Download economic insight GREATER CHINA Quarterly briefing Q4 2013 china’s role in the gloBal

economic Insight
Greater China
Quarterly briefing Q4 2013
China’s role in the global
economy is changing
Welcome to ICAEW’s Economic Insight: Greater China,
a quarterly forecast for the region prepared specifically
for the finance profession. Produced by Cebr, ICAEW’s
partner and acknowledged experts in global economic
forecasting, it provides a unique perspective on the
prospects for China over the coming years. In addition
to mainland China, we also focus on the Hong Kong
and Macau Special Administrative Regions.
China overtakes US to have largest share
of global trade
While it is well known that China’s dynamic growth
over the last three decades was driven by exports,
it is easy to fail to recognise the scale of imports the
world’s second largest economy attracts. China relies
on imported raw materials, including hydrocarbons
to power factories, iron and steel to build
infrastructure and other minerals used in technological
manufacturing. As China’s economy and exports have
grown, so has the volume of imports needed to keep
the system going, allowing China to overtake the US
as the economy with the largest share of global trade
in early 2013. Figure 1 illustrates the rapid growth
of China’s share of world trade. In 2005 this was just
above half that of the US, but the relative decline of the
world’s largest economy – partly driven by the global
financial crisis from 2008 – and China’s continued
expansion have led to a turnaround in fortunes. China
is now involved in 10.9% of global merchandise trade,
while the US plays a role in 10.5% of global goods
transactions.
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Figure 1: Share of global merchandise trade, rolling
four-quarter average, US and China 2005-2013
%
14
12
10
8
6
its Eastern neighbour, rather than to Europe. China is
also the largest destination for exports from Australia,
Indonesia, Japan, Malaysia, South Korea, Thailand and
Taiwan. Although the Chinese economy is expected
to slow in coming years, its rate of growth will still be
high compared to the rest of the world, and China will
continue to suck in resources from elsewhere. As the
Chinese economy develops and the purchasing power
of its consumers grows, more countries will be added to
this list.
4
2
0
2006
2007
2008
2009
US
2010
2011
2012
2013
China
Source: World Trade Organisation, Cebr analysis
China’s share of global trade is likely to expand further
in the coming decades, even as the economy’s growth
rate begins to fall back. The much-anticipated switch
from an investment-led growth trajectory towards an
economy driven by consumption will increase demand
for imports – already high among the emerging
Chinese middle class who see luxury foreign goods as
a status symbol. Concerns about safety and quality of
Chinese goods also increase demand for imports among
domestic consumers. Counteracting forces are at work
on Chinese exports: thanks to rapid increases in labour
costs, producing goods in China is no longer as cheap as
it was, but existing supply chain integration provides a
competitive advantage to firms which is hard to replicate
elsewhere, meaning that China remains a relatively
competitive location for manufacturing. Moreover, if
China can improve its record on innovation, reducing
the need to rely upon foreign designs, there will be
scope for further export growth. Given the emphasis
placed by Beijing on developing innovation, we expect
China’s share of global trade to increase further in the
coming years, rising to at least 12% of global trade by
the end of 2015.
China’s growth is changing global
trade patterns
China’s dramatic expansion is diverting longestablished trade routes. China has become the
world’s largest energy consumer, with its imports
of crude oil expected to hit 300m tonnes this year.
Demand for oil imports in the US, previously the
world’s largest consumer, has fallen thanks to rising
shale production, while China’s ongoing development
leaves it thirsty for fuel. Consumption of domestic
materials (including construction minerals, metal ores
and industrial materials, fossil fuels and biomass) per
capita is also particularly high in China – 62% above
the world average in 2008, according to the UN.1 Rapid
urbanisation and infrastructure development have
radically increased demand for resources, pushing up
China’s demand for imports.
This growth of Chinese energy demand has already
revolutionised markets in Central Asia.2 Countries
such as Turkmenistan and Kazakhstan used to sell
the majority of their oil and gas output to Russia – a
natural step following the dissolution of the USSR – but
China is now the largest trading partner of all except
Uzbekistan. Russia, too, is increasingly selling energy to
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Renminbi now used to settle nearly a
fifth of trade deals – something that was
essentially impossible just four years ago
International currency markets are known for their
stability. Indeed, there has only been a single change
in the accepted reserve currency in the past 100 years
– the switch from the pound sterling to the US dollar
after 1945. The renminbi’s ascent was never going to
be quick. And yet, signs are emerging that the currency
could gain market share relatively fast, driven by China’s
vast size and the wealth of opportunities to trade and
invest within it.
The proportion of trade settled in renminbi has risen
rapidly in the last three years, as illustrated in Figure 2.
By Q2 2013, 16.6% of China’s trade was settled in
renminbi, up from just 1.0% in Q2 2010. While uptake
has been relatively quick, the majority of Chinese trade
is still settled in US dollars. There are benefits to settling
in renminbi, however, that lead us to expect that the
volume of transactions settled in the currency will
continue to rise rapidly. For most businesses, conducting
deals in the Chinese currency would unlock savings. The
costs of converting between renminbi and US dollars,
and the associated exchange rate risks, are usually built
into contracts by Chinese firms; by taking on this
currency risk themselves, international firms should gain
greater clarity over pricing and potentially the power to
negotiate better value contracts. With smaller Chinese
firms struggling to deal in dollars, this would also allow
international firms access to a much greater segment of
the Chinese market. Dealing in renminbi is also
increasingly attractive to Chinese firms, as it limits their
exposure to exchange rate risk around the dollar. Given
these benefits, we expect that the volume of trade
settled in renminbi will continue to increase rapidly,
rising to at least 23% by 2015 and a third of all trade
by 2020.
Figure 2: Proportion of trade settled in renminbi
%
25
20
15
FORECA S T
10
5
0
2010
2011
2012
2013
2014
2015
Source: People’s Bank of China, General Administration of Customs of China, Macrobond,
Cebr analysis
economic insight – Gre ater Chin a
Q 4 2 013
Renminbi enters list of top 10 most
frequently traded currencies for the first
time, but still accounts for just 2.2% of
transactions
China is now a giant of world trade, but remains a minor
player in currency markets, as illustrated in Figure 3. The
yuan only entered the top 10 of globally-traded currencies
in 2013, ranking at the ninth most traded currency in the
world. Its share of total currency trading remains very
low, however, at just 2.2%. This is a result of the fact
that global currency markets tend to be dominated by a
few very powerful currencies – at present, the US dollar
and the euro, which are involved respectively in 87.0%
and 33.4% of all currency trades.3 While the proportion
of transactions including the yuan has increased 20-fold
since 2004, use of the renminbi is still a long way from
reflecting China’s importance to the global economy.
Figure 3: Currencies ranked by share of global foreign
exchange trade involving currency,
1 = currency used most frequently
1
2001
2004
2007
2010
2013
US dollar
Euro
5
Japanese yen
RANKING
10
Pound sterling
15
Australian dollar
20
Canadian dollar
Swiss franc
Mexican peso
25
Chinese yuan
30
New Zealand dollar
35
40
Source: Bank for International Settlements
This is likely to begin to change in the near future,
however, following recent agreements by the Chinese
Government to operate currency swaps with central
banks in 24 different countries. Cities around the world,
including London, Singapore and Taipei, are now battling
to compete with Hong Kong as hubs for renminbi trading,
and Beijing is developing relationships with a wide
range of partners, all contributing to increased renminbi
liquidity outside China. As these new centres emerge,
foreign exchange trading of the renminbi is growing at a
remarkable rate. Over the last three years, trade between
the US dollar and renminbi has more than tripled, rising
by 260%. This compares to growth in euro/US dollar
trades of 17% over the same period, and pound sterling/
US dollar trades which rose by 31%. Interest in the
renminbi is clearly rising.
Increasing international opportunities to
invest in renminbi
Until recently, the main factor preventing international
investors from making use of the renminbi was the
difficulty of obtaining the currency, thanks to China’s
closed capital account. In more recent years, however,
a new challenge to its use has emerged – the relative
scarcity of investment opportunities for those international
investors who do hold renminbi. While the offshore ‘dim
sum’ renminbi bond market offers some opportunities to
invest, until very recently the ability to invest in renminbi
onshore, in mainland China, was very limited. In this
respect, the extension of the Renminbi Qualified Foreign
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Institutional Investor (RQFII) quota scheme in March
2013 to include financial institutions operating outside
Hong Kong is likely to be an important development.
This scheme will now allow a broader range of investors
access to the domestic interbond market for the first
time. As this market quadrupled in size between 2004
and mid-2012 to become the fourth largest domestic
bond market in the world, this is an exciting opportunity
for international investors and one we are confident a
growing number will want to take advantage of. This will
also bring substantial benefit to China, creating additional
liquidity in markets and attracting long-term investment
which can facilitate transfer of innovation and know-how.
Many international institutional investors were previously
discouraged from investing in renminbi by the limited size
of offshore markets, but should now be able to fulfil their
ambitions to extend operations in China. The opening of
onshore markets should vastly increase the availability of
international capital to Chinese businesses.
The renminbi has some way to go before
becoming a reserve currency
Although use of the renminbi is rising and an increasing
number of central banks hold it as part of their foreign
exchange reserves, it is a long way from being a major
reserve currency like the dollar. The most recent data
from the IMF, covering Q2 2013, suggest that 62% of all
foreign exchange reserves are still held in US dollars, with
just 3% of all reserve held in ‘other currencies’ including
the yuan. Change in these markets is subject to significant
inertia, as illustrated in Figure 3: big changes in the
rankings of global currencies are rare. There has been
only one change in the main reserve currency over the
last 100 years – the switch from the pound sterling to the
US dollar following the Second World War. There is little
reason to think that the rise of the renminbi will be quick,
given the cautious attitude of the Chinese authorities to
liberalisation.
Yet although it will be slow, the rising importance of the
renminbi for trade will ensure it has a place on the roster
of most central banks – as more trade is conducted in the
currency, monetary authorities will become increasingly
keen to hold it to protect against sudden movements
in the exchange rate. For foreign exchange reserves to
perform a protective function, however, the currency in
which they are held must be freely transferable, creating
deep, liquid markets where monetary authorities can
swap currencies quickly in times of need. Despite the
progress described above, Chinese financial markets
continue to lack the depth necessary for this to be a
reality. But growing use to settle trade is likely to be a
gateway to wider use of the renminbi, increasing demand
for assets in the currency which can be used to hedge
foreign exchange risks and encourage the flow of capital.
The renminbi has the additional attraction of presenting
an alternative to the US dollar at a time when political
uncertainty is creating doubts about the stability of this
and its main rival in international currency markets, the
euro.
The main barrier to broader international use of the
renminbi remains the lack of full, official convertibility.
Concerns about volatile flows of ‘hot money’ seeking a
quick return on an appreciating currency, which were one
cause of the Asian financial crisis of 1997–98, mean that
any progress on liberalisation will be relatively slow. The
road to renminbi convertibility will be smoothest if the
economic insight – Gre ater Chin a
Q 4 2 013
authorities can provide clear rules, consistently applied, to
help international users develop trust in the currency.
The flow of capital runs in both ways,
with Chinese investment overseas nearly
increasing ten-fold over the past eight years
Chinese influence is not just growing in financial
markets. The stock of foreign direct investment (FDI)
in China – investments made by companies based
overseas – continues to dwarf China’s stock of Overseas
Direct Investment (ODI), but the latter is growing much
more rapidly, as Figure 4 shows. Between 2004 and the
end of 2012, the stock of Chinese investment overseas
increased nearly 10-fold, rising from a value of $52.7bn
to $502.8bn. At $21,596bn the stock of FDI in China
remains much higher, but it is clear that the Chinese are
increasingly keen to reap the benefits of investing abroad.
Figure 4: Growth in Chinese direct investment
overseas and foreign direct investment in China (ODI
and FDI), 2004-2012, index 2004 =100
benefits to Chinese firms, helping them to step up the
ladder of production from manufacturing to design,
increasing their value added and putting the country on a
more sustainable long-term growth path.
Figure 5: Changing destinations of Chinese ODI,
proportion of total Chinese ODI in selected
destinations, 2005–2011 and 2012–June 2013
Germany
Russia
Indonesia
Britain
Brazil
Canada
US
Australia
0
2
4
6
8
10
12
Proportion of total ODI, 2005–2011
14
%
Proportion of ODI, 2012–June 2013
1000
Source: The Heritage Foundation, Cebr analysis
900
800
700
600
500
400
300
200
100
2004
2005
2006
2007
2008
2009
2010
2011
2012
Foreign investment in China (foreign direct investment)
Chinese investment overseas (overseas direct investment)
Increasing the diversity of Chinese investments abroad
should also help to improve the stability of the world
economy. China’s high savings rate – still more than
half of GDP – has left the country with a remarkable
accumulation of reserves, much of which has been pushed
into US treasuries and similar bonds. Demand for these
‘safe’ assets was partially responsible for the financial
crisis, driving the development of ever more complex
asset classes that later turned toxic. Direct investments by
China, in infrastructure and industry, are more likely to
be a productive use of Chinese capital, and less likely to
unbalance the global economy.
Source: China State Administration of Foreign Exchange, Cebr analysis
Moreover, the type of international firms that China
is investing in continues to diversify. The first wave of
Chinese ODI was mostly led by state-owned enterprises
(SOEs) and focused on guaranteeing access to energy
and other natural resources in developing countries.
This included substantial investment in Africa, where the
Chinese have invested in mines and oil wells in a bid to
ensure their energy security. More recently, however, ODI
has begun to take on different forms. While resources
remain an important part of China’s overseas shopping
spree, private sector firms are increasingly seeking other
investment opportunities overseas; access to brands,
technology and skills – Chinese car manufacturers,
for example, are showing growing interest in buying
out struggling competitors in Europe. Investment in
infrastructure and prime property in advanced economies
is also increasing, with Chinese companies recently
winning contracts to build a major new business park and
nuclear power station in the UK. Advanced economies
now account for two-thirds of Chinese ODI, up from just
one tenth in 2002.
Figure 5 illustrates this turning tide in the destination for
Chinese investment overseas: over the 18 months to June
2013, the proportion of Chinese ODI destined for energyrich countries such as Russia, Canada and Australia fell,
while investment in non-resource intensive economies
such as Germany, the UK and the US has increased. This
move towards more diverse ODI should bring myriad
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China set to hit 2013 growth target,
but pace of expansion will slow in the
medium term
As advanced economies begin to see signs of sustained
recovery, emerging markets have begun to slow. Despite
a strong fiscal squeeze equivalent to 3.2% of GDP, the US
is expected to grow by 1.6% over 2013 as a whole, and
resilience in the private sector is expected to boost growth
to around 2.5% in 2014. The eurozone has also turned
a corner, and is expected to see positive growth in 2014
for the first time in three years. By contrast, emerging
markets appear to be entering a cyclical slowdown. After
years of very rapid expansion, countries including China,
India, Russia and Brazil are hitting bottlenecks.
After slower growth through the first half of 2013,
mainland China witnessed an increase in the pace of
economic expansion in Q3, and is now expected to hit its
growth target of 7.5% this year. A major driver of growth
in this period, however, was Beijing’s ‘mini-stimulus’
package of investment in infrastructure, which is unlikely
to be repeated in future. China will benefit from stronger
growth in advanced economies, which will improve
demand for exports, however a build-up of risk in the
financial sector is likely to limit the growth of domestic
consumption.
After three decades of break-neck paced growth,
China appears to be experiencing a cyclical slowdown,
economic insight – Gre ater Chin a
Q 4 2 013
exaggerating the deceleration in growth driven by the
changing nature of its economy and demographics.
The returns on investment have fallen, and the country
is beginning to lose its competitive advantage in
manufacturing as wages rise. China needs to find a new
growth trajectory, based around domestic consumption
rather than investment. While its population of 1.3bn
people should provide plenty of scope for this, it will also
be important to ensure that the policy environment is
conducive to rebalancing the country’s growth path.
The country’s leaders appear to be committed to moving
policy in the required direction – demonstrated most
recently by the opening of the experimental Shanghai
Free Trade Zone, officially called the China (Shanghai)
Pilot Free Trade Zone, suggesting broader underlying
ambitions. However, the list of changes needed to
promote consumption and rationalise investment is
daunting, including reform of the hukou household
registration system, interest rate liberalisation, reform of
state-owned enterprises (SOEs), liberalisation of financial
systems and the need to encourage innovation.
In the long run, China’s prospects remain positive,
however the scale of change needed to protect the
country’s future potential is such that some slowing
of growth in the interim is inevitable. Given this, we
expect growth on the mainland to slow to 7.3% in
2014 and 7.0% in 2015 as the government grapples
with the necessary reforms. In the immediate term,
the accumulation of risk in the country’s shadow
banking sector, rising property prices and sizeable local
government debt burden could pose a threat to GDP
growth if not carefully managed.
Figure 6: Greater China GDP growth forecasts
%
Although domestic demand growth in mainland China
is expected to slow slightly from 2014, stronger demand
from the eurozone and US will more than compensate
for this. The effect of this pick up in global demand,
however, will be muted by domestic factors. Falling
property prices, driven by an increase in housing supply,
stalling income growth and a growing risk of interest rate
rises, will constrain GDP growth over the next two years
by deterring investment in property. This price fall will
have a relatively muted effect on domestic consumption,
however, thanks to the substantial role played by nonresidents in the Hong Kong economy. Nevertheless,
this will limit the rate of economic expansion to around
3.7% in 2014 and 3.8% in 2015. Major infrastructure
projects, such as the Hong Kong-Macau-Zhuhai bridge,
which should be completed by 2016, will help to support
continued growth, as will government spending.
Strong investment in Macau is set to keep the economy
expanding at a rapid pace over the next few years, even as
the mainland slows. Gambling revenue growth has been
strong throughout 2013, and high hotel occupancy rates
suggest that the gambling hub will grow by 9.2% this
year. With the Hong Kong-Zhuhai-Macau bridge expected
to open in 2016 and investment in new facilities ramping
up in preparation for the boost to tourist numbers this is
likely to bring, growth should remain strong in 2014 and
2015.
China’s continued growth depends upon
reform
12
10
There is little doubt that China’s importance to the global
economy will only continue to grow over the coming
decades. The scale of the country, combined with its
relatively low level of development, means that there is
still enormous potential for further economic expansion.
8
6
4
2
0
Mainland China
2013
Hong Kong
2014
Macau
2015
Source: Cebr
1 West,
The international status of the Chinese economy,
however, now depends upon the ability of China’s
leaders to steer the country through a testing period of
change. The outcome of the Third Plenum, held in early
November 2013, will provide a vital insight into the shape
this process is likely to take. If party leaders are brave
enough, this could be the dawn of a new era of economic
expansion for China.
Schandl, Heyenga and Chen (2013), Resource Efficiency: Economics and Outlook for China, UNEP, Thailand
2 Central
3 As
Weak external demand is expected to hinder Hong
Kong’s expansion in 2013, with the eurozone in particular
weighing on growth prospects. Investment levels have
also fallen back after rapid expansion over the last two
years. The Special Administrative Region (SAR) is expected
to expand by 2.9% this year.
Asia is made up of five countries: Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan.
two currencies are involved in each foreign exchange trade, market shares sum to 200% rather than 100%.
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economic insight – Gre ater Chin a
Q 4 2 013
For enquiries or additional information, please contact:
Vivian Yu
T +86 10 8518 8622
E [email protected]
Cebr
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