The IMF’s Latest External Sector Report Misses the Mark

Every now and again, a major international institution misfires in its analysis. The IMF just did so in its 2024 external sector report.

The basic theme of the report is that global trade and payments imbalances receded after the pandemic (there is no ambiguity here, the report was called “Imbalances Receding”), and that this was a permanent shift, not simply a one-off normalization:

“Over the medium term, the global current account balance is projected to continue narrowing, as current
account deficit countries embark on fiscal consolidation and commodity prices moderate.”

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That is, however, a selective read of the impact of current policies and prices. 

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China’s decision to prioritize goods supply and “new productive forces” over household demand should widen, not reduce, the global current account imbalance.

Moreover, the weakening of the yuan, yen, and won in 2023 as well as the strengthening of the dollar in 2022 and 2023 should naturally lead trade imbalances to widen, not shrink.

But the IMF also missed some key global trends, largely because it relied (too much) on China’s misleading current account data. Recall that China changed its current account data methodology radically in 2022: it literally stopped using its customs data to calculate its balance of payments goods surplus ((See paragraph 7 of appendix VII of the IMF's latest staff report), and thus current developments reflect, well, statistical changes in balance of payments reporting more than real trends.*

The IMF highlighted how China’s tourism deficit returned to normal in 2023, after China ended its zero-COVID policy and reopened its border.  Fair enough, that is in the data.

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The IMF also noted that the consumer import boom of 2022 faded in 2023, reducing the associated part of China’s surplus.

But China’s customs goods surplus didn’t actually fall much in 2023.  China’s auto and solar exports boomed, and because a weak recovery from COVID and the real estate slump meant that China’s own imports were weak.   

Alternative measures of China's imbalances, like the sum contributions from net exports over time in the Chinese GDP data, also show a persistent shift toward a larger surplus.

But China’s customs goods surplus mysteriously disappears from China’s reported balance of payments data after China changed its reporting standard in 2022; this disappearance has reduced China’s reported current account surplus by something like $300 billion (if not a bit more).

Higher global interest rates also should have increased China’s interest earnings and thus raised its current account surplus (the current account surplus is the sum of goods trade, services trade and the balance on cross border interest and dividend payments). China after all has roughly $6 trillion in external interest paying assets.

If China’s balance of payments goods surplus is measured using China’s old custom's based methodology and China’s income balance is marked to model (the reported data shows a puzzling fall in external interest and dividend income, even as global interest rates rose and the interest income of other surplus countries rose), the overall external balance of China and its neighbors in Asia has stayed quite elevated.  It now chalks in at a level that is well higher than it was before the pandemic.

And if global imbalances are plotted using the global customs goods data rather than the current account data, it is clear that trade and payments imbalances have not receded.**

The global goods imbalances (using customs data from the world’s major economies and the IMF’s data for fuel-exporting economies)  is now bigger than it was prior to the pandemic in dollar terms—and China share of the imbalance has also gone up.   The chart below shows the high frequency quarterly data.

The surplus and deficit sides of the ledger actually still line up well (and better than in the current account data, which involves a lot more judgement and discretionary adjustments, as China has shown). The following chart inverts the deficit countries and smooths out the seasonal pattern of global goods trade by taking a trailing four-quarter sum.

Moreover, if the IMF paid close attention to the high frequency trade volume data, it would not forecast that trade and payments imbalances will recede.

U.S. import volumes have picked up this year, after a weak 2023 (2023 was itself a response to the excess inventories built up during the surge in goods imports after the ports backlog cleared in 2022).

And China’s exports have absolutely surged this year. Export volumes are up by something like 12 percent in the last twelve months of data while import volumes are only up 4 percent. Falling Chinese export prices have obscured these trends in the nominal data, but there is no reason to think—given the large reported contribution net exports are making to China’s 2024 growth—that the underlying imbalance is receding.

Basically, the misfire in the external sector report is a function of getting China wrong—and a bit too much linear extrapolation from a one off change to China's data reporting. 

But China is too big and too central to the global economy for bad Chinese data to let the IMF entirely off the hook.

What’s interesting, though, is that the IMF’s own modeling generally gets the story right. 

The external sector report includes a box (Box 1.3) outlining how a real estate slump in China should impact China’s balance of payments and the global economy.

The (unsurprising) conclusion is that a real estate slump in China would raise China’s external surplus and slow the growth of China’s trading partners:

“Following a near-term decline in private investment, private consumption, and GDP, the resulting macroeconomic
adjustment in China entails a persistent medium-term surge in saving, which reduces domestic demand. Demand for imports falls and trade balance increases. Added saving decreases the real interest rate, which in turn increases the investment rate in the medium term. However, the adjustment in the investment rate is a fraction of the increase in saving, and China’s current account surplus expands. China’s current account surplus expands (Figure 1.3.1). Given China's size, the scenario generates global spillovers.”

Guess what: China has had a massive real estate slump. This isn’t just hypothetical. Real estate investment has fallen from 14 percent of China’s GDP in 2021 to 8 percent of China’s GDP in 2024, a massive 6 percent of GDP swing. Real estate “starts” have collapsed, as have sales and the cash flows of China’s property developers. 

That isn’t quite the shock the IMF modeled—the IMF looked at a 10 percent fall in the value of existing buildings, a tightening of financial conditions for real estate developers (modeled as a 4 percentage point increase in the equity premium in the real estate sector rather than a fall off in bank credit) and a 2 percentage point of GDP increase in in households precautionary savings—which increases (see figure 1.3.1 in the report) China's current account surplus by 1.2 percentage points of GDP.

But it wouldn't have been a stretch for the IMF to conclude that a 6 percentage point fall in real estate investment would increase the current account by at least that much—it might even increase it by more.

But, as the chart above shows, the opposite actually happened.  A real estate slump coincided with a large fall in the current account surplus.

The IMF thus should have asked why, given their modelling of how a real estate slump impacts the current account , China’s current account surplus fell by over a percentage point during an epic contraction in real estate investment.

The swing in the current account surplus is basically the opposite of what the “real estate” model of Box 1.3 would predict.

Yes, there could have been other offsetting shocks (the end of zero-COVID). But a serious examination of the question would at least have at least looked at the evolution in China's goods balance—and found that the goods balance is in fact showing the impact of the real estate slump and China’s associated pivot back to a manufacturing- and export-based growth model.

Afterall, it is now clear that China’s goods surplus—and the broader Asian goods surplus—didn’t just rise because of the pandemic, but rather shifted up in a durable way. That overall surplus is now getting bigger even with relatively elevated global commodity prices—and should expand further if iron and oil prices continue to moderate.***

There are two related points.

First, the external sector report has long been the junior partner to the IMF’s other “flagships.” It traditionally hasn’t had a lot of support from most of the European and Asian members of the board (as most of the IMF’s larger members run current account surpluses, and the external sector report tends to highlight surpluses rather than just deficits—unlike the fiscal monitor). That should change.

Second, the IMF should stop encouraging China to allow the yuan to depreciate to help solve China’s internal deflation problem (The code words here are "price based monetary policy" and "exchange rate flexibility" to counter deflation). The solution to China’s internal imbalances can no longer be policy advice that would make already large external imbalances bigger. This too should be something that the European members of the IMF support, as Europe is far more exposed—given its export dependence—than the United States a second China shock.

* China argues that its new methodology better captures the “transfer of ownership” of a good to a foreign resident because that transfer is captured even if it occurs inside China's customs border. Perhaps, but a methodology in which production “in China for China” generates a (BoP) goods deficit is far from intuitive, and it isn’t clear that the “transfer of ownership” methodology really improves the data (this a broader issue for the IMF’s balance of payments statisticians). What is clear is that this adjustment should change other components of the balance of payments—most obviously the income balance. Moreover, if the foreign company operating in China has set up a Chinese subsidiary (as most have) there shouldn’t actually be any transfer of ownership as the subsidiary is itself a Chinese resident (the transfer of ownership to a non-resident would occur when the resident Chinese subsidiary transfers the profit to its non-resident foreign parent, which makes much more intuitive sense). So it is in no way clear that the change in China’s methodology actually now conforms to BPM6 standards. Moreover, it is absolutely clear that the rest of China’s balance of payments data (the income balance, the components of the financial account) are very far from meeting BPM6 standards, as China doesn’t publish a lot of fundamental underlying detail (such as interest and dividend income in its income balance or portfolio investment by economic sector in the financial account).

** A focus on goods imbalances is now necessary because of flaws in the services and income accounts, which don’t match up across countries. The goods balance is influenced by tax avoidance, but not to the extent that (non-tourism) services and FDI income are. A focus on the goods imbalances actually take a bit of attention off the euro area and Japan, which have larger current account surpluses relative to GDP than China, but smaller goods surpluses. Part of this is real—persistent goods surplus in Germany, Japan, and Korea have translated into a buildup of external assets and a surplus in investment income. The puzzle, of course, is why China’s persistent goods surplus has generated the opposite result.

*** One strange feature of the global current account data was that surpluses and deficits tended to line up very well IF Europe was excluded from the data (European countries have big services and income balances, so this isn’t a total surprise). However, that correlation has weakened after China unilaterally changed its methodology for calculating its current account balance, and now the surplus is smaller than it should be given the reported deficits. 

I interpret this as evidence that China's adjustment is making the global data worse.   

Clearly, the customs goods data now matches up better than the balance of payments data.

For what it is worth, I really did feel a disturbance in the global balance of payments force in 2022 (see this blog for example), and it is now clear that this disturbance corresponds with China’s unilateral shift to a new methodology for calculating its goods balance, which wasn’t transparently explained until very recently.