China leans on higher trade surplus to lift economy

Despite shrinking exports, China's leadership is pleased with a recent trade surplus increase, which is being counted on to ease pressure on capital outflows and back a stronger currency.

According to data from the General Administration of Customs, in the third quarter, China's exports declined by 5.6 percent year-on-year, and further extended the 2.9 percent contraction in the second quarter.

An even faster drop in imports resulted in the trade surplus expansion to $424.1 billion in the first nine months, which has exceeded the last year's total surplus of $382.4 billion. In September, the trade surplus increased to $60.3 billion, reaching the highest level since May.

The huge trade surplus will offset the liquidity shortage due to the unexpected rise of capital outflows since August, said Liu Ligang, chief economist at ANZ Bank Group in China.

"China's trade surplus is likely to remain at a high level in the coming months, which means the foreign exchange reserve is unlikely to see sharp drops," said Liu.

In China, economists calculated that about 70 percent of the foreign exchange reserve increases have come from trade surpluses between 2005 and 2014. Another contributor is from net foreign direct investment inflows.

The country's foreign exchange reserves, which are seen as the foundation to support a strong currency and to cover the foreign debt, suffered an unexpected decline in August, as the central bank sold dollars to boost the yuan.

Widespread worries emerged in the market when the total foreign exchange reserves dropped by $180 billion in the third quarter－the largest fall in two decades－although the remaining $3.51 trillion still makes it the world's largest.

"Signs have shown the reserve contraction is slowing, as the central bank's measures have taken effect," said Liu.

Song Yu, chief economist in China at Goldman Sachs, expects the yuan to stabilize against the US dollar in the near term.

The Chinese yuan had appreciated for eight consecutive days on Oct 13 to 6.3231 per US dollar, hitting its highest level since Aug 12. The increase in value began on Sept 24, when the central bank set the reference exchange rate at 6.3791 per US dollar.

"The People's Bank of China's intervention in the foreign exchange market to stabilize the yuan's value has taken effect," said Lian Ping, chief economist at the Bank of Communications.

"It will help to slow capital outflows and win back confidence of global investors," he said.

Economists said the yuan has finally stabilized since its more than 4 percent drop in value against the US dollar over a period of three days in August. With this leveling off, largely because of the central bank's reforms, investors have gained more confidence in the Chinese currency.

Because the Chinese economy is still feeling the pressure of a slowdown, the yuan is likely to experience a moderate drop in value over the long term, according to economists.