China's current-account surplus: Fair play or foul? AT ITS peak, of over 10% of GDP in 2007, China's current-account surplus offered firm proof that the yuan was undervalued. The evidence is much less conclusive now. China's currency is 30% stronger in real trade-weighted terms than in 2005, when its peg to the dollar was scrapped. Partly as a result, the country's current-account surplus fell to 2.8% of GDP last year. Even the International Monetary Fund (IMF), which has been consistently more pessimistic than most economists (see chart), has slashed its forecasts for the surplus. The fund now expects it to dip to only 2.3% of GDP this year, and then to rise gradually to just above 4% of GDP by 2017 (compared with predictions in April 2011 of 6.3% and 8%, respectively). It may still be overegging things, even so. The IMF assumes that China's real trade-weighted exchange rate will remain constant over the period. Because China has higher inflation than America, this oddly implies a steady depreciation in the yuan's nominal rate against the dollar of 10% over the next five years. The forecast surplus would be smaller if you instead assume that the yuan's nominal exchange rate will stay constant. The most common method for judging a currency's fair value is to estimate the exchange rate needed to bring a country's current-account imbalance to a "normal" level. The Peterson Institute for International Economics, a think-tank which has done lots of work in this area, reckons that a surplus or deficit of less than 3% of GDP is acceptable. The IMF's new forecasts imply that China's surplus will average 3.2% over the seven years to 2017. If this is so, it is hard to argue that the yuan is significantly undervalued. Chinese officials have already said that the yuan is now close to its fair value. So far this year it has been broadly flat against the dollar. But that does not rule out further appreciation. First, although its overall trade surplus fell last year, China's surplus with America rose to a record $202 billion, more than accounting for its total surplus (China ran a deficit with the rest of the world). To defuse mounting trade tensions, the Beijing government will remain under pressure to let the yuan climb against the dollar. Second, even if the yuan's value is "correct" today, faster productivity growth than elsewhere means that China should continue to allow its real exchange rate to rise. Most economists expect the yuan to resume its rise soon, but at a much slower pace than before and with greater flexibility up and down. On April 16th the People's Bank of China (PBOC) doubled the size of the yuan's daily trading band against the dollar to plus and minus 1% from a fixed midpoint. The immediate impact may be small: the yuan rarely hit its previous limits anyhow, and the PBOC will still set the midpoint each day. But it is a modest, welcome step towards allowing market forces to play a bigger role.