Latest / China Economy with Fexingo: Beijing's Policies, Trade, and Asia-Pacific Markets / How Iran Oil Spike Worsens China Trade Deficit
Transcript
- Lucas: Luna, as of this morning, oil is up sharply — we're talking a significant jump after the U.S. and Iran resumed strikes overnight. For China, the world's biggest oil importer, that's an immediate pressure point on an already widening trade deficit. Luna: Right. The latest data shows the trade deficit hit negative 77.6 billion dollars in May. That's down from negative 54.6 billion in April. So oil gets more expensive, and the deficit just grows. Lucas: Exactly. And it's not just the trade deficit. The current account deficit for the first quarter is running at negative 226.8 billion dollars. That's a huge number — China is now a net borrower from the rest of the world for the first time in decades. Luna: But the yuan has been remarkably stable. It's holding at 6.77 per dollar, barely budging. How are they pulling that off with all this pressure? Lucas: The PBOC is managing expectations tightly. They're using the daily fixing to signal stability, and they've got enough reserves to intervene if needed. But they're also letting the deficit absorb some of the shock — they're not trying to defend the yuan at all costs. Luna: So you're saying the stable yuan is partly because the market believes the PBOC can hold it, and partly because they're allowing the deficit to widen rather than burn reserves? Lucas: Precisely. Look, they've got over 3 trillion dollars in foreign exchange reserves. They can afford to let the deficit run for a while. But the real question is how long this oil spike lasts. If it's sustained, it'll start feeding into domestic inflation and consumer spending. Luna: And that's where the stimulus targeting consumer spending comes in — higher fuel prices could blunt that recovery. Lucas: Yeah. But there's one thing that makes this episode a little different. If walking through the economy with us has made something click, honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. It keeps the show ad-free and independent. Luna: It's a small gesture that goes a long way. We appreciate every one. Lucas: Now, back to the oil. China has some tools to cushion the blow. They've built up strategic petroleum reserves over the last decade. Releasing some of that could dampen short-term price spikes. They also have the option to accelerate yuan-denominated oil contracts — we talked about that a few episodes back. Luna: Right, episode 123 about China's new oil price feeds. But how effective are those in the face of a geopolitical shock like this? Iran is a major supplier, and the Strait of Hormuz is a chokepoint. Lucas: Exactly. The yuan oil contracts help with pricing, but they don't solve supply disruptions. China imports about 2 million barrels a day from the Middle East, a lot of it through Hormuz. If that gets disrupted, even reserves won't last forever. Luna: So what are the options? They could ramp up purchases from Russia — that's been a reliable source since the sanctions. But Russian oil is already heavily discounted, and Russia might not have much spare capacity. Lucas: That's the bind. Russia is already selling near capacity to China and India. So China might have to pay spot prices. That'll add to the import bill and widen the deficit further. Luna: And meanwhile, the chip rout in South Korea and the broader tech sell-off is another headwind. SoftBank down 10%, Asian tech stocks getting hammered. China's tech sector isn't immune. Lucas: No, it's not. The Hang Seng Tech index is down today as well. But the chip rout is more about AI bubble fears in the US — it's hitting South Korean memory makers and Japanese chip equipment firms hardest. China's semiconductor stocks have their own dynamics, more tied to domestic policy and the state-led push for self-sufficiency. Luna: So you're saying the oil shock is the bigger near-term risk for China's economy, while the tech sell-off is more of an external sentiment thing? Lucas: For the trade deficit, definitely. Oil is a direct cost. But tech also matters because China imports a lot of chips — that's a big chunk of the import bill. If chip prices go up due to supply cuts from Korea, that adds pressure too. Luna: Let's look at the numbers. Exports of goods and services in the first quarter were about 3.5 trillion dollars, imports 4.3 trillion. That's a gap of 800 billion annualized. Oil imports are maybe 300 billion of that. So it's significant but not the whole story. Lucas: Right. And the current account deficit includes services like travel and education, which have been growing as Chinese tourists go abroad again. So the oil spike is compounding an existing trend. Luna: What does this mean for the yuan going forward? Can the PBOC keep it stable if the deficit keeps widening? Lucas: They can, but it comes at a cost. They have to keep interest rates high enough to attract foreign capital to finance the deficit. That's why we saw the 10-year bond yield around 2.8% — still attractive compared to developed markets. But if the deficit grows too fast, investors might demand a risk premium. Luna: So it's a balancing act. Keep the yuan stable to avoid capital flight, but let it weaken a bit to help exports? Lucas: Exactly. So far, they've chosen stability. The trade-weighted dollar index has been falling, which helps Chinese exports against other currencies. But if oil keeps rising, they might have to revise that strategy. Luna: We should also mention the geopolitical angle. Iran is a key partner in the Belt and Road. China has invested in Iranian oil fields and infrastructure. So this conflict puts Beijing in a tough spot diplomatically. Lucas: Absolutely. China has called for restraint, but it's also dependent on Iranian oil. They can't just cut ties. They'll likely try to mediate or at least keep oil flowing through diplomatic channels. Luna: And the US response? Biden is under pressure to retaliate more forcefully. If the conflict escalates, oil could go much higher. Lucas: Then you're talking about a real stress test for China's economy. The trade deficit could balloon, the current account deficit could double, and the yuan might come under serious pressure. But for now, the PBOC seems confident they can manage. Luna: Let's keep an eye on the weekly data on crude imports and the yuan fixing. That'll tell us how they're really reacting. Lucas: Good idea. For now, the key takeaway is that the Iran oil spike is the single biggest external shock to China's trade balance since the pandemic. How Beijing handles it will set the tone for the rest of 2026. Luna: And we'll be tracking it here. For Fexingo Business, I'm Luna. Lucas: And I'm Lucas. Thanks for listening.