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Sounds confusing! Common wisdom suggests that as a nation’s exports increase it forex inflow should rise and it trade surplus should grow. The flip side of the argument suggests that on the back of falling exports, the trade surplus should shrink. That is not what is happening with the Chinese economy. As the title suggests, Chinese exports have been falling rapidly, but its trade surplus is on the rise. Something seems amiss! And the news isn’t good either.

The Chinese economy has been hit hard by the economic male storm to the extent that demand in the economy is shrinking rapidly. This has hit China’s imports harder than it exports. Thus, along with falling export earnings, China’s import expenses have fallen faster, leading to a situation that its trade surplus has actually grown. Super soft oil prices and falling commodity prices have added to the faster shrinkage of China’s import bill.

China’s exports fell 13% in the last quarter of 2008, while its trade surplus rose to a record $457 billion in the same period. This surplus was almost 50% higher than in the same period in 2007. The shrinkage in Chinese exports seems to be a self feeding cycle. With a fall in demand for its exports, the demand for imports of inputs that go into exportable products has fallen sharply. Imports of inputs used for the manufacture of exportable goods account for nearly 50% of Chinese imports. This suggests the fact that the Chinese economy is over dependent on exports. Data also suggests that China’s household consumption accounts for only around 35% of the nation’s economic output, which is down form 50% in the 80s. In the US, consumption demand accounts for over 70% of the nation’s economic output. Thus, the Chinese economy could benefit from a boost in its internal demand, especially in times of weakening global demand.

The scenario for Chinese exports does not seem to be getting any brighter in the near future, with US retail sales falling 2.7% in December, which was significantly higher than expected. This indicates that the recession may be poised to become worse for the time being. Since the US is the biggest consumer of China’s exports, Chinese woes seem set to get worse. Ironically, the Chinese economy is still expected to grow around 8% this year, notwithstanding all the bad news.

In order to boost the economy and cushion the rising unemployment, the Chinese government is planning a massive Keynesian styled stimulus package of undertaking public works via creation of infrastructure. This is expected to enhance employment, increase domestic demand and even demand for import of raw materials for infrastructure projects. This increase in imports is likely to help reduce the export surplus, which may be a favorable condition in these times.  

This leads to the question of the impact of the trade surplus on the Yuan. Rising trade surplus means oversupply of foreign currency, which is likely to exert an upward pressure on the local currency. A stronger Yuan will make the nation’s exports more expensive and dent its economy even further. While, the Chinese government still manages the value of the Yuan to some extent, it cannot go too much against market forces as the US does not favor that. Thus, it appears that the Chinese currency is headed into a conflicting scenario, where it needs to depreciate, but may find it hard to come down under the given circumstances.