Question: At the end of last year, against the background of the more serious international financial turmoil, in the fourth quarter China experienced capital outflows, with a current account surplus but a capital account deficit in terms of the balance of payments. What is the situation this year?

Answer: In the first quarter of this year, the situation of the fourth quarter of last year, whereby China had a current account surplus but a capital account deficit in terms of the balance of payments, was changed, and there was a return of the “twin surplus,” i.e., there was a current account surplus as well as a capital account surplus. However, the status of the overall balance of payments  more closely approached equilibrium, mainly embodied in the following respects: First, the current account surplus was narrowed, accounting for a lesser proportion of GDP. According to preliminary estimates, the current account surplus in the first quarter was USD 24.7 billion, a decrease of 14 percent compared with that during the same period of last year, and the proportion of the current account surplus to GDP in the same quarter was 1.4 percent, a decrease of 1.4 percent compared with last year. Second, once again there was a capital account surplus. The size of net inflows of capital (including errors and omissions, the same below) in the first quarter was USD 49.9 billion, a decrease of 56 percent compared with the same period of last year, whereas there was a deficit of USD 48.1 billion in the fourth quarter of 2011. Third, the trend of increasing foreign exchange reserves further slowed down. After adjusting for the change in the exchange rate and asset prices, foreign exchange reserves calculated on the basis of the coverage of the balance of payments in the first quarter increased by USD 74.8 billion (including foreign exchange reserve earnings in the current period), a 46 percent decrease in the increment compared with the same period of last year.

In other words, although since the beginning of this year net inflows of foreign exchange rebounded somewhat compared with the end of last year, there were still on a downward trend compared with the same period of last year. This is consistent with our earlier basic judgment that China ’s balance of payments was expected to maintain a surplus, but the size of the surplus would decrease significantly.

Question: According to data published by the People’s Bank of China (PBC), there was a new increase of USD 123.8 billion in foreign exchange reserves in the first quarter of this year. Does this mean that China will again face pressures of massive capital inflows?

Answer: This does not mean that China will again face pressures of massive capital inflows. First of all, although the data published by the PBC show there was a new increase of more than USD 120 billion in the balance of foreign exchange reserves in the first quarter, this was an increase in the book value of the reserve assets mainly arising from such factors as exchange rate and asset price changes, and it does not reflect actual cross-border capital flows. Second, the increment in the foreign exchange reserves included the operating earnings of the reserves. In view of the large size of operations and management of foreign exchange reserves in China, the operating earnings of the reserves play a significant role in the increase in the balance of foreign exchange reserves. Third, according to the data published by the PBC, in March there was a large increase in outstanding foreign exchange funds, but this does not lead to the conclusion that there is current a large net inflow of capital, mainly because there are differences in the concept and coverage between the outstanding foreign exchange funds and the increment in foreign exchange reserves. Fourth, net inflows of capital rebounded the first quarter, mainly because the environment for international markets improved, the appetite for global investment risks increased, and capital flowed back to the emerging markets. However, the net inflows of cross-border capital in the first quarter still decreased by more than 50 percent compared with the same period of last year. Finally, because the European sovereign debt crisis is still developing and evolving, and the world is still in the process of financial deleveraging, the risks of massive cross-border capital flows are increasing.

Question: The PBC announced that the range of fluctuations in the RMB exchange rate against the USD would be expanded as of April 16. What effect will this have on China ’s foreign exchange situation?

Answer: This is a major move to further deepen the reform of the RMB exchange rate formation mechanism under the circumstances that China ’s balance of payments situation has gradually improved, the RMB exchange rate has approached a reasonable equilibrium, and development of the foreign exchange market has matured. Since the expansion of the fluctuation range of the exchange rate, in terms of appreciation and depreciation expectations of market transaction participants and actual transactions, the RMB exchange rate fluctuated moderately, and therefore expectations were stable, foreign exchange transactions and investments became more active, and the self-balancing capability of the foreign exchange market was further strengthened.

Overall, deepening the reform of the RMB exchange rate mechanism is conducive to allowing market supply and demand play a larger role in the formation of the exchange rate and allowing the RMB exchange rate to approach a reasonable equilibrium level, promoting China’s balance of payments status to develop toward an equilibrium, improving the self-balancing capability of the foreign exchange market, and slowing down the accumulation of foreign exchange reserves.