Regearing China’s growth engine – Managing the transition

Weighed down by overcapacity in the ‘old’ manufacturing economy, China’s ‘new’ service economy is yet to truly gain traction. Could a new era of opportunity based on interconnectedness, innovation and inclusiveness deliver the spark it needs?

Shanghai's business district, China
Mirroring the speed of the famous New Year‘s Eve ball drop in New York’s Times Square days earlier, China’s stock markets fell precipitously as financial trading resumed after the Christmas break.Echoing last August’s Black Monday, the new-year drop erased just over 3 per cent of share values in the first 45 minutes of trading, and 7 per cent at the session’s end, as concerns about China’s macroeconomic indicators and currency reached critical mass, causing investor panic.The first day of remarkable falls, 4 January, was the prelude to four further days of turbulence on the Shanghai indexes, sending shockwaves through the world’s financial markets and wiping trillions of dollars off index values.Reflecting China’s influence on global wealth and economic stability, the Chinese government’s newly engineered ‘circuit-breaking’ trading rules were just as closely scrutinised as the reasons behind the falls for signals on future fiscal policy and world economic prospects.  

Reading the numbers

So began 2016, which, about a lunar month later, would herald the Chinese year of the red monkey – a year, according to Chinese horoscopes, characterised by ambition and adventure, and in which financial events are likely to take centre stage.China’s meteoric rise to become the world’s second-largest economy certainly shows its ambition, as does the 6.5 per cent to 7 per cent year-on-year growth its leaders are targeting for the next five years. If the Chinese horoscope for 2016 is indeed a portent, the economic signs are also that the year will not be a smooth one for China’s continued high rates of wealth creation.Overcapacity in China’s manufacturing base and the transition to a more service and consumption-based economy are proving difficult to balance, both economically and politically.Alongside manufacturing data in negative growth and declining expansion in the services sector, costly restructuring in state-manufacturing enterprises is helping to push China's national debt-to-GDP ratio to 260 per cent, which, observers point out, is the level that often precedes a financial slowdown.According to the Economist, around two-fifths of new debt is used to service interest on existing loans, with close to four yuan of new borrowing now needed to generate one additional yuan of GDP.

Ambition revisited

Exactly how gloomy the outlook is depends on whom you listen to. However, it is clear from the numbers that there are opportunities as well as risks – both for China and for its businesses and investors – which President Xi Jinping seems keen to mitigate in cooperation with the world’s leaders. Notwithstanding the possibility of a hard ‘soft’ landing, China is the world’s second-largest economy by nominal GDP and the world’s most populous nation, with assets reportedly equivalent to 40 per cent of global GDP.Ahead of China’s taking up the presidency of the G20 forum for economic cooperation this year, President Xi Jinping acknowledged the difficulties facing the world economy’s prospects in his message as incoming chair. Setting out the themes and agenda for debate ahead of the G20 summit – the first-ever in China, which the south-eastern city of Hangzhou will host in September – he called for a reinvigorated world economy.“We should strive to build an innovative, invigorated, interconnected and inclusive global economy and explore new ways to drive development and structural reform, injecting impetus into the growth of individual countries and energising the global economy,” wrote President Xi Jinping. “We should embrace the vision of a global community of shared future, enhance economic connectivity and exchanges among countries, and improve global economic and financial governance.”

Outbound investment in full flow

The emphasis on connectivity at home and abroad chimes with two recent domestic policy initiatives in support of the latest five-year action plan ratified at the National People’s Congress in March.These include the One Belt, One Road foreign policy, which aims to connect China with its neighbours and trading partners globally through a $40 billion private investment fund, and the Made in China 2025 initiative, which seeks comprehensively to upgrade China’s manufacturing and services sector, boosting competitiveness and innovation in the process.Although some would argue that detail on the policy is limited, together the plans suggest a new willingness to collaborate internationally and build on what are already major investments.In April, global professional services firm EY released the report Going Out: The Global Dream of a Manufacturing Power – 2016 China Outbound Investment Outlook. On its analysis, China’s outbound investment is set to hit a record high in 2016, with developed countries in Europe and America in China’s sights – as the recent $43-billion buyout by state-owned ChinaChem for Swiss-based global agribusiness Syngenta attests – alongside emerging economies in the wider Asia-Pacific region and beyond.President Xi Jinping’s state visit to the UK in October came with a flurry of announcements on Chinese investments in the UK.Loletta Chow, EY’s global China overseas investment network leader, commented, ”We believe more Chinese enterprises will ‘go global’, and they will invest in wider areas around the world, accelerating industry upgrade and deepening international capacity cooperation.”

Inbound investment continues

Similarly, the past year’s turbulence appears to have had limited impact on US investors’ intentions in China. A survey from the American Chamber of Commerce (AmCham) in Shanghai, carried out in November, suggested that businesses were more cautious, but overall still quite positive, about China’s prospects as an investment destination.The advocacy body’s annual survey canvassed the views of more than 400 member companies, both China and US headquartered. Overall, it shows survey participants remaining optimistic about China’s economic prospects to 2020, despite the evident challenges, findings broadly backed by AmCham’s data from Q1 2016.Recognising China’s pockets of stagnation as well as high growth, and thus the difficulty in describing business experience in this respect in a single phrase, AmCham noted that its respondents in the retail and services sectors were the most optimistic.The survey also matches China’s macroeconomic outlook with reports of lower revenue growth. Fewer companies recorded revenue growth in 2015 – 61 per cent of companies in 2015 compared with 75 per cent in 2014. At the same time, an increased proportion reported declining revenues: 11 per cent in 2014, up to 23 per cent in 2015.Interestingly, 81 per cent of respondents were still planning to increase investment in 2016, but at lower levels, underlining the scale of the risk and the potential rewards.

Changing gear?

In the context of China’s restructuring, its G20 ambitions, and the wider themes of cooperation and openness, additional findings from AmCham’s study reveal some of the concerns its member businesses have and the potential blocks to China’s realising its goals – both qualitative and quantitative.Respondents reported that they were investing and customising products and services for the China market and would do more. However, 49 per cent said that a lack of intellectual property rights protection and enforcement constrained their investment in innovation and R&D.Internet quality, domestic competition, costs, and the economic slowdown were also seen as key risks. Regulation and government policy changes, along with unpredictable fiscal policy, were further significant concerns among AmCham survey respondents. The proportion who felt regulatory transparency had improved rose – 28 per cent in 2015, compared with 14 per cent in 2014 – but concerns remained around implementation, according to the study.

Building momentum

Taking the big-picture view, China needs the world and the world needs China as the world’s second-largest economy, accounting for around a third of global growth.The question is how to bring it all together. More cooperation, innovation and openness sound like good starting points, as clearly China’s impact on the world economy is only set to increase.

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