On December 3, the U.S. Treasury Department issued its biannual report to Congress on "Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States." As part of that report, Treasury evaluated "whether trading partners have manipulated the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade." China met only two of the three criteria, and therefore was not named a currency manipulator.

The three criteria set out in the statute are:

• Significant bilateral trade surplus with the United States (at least $15 billion)
• Material current account surplus (one that is at least 3% of GDP, or a surplus for which Treasury estimates there is a current account “gap” of at least 1 percentage point of GDP using Treasury’s Global Exchange Rate Assessment Framework (GERAF))
• Persistent, one-sided intervention (when net purchases of foreign currency are conducted repeatedly, in at least 8 out of 12 months, and these net purchases total at least 2% of an economy’s GDP over a 12-month period)

Treasury explained that China "met two criteria in this Report for the first time since the April 2016 Report (the initial Report based on the 2015 Act), having a material current account surplus and a significant bilateral trade surplus with the United States."

In terms of the surplus this past year, China's trade surplus with the United States reached $318 billion, exceeding the $15 billion threshold.

With regard to China's current account, Treasury stated that "China’s current account surplus rose to 2.1% of GDP in the four quarters through June 2021," which is below the threshold. However, "China’s external position was stronger than warranted by economic fundamentals and desirable policies, with an estimated current account gap of 1.7% of GDP." As a result, China met the criterion of "a surplus for which Treasury estimates there is a current account 'gap' of at least 1 percentage point of GDP using Treasury’s Global Exchange Rate Assessment Framework (GERAF)."

On the other hand, China did not have persistent, one-sided intervention with regard to its currency. The report noted that "monthly net foreign exchange settlement data, another proxy measure for foreign exchange intervention that includes the activities of China’s state-owned banks, recorded net foreign exchange purchases of nearly $278 billion (1.7% of GDP) in the four quarters through June 2021, adjusted for changes in outstanding forwards. This figure represents the largest 12- month sum of net purchases since 2014." At the same time, "monthly changes in the PBOC’s foreign exchange assets recorded no significant changes, increasing by only $6.2 billion." In the end, Treasury was not able to conclude that China met the criteria of "net purchases of foreign currency, conducted repeatedly, in at least 8 out of 12 months, totaling at least 2% of an economy’s GDP." Treasury also set out the following general criticism of China's practices in this area:

As Treasury has stressed in past reports, China’s exchange rate practices and policies continue to lack transparency, including its lack of disclosure regarding intervention in foreign exchange markets, as well as directing changes to the interest rates of RMB-denominated assets that trade offshore, directing the timing and volume of forward swap sales and purchases by China’s state-owned banks and the conversion of foreign exchange proceeds by state-owned enterprises. Given China’s long history of facilitating an undervalued currency through protracted, large-scale intervention in the foreign exchange market, and the sheer size of China’s reserves, it is increasingly troubling that China has not enhanced the transparency of its foreign exchange policies and practices.

Treasury's overall summary of its findings for all countries was as follows:

Pursuant to the 2015 Act, Treasury finds that Taiwan and Vietnam met all three criteria for enhanced analysis in the current review period of the four quarters through June 2021 based on the most recent available data. Switzerland, which had met all three criteria for enhanced analysis in the two preceding Reports, met two of the three criteria for enhanced analysis under the 2015 Act. Additionally, eleven major trading partners met two of the three criteria for enhanced analysis under the 2015 Act in this Report or in the April 2021 Report. These twelve economies—China, Japan, Korea, Germany, Ireland, Italy, India, Malaysia, Singapore, Thailand, Mexico, and Switzerland—constitute Treasury’s Monitoring List.

And Treasury's full evaluation of economic developments in China was as follows:

The economic effects of the pandemic resulted in growth of just 2.3% in 2020, the lowest since 1976. China’s real GDP grew by 18.3% year-over-year in the first quarter of 2021 and by 7.9% year-over-year in the second quarter. China’s economic recovery and COVID-19 containment strategy emphasized supply-side support that enabled a rapid resumption of manufacturing and minimized disruptions in production. At the same time, a focus on investment instead of household support in combination with an inadequate social safety net stymied the recovery in domestic consumption, which has been further exacerbated by lockdowns following periodic outbreaks of COVID-19. The authorities have shifted to a tighter fiscal stance this year amid renewed efforts to rein in infrastructure and property investment. China’s monetary policy has continued to normalize following modest loosening in 2020, but the authorities have shown flexibility recently by taking actions to ease banks’ funding costs.

China’s current account surplus rose to 2.1% of GDP in the four quarters through June 2021, compared to 1.9% of GDP in 2020, driven by larger surpluses in the second half of 2020. In the first half of 2021, China’s current account surplus moderated to 1.5% of GDP, largely driven by an increase in imports due to increased commodity prices, among other factors. Exports slightly increased in the first half of 2021 relative to the second half of 2020, reflecting China’s ability to maintain its manufacturing capacity and meet broad-based external demand while pandemic-related supply chain disruptions impacted other major exporters. Meanwhile, China’s services deficit remains subdued; the $50.5 billion deficit recorded in the first half of 2021 is roughly one-third of its pre-pandemic level, primarily due to the collapse of outbound tourism. Treasury assesses that in 2020, China’s external position was stronger than warranted by economic fundamentals and desirable policies, with an estimated current account gap of 1.7% of GDP. China’s bilateral goods trade surplus with the United States remains the largest by far of any U.S. trading partner, reaching $338 billion in the four quarters through June 2021. China ran a bilateral services trade deficit of $19 billion with the United States over the same period. Overall, the bilateral goods and services balance reached $318 in the four quarters through June 2021, compared with $275 billion in the year prior. China experienced substantial portfolio debt inflows in the four quarters through June 2021, while inbound foreign direct investment to China reached a record $321 billion over the same period. These capital inflows, which create pressures for the RMB to appreciate, were balanced by a large “other investment” deficit, bringing the overall financial account into a deficit. China’s other investment deficit reached $335 billion in the four quarters through June 2021, compared to $100 billion in the four quarters through June 2020, suggesting an increase in capital outflows related to bank activity. A net errors and omissions deficit of $206 billion, compared to $99 billion a year prior, provided another balancing outflow and suggests an uptick in undocumented capital outflows that are not captured within the conventional components of the financial account.11 Treasury’s estimate of net capital outflows (excluding flows accounted for by trade and direct investment) totaled $529 billion in the four quarters through June 2021, compared to $297 billion a year earlier. While substantial, these outflows remain below the peak levels witnessed in 2015 and 2016.

The RMB appreciated by 8.3% against the dollar in the second half of 2020, but appreciation moderated in the first half of 2021 to 1.8% despite continued strong trade surpluses. The RMB appreciated by 1.9% against the dollar in the first ten months of 2021. Over the same period the RMB strengthened by 5.7% against the People’s Bank of China’s (PBOC) China Foreign Exchange Trade System (CFETS) nominal basket and by 2.7% on a real effective basis. 12

China provides very limited transparency regarding key features of its exchange rate mechanism, including the policy objectives of its exchange rate management regime, the relationship between the PBOC and foreign exchange activities of the state-owned banks, and its activities in the offshore RMB market. The PBOC manages the RMB through a range of tools including setting the central parity rate (the “daily fix”) that serves as the midpoint of the daily trading band. Chinese authorities can directly intervene in foreign exchange markets as well as influence the interest rates of RMB-denominated assets that trade offshore, the timing and volume of forward swap sales and purchases by China’s state-owned banks, and the conversion of foreign exchange proceeds by state-owned enterprises.

Over the past year, the authorities have taken regulatory measures that in aggregate appear to disincentivize RMB appreciation. In 2020, the authorities removed the foreign exchange forward risk reserve ratio and indefinitely suspended the counter-cyclical factor in setting the daily fix, facilitating RMB depreciation against the dollar. As capital inflows increased in the second half of 2020, the authorities announced a series of increases to outbound investment quotas that could provide offsetting capital outflows to stem RMB appreciation pressures. While the above measures are liberalizing in principle, in practice the timing of their implementation appeared to disincentivize RMB appreciation. The authorities also pursued verbal intervention as RMB appreciation pressures mounted, including a May 2021 statement by a PBOC official emphasizing two-way movements in the RMB exchange rate, followed days later by comments from a former PBOC official portraying the RMB’s appreciation as “unsustainable.” In June 2021, the PBOC raised the foreign exchange required reserve ratio for the first time since 2007, which tightened onshore foreign currency liquidity conditions. China’s lack of transparency and use of a wide array of tools complicate Treasury’s ability to assess the degree to which official actions are designed to impact the exchange rate. Treasury will continue to closely monitor China’s use of exchange rate management, capital flow, and macroprudential measures and their potential impact on the exchange rate.

Compared to other major economies, China is increasingly an outlier with respect to its non-disclosure of foreign exchange market intervention, which forces Treasury staff to estimate China’s direct intervention in the foreign exchange market.

China’s headline foreign exchange reserves increased by $102 billion in the four quarters through June 2021, standing at $3.2 trillion. In contrast, over the same period monthly changes in the PBOC’s foreign exchange assets recorded no significant changes, increasing by only $6.2 billion. Meanwhile, monthly net foreign exchange settlement data, another proxy measure for foreign exchange intervention that includes the activities of China’s state-owned banks, recorded net foreign exchange purchases of nearly $278 billion (1.7% of GDP) in the four quarters through June 2021, adjusted for changes in outstanding forwards. This figure represents the largest 12- month sum of net purchases since 2014. The precise causes for the large divergence between monthly changes in the PBOC’s foreign exchange assets and net foreign exchange settlements data remain unclear. As Treasury noted in the April 2021 FX Report, the divergence between these proxy measures could be an indication that monthly changes in the PBOC’s foreign exchange assets are not adequately capturing the full range of China’s intervention methods, including official intervention conducted through the state-owned banks. Overall, these developments highlight the need for China to improve transparency regarding its foreign exchange intervention activities.

Chinese authorities must balance supporting economic growth against managing growing financial stability risks. Lackluster private demand—underpinned by continued weakness in the labor market—raises concerns that China will not be able to increase reliance on household consumption absent additional official support. China should seek to reverse lost momentum on economic rebalancing and strengthen long-term growth prospects by taking decisive steps to strengthen its social protection system and allow for greater market openness. Authorities should prioritize structural reforms that reduce state intervention in the economy and enhance social safety net measures that reduce precautionary saving and support household consumption growth.