--- Chinese Capital Account and Current Account Financial Market of China

Introduction Concept and Relationships between current account, capital account and official reserves Concept and Relationships between current account, capital account and official reserves Present Capital Account and Current Account Reasons, Advantages and Disadvantages from the data Forecasted Capital Account and Current Account Reasons, Advantages and Disadvantages from the Forecasted Results Conclusion: Good Expectations for the Development of China Good Expectations for the Development of China

Part I  Current Account: It is the sum of net sales from trade in goods and services, net factor income (such as interest payments from abroad), and net unilateral transfers from abroad.  Capital Account: (Financial account) It is the net change in foreign ownership of domestic assets.  Current Account: It is the sum of net sales from trade in goods and services, net factor income (such as interest payments from abroad), and net unilateral transfers from abroad.  Capital Account: (Financial account) It is the net change in foreign ownership of domestic assets.

KA account deficit: domestic ownership of foreign assets has increased more quickly than foreign ownership of domestic assets KA account surplus: foreign ownership of domestic assets has increased more quickly than domestic ownership of foreign assets

 Official reserve: It records the government's current stock of reserves. Reserves include official gold reserves, foreign exchange reserves, and IMF Special Drawing Rights (SDRS).  Official reserve: It records the government's current stock of reserves. Reserves include official gold reserves, foreign exchange reserves, and IMF Special Drawing Rights (SDRS).

Relationships between : current account, capital account and official reserve Current Account + Capital Account = Change in Official Reserve Account

Part II Present Current account and capital account prevailing in China

China’s Balance of Payments Components, (USD billion)

1. Current Account Surplus

Bank of China declared 2% appreciation of RMB Exchange rate US dollar/ China RMB decreased from 8.27 to China's accession to the World Trade Organization (WTO) Export is booming faster 2001~2007 The increase rate of current account = ( )/17.4 = 824.1%

2. Capital Account Surplus

Figure ２ : China’s International Direct investment of capital inflows and outflows ( ) Unit: $100million Year Capital Inflows Capital Outflows Net Differences Source from: According to 2003 Chinese foreign economical trade yearbook 2004 Chinese commerce yearbook computation

3. Official Reserve

Why this “Double surplus” ?  1. Increasing in FDI: (1)FDI need to balance the resources settles around the globe. (2) Chinese economic characters strengthen the capability to absorb capital in ： Cheap- Labour => Low Cost

Cumulative FDI

2. Less domestic invest abroad:  1. China’s stage of development:  2. China’s macro policy: (1) Aim to enlarge the export, lack of independency. (2) T he examination and approval system is too complex.  3. The enterprises in China have problems themselves.  4. China has a relative higher return of interest on saving.China has a relative higher return of interest on saving

Advantages for this surplus in capital account  1. Balance the international profit.  2. Having more money to boost up domestic economy.  3. Lower unemployment Rate  1. Balance the international profit.  2. Having more money to boost up domestic economy.  3. Lower unemployment Rate

Disadvantages for this surplus in capital account  1. Means that the domestic market is occupied by foreign investors.  2. Since foreign investor will gain from investment, the profit as a financial capital massive will backflow to developed country.  3. The domestic economical industrial structural adjustment may be affected.  4. Financial foreign exchange crisis ： more pressure in appreciation of RMB  1. Means that the domestic market is occupied by foreign investors.  2. Since foreign investor will gain from investment, the profit as a financial capital massive will backflow to developed country.  3. The domestic economical industrial structural adjustment may be affected.  4. Financial foreign exchange crisis ： more pressure in appreciation of RMB

Part III Forecast Capital Account Reasons for Our Forecasts Advantages of Our Forecasts Results Disadvantages of Our Forecasts Results

The Volume of International Trade between China with UK, USA and Mongolia (Source: World Trade Organization)

Import and Export in the 10th Five-year Plan Period ( t _ htm)

RMB exchange rate to USD 2005/07/21 to 2007/03/12 Source from: The People’s Bank Of China

From the data and Charts above, there is big pressure for RMB to appreciate, and let’s look at what would happen for the capital account.

The appreciation of Chinese Currency will make investment less attractive because of the speculation reasons. Adding…

Our Theoretical Prove Recall: Current Account + Capital Account = Change in Official Reserve Account From the data above, China is now experiencing a “Double Surplus” in both current account and capital account. =>If a government runs a current account surplus and has no change in official reserves, then the current account surplus must be balanced by a capital account deficit. Recall: Current Account + Capital Account = Change in Official Reserve Account From the data above, China is now experiencing a “Double Surplus” in both current account and capital account. =>If a government runs a current account surplus and has no change in official reserves, then the current account surplus must be balanced by a capital account deficit.

As there will be a Capital account deficit…  Advantages: 1. Avoid Repeat Investment  Advantages: 1. Avoid Repeat Investment 2. Balance the Payment of domestic without increasing Official reserve. 3. Increasing the demand of foreign currency, which will less the pressure of evaluated domestic currency.

Advantages: 4. Stop borrowing useless capital from foreign countries and lending to foreign countries. 5. Having more influence in global market. 6. Gain good money from investing abroad. 4. Stop borrowing useless capital from foreign countries and lending to foreign countries. 5. Having more influence in global market. 6. Gain good money from investing abroad.

Explanation I : Solow Model

there is a decrease on saving rate the saving line shifted from L1 to L2 the capital per worker (k) decreases from K1 to K2 the output decreases from y1 to y2 Worse off

Explanation Ⅱ : Disappear of Speculation Short Run: There is a difference between actual exchange rate and market exchange rate Investors have the motivation to get the profit from speculation If there is an appreciation on Exchange rate, there will be a decrease on capital inflow

Long-Run: The attractive points on investing foreign assets still exist There will be a capital outflow In total: KA will have a negative sign in the long term.

Explanation Ⅲ : Output Function Y = C + I + G + Export - Import d Y/Y = d C / C * C / Y + d I / I * I / Y + d G / G * G / Y + d NX / NX * NX / Y There will be a decrease on economic growth.

Explanation Ⅳ : Labour Market the cost of labour will increase. the opportunities provided will decrease. the unemployment rate will increase due to the above reasons.

Explanation Ⅴ : Aggregate Demand Foreign investment decreases Domestic interest rate decreases Saving rate decreases Domestic investment decreases Less motivation for economic growth

IS1 IS2 LM R Y R1 R2 Y1Y2

Nowadays, China runs surplus on both Current Account and Capital Account. Under the pressure of International Trade Partner, Chinese Currency has the tendency to appreciate. After the adjustment of Chinese Currency, Speculation Investment will be withdrew. China now is experiencing the specific development period and there will be some problems.

Group Members: Stella, Xu Tony, Chen Lucy, Zhang