26,139

34,171

41,081

43,664

Contracted ($ Billion)

6.60

91.28

73.28

51.00

52.10

41.22

62.38

69.19

82.77

1 1 5.07

1 53.47

na

Amt. Utilized ($ Billion)

3.41

37.52

41.73

45.26

45.46

40.32

40.72

46.85

52.74

53.51

60.63

60.33

U.S. No. of Contracts

357

3,474

2,517

2,188

2,238

2,028

2,609

2,594

3,363

4,060

3,925

na

U.S. Amt. Contracted ($ Billion)

0.36

7.47

6.92

4.94

6.48

6.02

8.00

7.51

8.20

10.16

12.17

na

U.S. Amt. Utilized ($ Billion)

0.46

3.08

3.44

3.24

3.90

4.22

4.38

4.86

5.40

4.20

3.94

3.06

U.S. Share of Contracted Investment

5.40%

8.20%

9.44%

9.68%

12.44%

14.59%

12.83%

10.85%

9.91%

8.83%

7.93%

na

Source: The U.S.-China Business Council.

Source: The U.S.-China Business Council.

time, China has also focused on production of high value-added exports. This transformation is reflected in the significant shift in China's exports away from basic manufactured items and textiles into electronics and high-tech products, which now account for an increasing share of China's exports. For example, the customs figures showed that in 2005 China's high-tech exports rose 32 percent year-on-year to $218.3 billion. Exports of electronics products also rose 32 percent to $426.8 billion, accounting for 56 percent of total export value for the year. This move is further strengthened by the fact that Taiwanese manufacturers are making use of China's low-cost production as a base for high-tech manufacturing, more for re-importing into Taiwan than for China domestic sales. Table 1.3 lists China's market shares in Japan, the United States, and the European Union.

China has experienced a tremendous increase in infrastructure-related imports as it modernizes across the transportation, power, shipping, and telecom industries to foster the development of industry and sustain economic growth. Projects to develop infrastructure go hand-in-hand with China's efforts to support the surge in foreign direct investment. China has proven its ability to meet promised timeframes for order fulfillment and to satisfy the requirements of U.S. and European importers. High quality goods consistently delivered on time, along with access to markets and competitive pricing, have all contributed to China's success story. This success is reflected in an impressive real gross domestic product growth of 10 percent in the most recent three years, and a continued steady growth in trade, which reached $851 billion in 2003 and over $1 trillion in 2004.

As China broadens its production base to include higher-value products, the country's requirement for raw materials has grown in parallel with increased global demand. For example, oil demand is rising rapidly as the government works to diversify energy sources and move away from a reliance on coal. China accounts for about one third of the growth in global oil demand. There is also a rapid rise in demand for natural gas and hydropower. Companies in China, both multinational and state-owned enterprises (SOEs), need raw materials and semifinished goods for conversion to larger-ticket goods for sale in the domestic market and for re-export overseas. This, in turn, is driving an increased inflow of commodities.

TABLE 1.3 China's Export Market Shares (Percent)

1970

1980

1990

1995

2000

2003

2005

Japan

1.4

3.1

5.1

10.7

14.5

18.5

11.03

United States

0.0

0.5

3.2

6.3

8.6

12.5

21.42

European Union

0.6

0.7

2.9

3.8

6.2

8.9

18.87

Source: International Monetary Fund, "Direction of Trade Statistics."

Note: Figures are imports from China divided by total imports, in percentage.

Source: International Monetary Fund, "Direction of Trade Statistics."

Note: Figures are imports from China divided by total imports, in percentage.

The immediate challenge is to keep up with China's voracious commodities appetite and the growing world demand for Chinese goods. These two demands are putting an upward pressure on pricing. For example, as the world's largest producer of steel, China requires a large inflow of iron ore and other ingredients for steel production. Commodity flows to China such as iron ore, copper, and oil have all seen price increases. With world pressure to keep the supply of raw materials apace with demand, the related challenge is to maintain competitive pricing for commodity imports. Upward pricing pressure must be kept in check to facilitate China's processing of raw materials to finished goods at competitive prices. This impacts China's ability to compete on big-ticket exports destined for large U.S. and European importers and importers in developing countries where China has made considerable inroads.

There has been a significant shift in share of total Asian exports into China. The fact that China has become increasingly prominent as an export destination for Asia as a whole underscores China's growing role as the Asian production hub. In addition, more intermediate products are being shipped to China for assembly before being shipped on to their ultimate markets. China's role in Asian regional trade has also become increasingly important. Imports from the region are growing rapidly, and China now is among the most important export destinations for other Asian countries (Table 1.4).

China's trade expansion in part reflects greater specialization in production within the Asian region. China now serves as the final processing and assembly platform for a large quantity of imports coming in from other Asian countries and then going out to the West. These changes have resulted in a shift in China's bilateral trade balances, with a significant portion of the surpluses with the West offset by the deficit with the neighboring countries, as evidenced by the trade statistics mentioned earlier that China ran a trade deficit with its trading partners excluding the United States. Reflecting this growing prominence and rising imports, China has been an important source of growth for the world economy. China's imports are growing rapidly from all trading partners and it is now the third largest importer of

TABLE 1.4 Imports to China (Percent)

I98G

199G

1995

2GGG

2GG3

2GG5

Asian

15.0

41.0

47.1

53.5

52.8

38.00

ASEAN

3.4

5.6

7.4

9.3

11.3

na

Japan

26.5

14.2

21.9

17.8

18.0

15.22

Korea

na

0.4

7.8

10.0

10.4

11.64

Taiwan

na

na

11.2

11.3

12.9

na

European Union

15.8

17.0

16.1

13.3

12.9

11.14

United States

19.6

12.2

12.2

9.6

8.2

7.42

Source: International Monetary Fund, Direction of Trade Statistics.

Source: International Monetary Fund, Direction of Trade Statistics.

developing countries' exports after the United States and the European Union. It is the largest importer of copper and steel, and among the largest importer of other raw materials.

Foreign Exchange Reserves

China has accumulated more than $1 trillion in foreign exchange reserves. The allocation of those funds for investment purposes has huge implications on global financial asset prices and interest rates.

At the start of the economic reform in the late 1970s, China's foreign exchange reserves were minimal. In the early 1980s, export growth contributed to an initial increase in reserves that grew to $8.9 billion by 1983. Trade deficits in 1985 and 1986 eroded the reserves in those years (declined to $2.1 billion in 1986). In 1987, the surplus on trade in services slightly exceeded the merchandise trade deficit, producing a small current-account surplus, and a net capital inflow helped push reserves back up to $2.9 billion. The reserves were held above this level for another two years. The economic slowdown of 1989 to 1991 produced a sharp fall in imports in 1990, while exports continued to rise, producing a merchandise trade surplus for that year of $11.1 billion. The level of foreign exchange reserves crossed over the $100 billion mark in 1996 to $105.0 billion.

Joining the WTO in 2001 contributed to a rapid growth in China's imports and exports. Foreign direct investment inflows exceeded $50 billion a year in 2002 to 2003 and topped $60 billion a year in 2004 to 2006. Foreign exchange reserves reached a record $819 billion at the end of 2005 (see Table 1.5). By the end of 2006, the amount exceeded $1 trillion.

There has been much talk recently about stimulating private consumption in China, which is seen by a growing chorus of policy makers and analysts worldwide to be an important means of reducing China's growing external surplus. It is important for China to rebalance the economy away from heavy dependence on exports to lead growth toward self-sustaining domestic demand.

As companies have improved their performance, corporate savings have risen and now account for almost half of national savings. Corporations have an incentive to retain their earnings in order to finance their investment with internal funds. This is particularly true for private sector companies, which have limited access to bank financing and few domestic alternatives for raising money. State-owned enterprises that do make profits are generally not required to pay dividends to the government, and these companies naturally prefer to retain their earnings and plow them back into new investments.

By some measures, Chinese households have in recent years saved almost a third of their disposable income. One would expect a lower saving rate in an economy that still has a relatively low per capita income and, more importantly, good prospects for continued high income growth. So why do Chinese households save so much of their current income? Most observers believe the precautionary motive for saving is very strong among Chinese households because of the lack of an adequate pension system

TABLE 1.5 China's Foreign Exchange Reserves

Year

$ Billions

I977

I.O

I978

0.2

I979

0.8

I980

-I.3

I98I

2.7

I982

7.0

I983

8.9

I984

8.2

I985

2.6

I986

2.I

I987

2.9

I988

3.4

I989

5.6

I990

II.I

I99I

2I.7

I992

I9.4

I993

2I.2

I994

5I.6

I995

73.6

I996

I05.0

I997

I40.0

I998

I45.0

I999

I54.7

2000

I65.6

200I

2I2.2

2002

286.4

2003

403.3

2004

609.9

2005

8I8.9

2006

I,066.0

Source:

State Administration of Foreign Ex-

change, China.

change, China.

and the sharply rising costs of health care. Demographic factors add to this saving motive. The one-child policy instituted in the 1970s to control population growth has led to a declining young working class to support the old generation. The need to finance education expenses has also bolstered saving.

The slow development of financial markets in China has meant limited availability of credit, so that households generally have to save in order to purchase big-ticket items, like houses and cars, rather than being able to borrow against future income. It also has meant that there are low returns on households' financial assets and limited opportunities for portfolio diversification, since there are few alternatives to depositing savings in state-owned banks.

All of this suggests that financial market reform and development is a key priority, which the Chinese authorities recognize. The pace of the reform has picked up since China joined the WTO in 2001. Enterprises might be less compelled to rely on internally generated funds if they have access to financial markets to raise capital. Increased access to credit for households, the availability of a wider range of saving instruments that would help them to diversify risk, and higher returns on their assets also could contribute to a reduction in household savings. Thus, building a broader-based, well-functioning financial market would help to rebalance China's economy by tilting domestic demand growth away from heavy reliance on investment toward consumption. Exchange-rate flexibility could have a role by providing more scope for monetary policy independence and helping cushion the economy from economic shocks. It could contribute to rebalancing the economy by improving investment decisions, and the appreciation of its currency raises consumption by bolstering households' real incomes. The government also has a major part to play in influencing saving and consumption, particularly through provision of education, health care, and pensions. Reducing uncertainties in these areas could substantially diminish the strong precautionary saving motive among Chinese households and give them the confidence to raise their consumption.

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