China Export Woes Point to Trade Distortions

By Tom Wright and Michael S. Arnold

China’s exports were down 6.6% on year in March, confounding economists, many of whom expected growth of over 4%. What’s going on? First, it’s important to remember that China’s trade statistics in the first quarter are often skewed by the Chinese Lunar New Year holidays, when activity slows down in much of East Asia. But economists expected exports to show signs of a pickup in March, the first month not affected by the holidays, which this year fell in late January and early February. One explanation is the March data was warped by overinvoicing. This is a practice by which Chinese companies dodge capital controls by using fake export invoices to get money into the country to benefit from relatively high onshore interest rates. Beijing cracked down on the practice last spring, but over-invoicing was still prevalent in March 2013. Since then it has decreased because of tighter regulatory controls. The government’s efforts to guide the yuan currency lower this year also has diminished the attraction of such a carry trade. That could mean the year-ago comparison was artificially boosted, making March 2014’s numbers look poor by comparison. “Do not worry about the export data,” wrote Louis Kuijs, an economist at RBS in Hong Kong, in a note to clients. RBS estimates year-on-year export growth in March 2013 was inflated by 11.8 percentage points due to overinvoicing. The bank also thinks export growth on-year in March was 5.2% adjusting for overinvoicing. “The competitiveness of China’s manufacturing sector is still solid, allowing its export sector to benefit from global demand growth,” Mr. Kuijs wrote. Andrew Tilton, an economist at Goldman Sachs in Asia, agreed with this assessment. “The main reason is that the overinvoicing distortions were peaking last year around this time,” he said. Now, “the increased currency volatility and deprecation is discouraging that activity from a financial incentive perspective.” Goldman believes underlying export activity is “marginally positive,” he added. (Imports were also lower in March – down 11.3% on year versus economists’ forecasts of almost 3% growth. Mr. Tilton said imports also may have been distorted by the invoicing issue.) Still, both economists say the growth outlook for China, which is targeting 7.5% expansion this year, remains fragile. U.S. economic growth is failing to suck in as many imports from Asia as in the past, and that could hurt China’s prospects. Meanwhile, the Communist Party is attempting to rein in domestic credit growth, which could further temper growth expectations. Capital Economics noted that most of the export weakness was in goods sold to Hong Kong and Taiwan. In the past, overinvoicing has largely taken place in trade via these two places. Stripping that out, the research firm estimated exports to other nations grew about 7%, said Julian Evans-Pritchard, a China analyst at Capital Economics. “This suggests that today’s data is not nearly as downbeat as it looks at first glance,” he said. ANZ, in a note, concurred that overinvoicing was likely to blame. The bank pointed to other recent data – including new export orders in recent purchasing manufacturers indexes and container traffic out of China – that show signs of improvements.

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