By Yin Yuxi

China is adopting a strategy for a new round of high-level opening up policies for its economy in a new era marked by the 40th anniversary of its reform program. In his keynote address at the APEC CEO Summit in 2017, President Xi Jinping announced that China would proactively increase imports, with an estimated US$24 trillion worth of goods imported over the next 15 years. This year China will kick off this stepped up import drive by hosting the China International Import Expo. China will also attract$2 trillion in inbound direct investment, and make US$2 trillion of outbound direct investment over the next 15 years. From these strategic initiatives,China's current and capital account can be expected to come much closer to a dynamic balance over the next few years, moving further away from their structural surpluses of the past. The coming few years could be a period of evolution for the balance of payments and renminbi internationalization.

During the World Economic Forum in Davos earlier this year, Liu He, a key adviser to President Xi Jinping, announced four areas of focus in which China would implement more important reforms: A greater opening of the financial services sector, the opening up of a wide range of manufacturing and service industries, the enhancement of protection of intellectual property rights, and a proactive effort to increase imports. He added that China would launch new policies “beyond international expectations” to mark the occasion of the 40th anniversary of its reforms and opening-up program this year.

China's decision to increase imports and further open up its domestic market clearly shows that the nation will continue promoting a global and open world order and facilitate the participation of developing countries in economic globalization.China is the world's second largest importer, and a further opening up of China's large domestic market would create large incremental demand and economic opportunities for exporters in many countries.

This strategy is also significant for the Chinese economy. As economic nationalism and protectionism is on the rise in some countries,proactively increasing imports and reducing surpluses may help generate a better result by maintaining the overall magnitude of exports that could help the exporting firms domestically.Increasing imports would also help better meet the increasingly diverse demands from a more sophisticated consumer market, facilitate capital formation, and increase total factor productivity with new technology. It is beneficial for China's own plan for industrial upgrading by guiding Chinese firms onto a path of innovation-driven development, improving the supply and demand structure of the Chinese economy,and promoting more balanced external trade and investment.

Mr. Liu specifically mentioned in Davos that by lowering tariffs and hosting the Import Expo, China hopes to take this chance to increase imports and realize a balanced current account.

China has enjoyed a current account surplus for 24 consecutive years as of 2017. As a percentage of GDP,the current account surplus has decreased from the peak of over 10% in 2007 to below 1.5% in the past few quarters. According to SAFE's preliminary 2017 balance of payments report, China's current account surplus of US$172 billion is comprised of a US$476 billion goods trade surplus, a US$261 billion services deficit and a US$43 billion deficit in other current account items.Imports of goods grew by 16% in 2017, faster than the 11% growth in exports. This is the first time since 2012 that imports grew faster than exports. The deficit in services is mainly attributable to travel, which contributed US$221 billion of the US$261 billion total services deficit.

Given the current scale of China's imports and exports in the 2017 balance of payments report, if imports and exports grow at the same pace, then every percentage point of growth would widen the current account surplus by US$4.76 billion. But a proactive initiative to increase imports could drive imports to grow at a faster pace than exports, and this could narrow China's current account surplus. For every percentage point that imports grow faster than exports, it could narrow the trade surplus by US$17.4 billion.

A simple calculation helps to put this impact into perspective. In the IMF's January update to its World Economic Outlook, estimated growth of the world's trade in goods and services in 2018 was adjusted upwards to 4.6%, while its estimate for global trade growth for 2017 was 4.7%. Against this backdrop, China should be expecting continued growth for both imports and exports. But the high double digit growth rate seen in 2017 might be more difficult to achieve; the 2017 trade growth rate benefited from a low base in 2016, but this base effect will be less pronounced in 2018. If exports and imports both grow by the same rate of 5-10% in 2018, this will widen the surplus by US$23.8-47.6 billion.But as imports may grow at a faster pace, the force that narrows the surplus needs to be considered as well. Wei Jianguo, ex-Vice Minister of the Ministry of Commerce, has forecast that it is possible for China's imports to grow over five percentage points faster than exports for the next five years.This five-percentage-point difference is the same as the import-export growth rate differential for 2017. If this trend continues into 2018, it implies a narrowing effect on the current account surplus of about US$87 billion. The net effect, therefore, will be a narrowing of the current account surplus by US$39-63 billion, equivalent to 23-37% of the 2017 current account surplus.

The service trade deficit would also be impacted by the strategy of further opening up, with more Chinese people traveling overseas and making purchases during their trips. Travel is the largest component and the main driver of China's service trade deficit. The deficit for travel has expanded rapidly from US$9 billion in 2010 to US$205 billion in 2015, though growth has slowed over the past two years. Outbound travel registered 130 million visits in 2017, growing by 7% from 2016. China announced that in the next five years, outbound travel would register 700 million trips, indicating about 5% growth each year. If the travel related deficit increases by a similar magnitude, it implies about US$10 billion pressure on the annual current account surplus.

Therefore, with the announced policy objectives of increasing imports and further opening the Chinese market to the world, we may be seeing a greater force that would reduce the current account surplus for China. The two single factor analyses (accelerated import growth and continued growth of outbound tourism) above indicated that there might be some downward pressure on China's current account balance between US$49 and US$73 billion per year, or as much as 28-42% of the 2017 current account surplus. The realized current account balance will of course be impacted by many more factors, and therefore might not necessarily narrow by this magnitude every year. But the important takeaway is that we need to prepare for a new era in the coming few years, where China's current account balance will be sustained at a level much closer to a balanced level, and at some point the current account will no longer be a force producing large structural inflows to China.

Figure 1 Share of World Exports Source: WTO.

Figure 2 Share of World Imports Source: WTO.

This might also be supported when looking at the micro and macro factors that determine the trade surplus. From the micro perspective, China's export competitiveness has been shifting from low labor cost areas to the higher value-added fields.While the new growth drivers are emerging and playing a bigger role, there is a counterforce from the migration of lower value-added export sectors away from China. China's share of world exports is already over 13%, higher than Germany, Japan and the US. The US had a 21.8% peak share of the world's exports in 1948 but that was due to World War II. From the standpoint of historical experience,there might be more uncertainties as to how much China can further increase its share of world exports. Added to the increase in imports due to the effects of the new policies, this might keep the trade surplus at a relatively low level.

From the macro perspective, net exports could be seen as the gap between savings and investment. China has a high savings rate historically and it may have to do with population structure, culture, family structure, social welfare,and the stage of economic development etc. With an aging population in China and the evolution of the economy towards a consumption-driven model,China's savings rate may have passed its peak and be in a downward channel. As for investment, while structural reform in China is reining in excessive investments in sectors with over-capacity problems,the investments in areas of the new economic drivers will pick up and counterbalance the decline in investment rates. Therefore, the gap between savings and investment might not return to the high level of 10 years ago, but more likely this gap(and net exports) will remain at a low percentage of GDP.

The prospect of a continuously lower current account surplus caused by the initiative to increase imports and further open up China's domestic market would mean that over the next few years,we might see a shift in how we perceive the balance of payments. We are used to a sizable current account surplus, and managing the balance of payments would be primarily about managing the capital account flows. In the future, we may have a much smaller current account surplus that calls for an equally small capital account deficit to balance the payments position. But both the current and capital accounts will be much more dynamic.

Generally speaking, a strong and stable renminbi exchange rate would be preferable for facilitating the strategic initiative to increase imports. But as both the current and capital account are becoming closer to balance and much more dynamic, we may see more cases of temporary deficits that call for either flexible exchange rate adjustment or a reduction of foreign reserves. This might pose a challenge to maintaining a strong and stable renminbi exchange rate, especially when considering the potential for short-term market overreactions. Therefore, these few years of transition are critical to building more active twoway investment flows in the capital and financial account, and a more flexible exchange rate system that could act as an automatic stabilizing force for the balance of payments.

The rest of the high-level opening-up policy measures would help create more active two-way investment flows. Attracting foreign investment is still a very important task. It calls for a greater opening of China's industrial sectors to encourage foreign direct investment, and an opening of China's financial markets to promote portfolio investment.

China has already announced plans to open more industries in 2018, the 40th anniversary of its reform and opening-up program. The negative list (areas specifically designated as where foreign investment is restricted) would be further streamlined, the manufacturing sector greatly opened, and the services sector (including financial services) given improved levels of openness. The registration and market regulation aspects for foreign investment would also be streamlined, creating a more level playing field for all players. These measures would encourage FDI flows into China.

For portfolio investment flows to China, opening China's financial market has been one notable theme for the past few years, with the launch of multiple“Connect” programs and the strengthening of the traditional Qualified Foreign Institutional Investor programs. This year we could expect more opening up measures to facilitate foreign investments in China's financial market. As major index providers of the world include China domestic securities to their benchmark indexes, we could expect much greater inflows from foreign investors into China's domestic financial markets.

Active inflows must be accompanied by active investment outflows to achieve a dynamic balance of the capital account. Considering that China might sustain a dynamically balanced current account tilting to a small surplus, a small capital account deficit might be a desirable position. Therefore, in the next few years, it is very important to start a new round of highlevel opening-up measures that facilitates outbound direct and portfolio investment.

For outward direct investment, after 2016's exceptional growth, outbound direct investment has now returned to its multi-year development track.As China gears up for a new round of high-level opening-up policies, outbound direct investment is set to continue on a path of steady growth. Outbound portfolio investment has been taking place mainly via the Qualified Domestic Institutional Investor and the “Connect” channels. With the renminbi exchange rate expectations returning to a balance now, we can expect the restart of outbound portfolio investments on a higher level.

Renminbi internationalization is also set to gain momentum with the unfolding of the new round of high-level opening-up efforts.This is also a strategic opportunity for renminbi internationalization. China needs to take advantage of this window in time to significantly increase the renminbi's international usage in trade and investment, and enhance the openness and functions of the foreign exchange market as well as other financial markets. It would help the renminbi evolve from a new joiner of the club of reserve currencies, to a more mature reserve currency that is widely accepted by the rest of the world.

Development of renminbi internationalization is also necessary for the successful implementation of a high-level opening-up and the transition to a more dynamically balanced international payments situation. Significant increases in the usage of the renminbi helps it to become a more widely accepted reserve currency. With the renminbi strengthening its reserve currency status, it also reduces China's dependency on foreign reserves for temporary balance of payments deficits and increases market confidence in a stable and strong renminbi exchange rate, which in turn encourages further adoption of the renminbi in international trade, investment and financial transactions.This creates a virtuous cycle for renminbi internationalization, as well as the important strategy of high-level opening-up measures.Therefore, trade and investment policies and renminbi international usage policies must go hand in hand to achieve the maximum effect.

It takes concerted efforts to achieve the desired situation with a stable and strong currency,dynamically balanced international payments,upgrades in economic drivers and a general increase of economic welfare. As China embarks on this new era with a new round of high-level opening-up policies, the coming few years will be an important period that is rich in opportunities.