From Investing in Chinese Stocks.
It took until November 2015 for China to see as much capital outflow through the banking system as it has seen through May. This number shows excess of payments for imports/foreign investments versus receipts through the banking system, which isn’t a pure estimate of the outflow (Chinese data being what it is), but it does show whatever happened last year is happening to a larger degree this year.
This is background to a piece by Christopher Balding, Why China Does Not Have a Trade Surplus:
Life has few certainties except for death, taxes, and large Chinese trade surpluses. The expected large Chinese trade surpluses are always referred to as both proof of the strength of the Chinese economy and its financial foundation as money continues to flow in. In nominal RMB terms, the trade surplus amounted to 5.5% of GDP or 79% of total GDP growth. In other words, in 2015 China is almost entirely dependent on maintaining a large trade balance to drive GDP growth.
However, what if the assumed trade balance did not actually exist? In fact, how would it change our understanding of the Chinese economy and financial markets if the assumed trade surplus was actually a trade deficit? Unfortunately, this is not a counterfactual but the reality. China is running a small trade deficit.
The widely cited international trade data is provided by Chinese customs records. The value of goods leaving and entering and China is recorded by the Customs Bureau. According to Customs data, China imported $1.69 trillion (10.45 trillion RMB) and exported $2.27 trillion (14.14 trillion RMB) for a resulting trade balance of $593 billion (3.7 trillion RMB). These often repeated numbers form the basis for why China is running a large trade surplus.
Before explaining why China has no trade surplus, it is important lay some related groundwork. By now China watchers knows about the practice of trade misinvoicing. This is the practice where, as originally executed, capital was either moved into or out of the country based upon fraudulently invoicing an import or export. For instance, by over invoicing an export, capital can flow into China as the foreign counter party is over paying for the good and vice versa for imports.
To take one example, of trade between Mainland China and Hong Kong, there are significant discrepancies between the value reported to Chinese customs and Hong Kong customs. Hong Kong reported imports from China worth $255 million USD but China reported exports to Hong Kong of $335 million USD. The 31% difference in customs prices, or $79 million, is too large to be unintentional and acts as a capital inflow into China. Conversely, China reports $12.8 billion USD of imports from Hong Kong but Hong Kong only reports $2.6 billion USD of exports to China. The 385% difference is far in excess of the low mid to single digit invoicing discrepancies that are standard in global trade. Consequently, the $10.1 billion USD in over invoiced Chinese “imports” acts as a capital outflow from China.
Misinvoicing contributes a not entirely insignificant share to unrecorded capital inflows and outflows. However, Chinese authorities have become much more aware and concerned about these issues and gone through various waves of cracking down over this issue. Furthermore, the aggregate sums here are not enough to move the RMB and cause the currency pressures we are currently seeing. In fact, misinvoicing is merely the beginning of the financial flow problems in trade with Chinese innovation taking it a step further.
China, as a country with strict currency controls, maintains records on international financial transactions sorted by a variety of categories. For instance, there is data on payment or receipt of funds by current or capital account, goods or service trade, and direct or portfolio investment. For our purposes, this allows us to compare in a relatively straightforward manner, how international payments are flowing compared to the customs reported flow of goods.
The differences in key data surrounding trade data is illustrative. Chinese Customs data reports goods exports valued at $2.27 trillion, with SAFE reporting goods exports of $2.14 trillion but Chinese banks report receipts of $2.37 trillion. In other words, funds received for exports of goods and services or about $100 billion higher than reported. At 4-11% higher than the Customs and SAFE reported values this is slightly elevated, but given expected discrepancies in the mid-single digits, this number is slightly elevated but not extreme.
The differences between import and international payment data, however, is astounding. Whereas Chinese Customs reports $1.68 trillion and SAFE report $1.57 in goods imports into China, banks report paying $2.55 trillion for imports. In other words, funds paid for imported goods and services was $870-980 billion or 52-62% higher than official Customs and SAFE trade data. This level of discrepancy is extreme in both absolute and relative terms and cannot simply be called a rounding error but is nothing less than systemic fraud.
If we adjust the official trade in goods and services balance to reflect cash flows rather than official headline trade data as reported by both Customs and SAFE, the differences are even worse. According to official Customs and SAFE data, China ran a goods trade surplus of $593 or $576 billion but according to bank payment and receipt data, China ran a goods trade surplus of only $128 billion. If we include service trade, the picture worsens considerably. China via SAFE trade data reports a $207 billion trade deficit in services trade. Payment data reported via SAFE actually reports about $42 billion smaller deficit of $165 billion. In other words, the supposed trade surplus of $600 billion has become a trade in goods and services deficit of $36 billion. Expand to the current, through a significant primary income deficit, and the total current account deficit is now $124 billion.
There are two very important things to emphasize about these discrepancies. First, the imports customs and payment discrepancy is responsible for essentially all of the discrepancy between payments and customs. Neither goods exports or differences between service imports at customs and payments explain the difference. In fact, service is underpaid according to payment and customs data. Second, if there was a more benign explanation, we would expect to see symmetry between various categories. Rather, we see most categories reconciling close enough and one channel, conveniently enough one that funnels capital out of China, enormously mis-stated.
This discrepancy between official reported trade data and bank payments is a relatively new phenomenon but has been growing rapidly and reveals important details about flows into and out of China. For instance, since 2010 China has an aggregate trade in goods and services surplus based upon payments of 1.9 trillion RMB; however, since 2012 an aggregate deficit of 120 billion RMB. 2010 and 2011 were the only years where China ran a trade in goods and services surplus using payments data rather than customs data. Expanding to consider the current account significantly worsens the outlook. From 2010 to 2015, China has run a current account surplus of 462 billion RMB but from 2012 to 2015 ran a deficit of 1.44 trillion RMB. The reason for the shift is simple. In 2012, China freed international currency transactions made through the current account creating an enormous asymmetry.
…the nature of capital flight from China cuts directly to the heart of why capital controls would be a poor remedy. Capital is not leaving through the capital account. Rather with a restricted capital account and a relatively free international transaction via the current account, enterprising Chinese are moving capital via the current account. To arrest the flood of capital leaving this way, it would require China to bring goods and services trade in the world’s second largest economy to a complete standstill. Every transaction would have to be verified for units, market price, agreement between importer and exporter, and accurate payment matching the invoice. It is simply not feasible to impose currency controls that would arrest disguised capital outflows via international goods and services payment without bring international trade in China to a halt.
My own view is that it is not so hard to clean up the trade account a little if that is the desire of Communist authorities and it may end up being so given if outflow really gets going it will threaten the Party via financial crisis.
A few high profile arrests, show trials and executions of bogus invoicing kings would surely achieve it.
