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Economic Insight:
Greater China
Quarterly briefing Q3 2015
China worries global markets but
warnings over imminent crash miss the
broader picture
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 look
at the Hong Kong and Macau Special Administrative
Regions (SARs).
The global economy has been on a rough ride during
the third quarter of 2015, with a variety of important
events taking place. Firstly, after a decade of crippling
economic isolation and over a year of negotiations,
Iran and the P5+11 reached a deal: Iran is to limit its
nuclear capacity in exchange for the lifting of
international sanctions. Given Iran’s oil wealth, its
re-admission to the global economy is expected to
boost supply in the market, providing downward
pressure to the price of ‘black gold’. This is good news
for most of the global economy, particularly for net-oil
importers such as China. Lower energy costs provide
a boost to consumer purchasing power and allow
room for central banks to keep rates lower for longer.
A second important economic event has been the
eurozone agreement for a third bailout package for
Greece. This package has cleared the uncertainty over
a potential Greek exit from the currency union for
now. However, the months running up to the final
deal exposed numerous structural deficiencies of
the eurozone, as well as a reluctance towards deeper
integration. This remains a key worrying factor for the
viability and economic success of the currency union.
China, meanwhile, continues to march to the beat
of its own drum. The Shanghai stock exchange rose
almost threefold over the year to a peak of 5,166 on
12 June 2015, but then fell by around 26% over the
course of one month. After stabilising for a while,
the index again lapsed into free-fall in mid-August,
declining by 27% over the course of just 10 days.2
Despite the big numbers, this is not conclusive
proof that China is imminently heading for a crash.
Equities hold a relatively small part in China’s overall
household wealth and overall economy (only about
10% of Chinese households hold stocks and shares).
BUSINESS WITH CONFIDENCE
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Looking at the broader picture, most indicators are
pointing to a definite slowdown, sharper than previously
expected. While a devalued yuan is widely expected
to boost Chinese exports by making them more
competitive, only a small part of Chinese exports’ value
is added inside China as trade activity mainly involves
the conversion of imported parts into finished goods
for exporting. As such we expect this boosting effect
to be contained. Overall, while it is tempting to use
tools such as monetary and exchange rate policies in
expansionary ways, it is important for policymakers to
keep in mind that doing so creates risks for the long run.
This is especially the case in China, where debt has been
increasing at a pace twice as fast as GDP for more than a
decade.
In this issue of Economic Insight: Greater China, we
explore the risks and opportunities around China’s
global economic influence. In doing so, we take a close
look at policies that shape the way China connects to
the world, such as China’s economic and soft power,
the internationalisation and rise of the renminbi, the
formation of the Asian Infrastructure Investment Bank
(AIIB), the creation of the New Development Bank
(also known as the BRICS5 Development Bank), and the
ambitious One-Belt-One-Road project. We also discuss
the recent developments in China’s stock market and
examine the economic case for an expected correction
and its potential impact. Following on from this, we
reassess the risks around a hard landing in China and
present our latest forecasts for the Chinese economy.
China’s economic power is undeniable but
there is room for development
Over the past three decades, China’s economy has
followed an unprecedented growth path, expanding
by 10% per year on average. From humble beginnings
as one of the world’s poorest economies, it has lifted
hundreds of millions of individuals out of poverty and
is now on track to surpass the US as the world’s largest
economy.6 This big economic leap has so far been mainly
powered by the exporting and manufacturing sectors.
As shown in Figure 1, in 2014 China was the largest
or second-largest trading partner in the majority of
countries around the world. This is extraordinary.
Figure 1: China’s importance as a bilateral trade
partner in 2014
China
Countries where
China is the largest
trading partner
Countries where
China is the secondlargest trading partner
Other
countries
Source: International Monetary Fund (IMF) Direction of Trade Statistics (DOTS), Cebr analysis
China’s status as second-largest trading partner applies to Europe as a whole, and not necessarily
to individual European countries
Yet digging deeper beneath gross trade flows and into the
value-added done in China would actually present a more
modest picture. A significant part of China’s trade activity
relates to the importing of parts and semi-finished goods
and the exporting of finished goods, which are always of a
higher value than the imports themselves. However, even
in this respect China has shown signs of development
in recent years. As shown in Figure 2, the share of raw
materials and intermediate goods (both categories
that typically entail a low level of value-add) have been
steadily in decline over the past two decades. Perhaps
more impressively, the share of capital goods exports that
typically entail a high level of value-add has more than
quadrupled in the same period. These now represent
around 45% of China’s total exports. This share is more
than that currently enjoyed by consumer goods, which
20 years ago used to make up almost 60% of the total.
Figure 2 : China exports to the world, broken down
by stage of processing of product
%
100
80
60
40
20
0
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
What is more, policymakers have rushed to support
the market through intervention, such as instructing
state-owned enterprises to suspend trading, creating a
‘market stabilisation fund’ of $19.3bn,3 or allowing the
state pension fund to invest up to 30% of their assets
in stocks.4 Intervention has also become the order of
the day when it comes to monetary and exchange rate
policies, with consecutive moves by the People’s Bank
of China (PBOC) in mid-August to weaken the currency
and ease credit through interest rate cuts and cuts in the
reserve requirement ratio.
Capital
goods
Consumer
goods
Intermediate
goods
Raw materials
Source: United Nations COMTRADE via World Bank Integrated Trade Solution (WITS),
Cebr analysis
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ECONOMIC INSIGHT – GRE ATER CHIN A
Q3 2 015
The interesting question is whether and how quickly
China will manage to make its export structure more
sophisticated and focused on higher value-added
exports. For this transition to be managed, China needs
to develop an innovation-driven model. A way to achieve
this is through foreign investment and joint ventures
that promote the exchange of know-how. So far, China’s
foreign investment has been heavily motivated by China’s
insatiable appetite for raw materials and natural resources
and has hence been heavily concentrated in regions that
offer these such as South America and Africa. However,
in recent years there has been a reversal in this trend with
China becoming increasingly interested in venturing into
higher-value added economies such as the UK.
Figure 3: Score on soft power, selected countries
UK
Germany
US
France
Canada
Australia
Switzerland
Japan
Sweden
Netherlands
Denmark
Italy
Austria
Spain
Finland
New Zealand
Belgium
Norway
Economic power is undisputed – acquiring
soft power is more of a challenge
As the focus on trade above proves, China’s ‘economic
power’ and its impact on the rest of the world is
undeniably major and has come a long way over the past
three decades. China’s importance manifests itself beyond
just trade; through its investment flows, contribution to
global growth, influence in global commodity markets,
and even tourism from China in the rest of the world. In
terms of its military ‘hard power’, China is again a clear
regional leader, as evidenced through recent military
supremacy, for example in the South China Sea and
elsewhere. However, the realm where China’s international
presence seems to be most deficient is with regards to its
‘soft power’.7
One way to quantify soft power is by constructing an index
of metrics in the realms of culture, politics and society.
This is exactly what Portland Communications’ ‘The Soft
Power 30’8 project does, the results of which are displayed
in Figure 3. The index looks at countries’ endowment of
a number of so-called ‘soft-power resources’, such as the
quality of their political institutions, the extent of their
cultural appeal, the strength of their diplomatic network,
the global reputation of their higher education system,
the attractiveness of their economic model and their
digital engagement with the world. To quantify these, it
uses metrics such as the number of tourists visiting the
country, the number of embassies abroad, and the level of
membership in international organisations (among others),
as well as international polling results to questions such as
perceptions of technology products of foreign countries or
desire to visit foreign countries for work or study.
Given China’s rich culture and history, the apparent lack
of soft power is puzzling. China scores bottom of the
pile of the countries included in the index, while Britain
ranked first. In terms of its performance on the six different
pillars comprising the index (enterprise, culture, digital,
government, engagement and education), China only
ranks within the top 10 for engagement. This is in large
part thanks to China’s big push on promoting the Chinese
language and culture abroad through its Confucius
Institutes. With 475 centres operating in 120 countries, the
Confucius Institutes have established footholds worldwide.
By contrast, Germany’s long-established Goethe-Institut
has 160 centres in 94 countries, and the British Council
maintains some 70 centres in 49 countries.
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Ireland
South Korea
Singapore
Portugal
Brazil
Poland
Greece
Israel
Czech Republic
Turkey
Mexico
China
0
10
20
30
40
50
60
70
80
Source: The Soft Power 30 (Portland Communications), Cebr analysis
Another way to gauge a country’s soft power is by
observing the international community’s attitudes towards
it. Global polls show that despite China’s increasing
economic rise, the US continues to enjoy a stronger
global image. As shown in Figure 4, China is viewed more
positively in Latin America and Africa compared to other
regions, potentially thanks to its high level of investments
and economic influence in these regions. Another
example that illustrates the positive impact of investments
on public opinion is that of Greece – the only one out
of eight EU nations polled where a majority expressed a
favourable view of China. China has invested heavily in
Greece’s economy through projects such as the port of
Piraeus. China also fares well in the Middle East, where
45% of those surveyed expressed a favourable opinion,
more than double those who viewed the US favourably.
Figure 4: Attitudes towards the US and China, % of
those who said favourable (median in region)
90
80
70
60
50
40
30
20
10
0
US
Canada
Europe
US
Middle
East
Latin
America
Asia
Africa
China
Source: Pew Research Centre, Cebr analysis
ECONOMIC INSIGHT – GRE ATER CHIN A
Q3 2 015
Over a larger time period, this same poll highlights a
significant shift in the economic balance of power since
the 2008 financial crisis. Looking at the 20 nations
surveyed in both 2008 and 2013, the median percentage
naming the US as the world’s leading economic power has
declined from 47% to 41%, while the median percentage
placing China in the top spot has risen from 20% to
34%. The trend has been especially apparent among
some of America’s closest allies in Western Europe. Today,
for example, 53% of Britons say China is the leading
economy while only 33% name the US. In Germany,
the contrast is even starker: 59% say China occupies the
top position while only 19% view the US as the global
economic leader.
Current global institutional order fails
to keep up with China’s development
This and previous editions of this Economic Insight report
have provided ample evidence of China’s economic
power. Yet, the world’s institutional order fails to reflect
this appropriately. One clear demonstration of this is the
discrepancy between voting rights in the International
Monetary Fund (IMF) and economic might as measured
by the size of national Gross Domestic Product (GDP).
As demonstrated in Figure 5, despite representing over
15% of global GDP, China has less than a 5% share of
IMF voting rights. The rest of the BRICS as well as the
US are also under-represented and would benefit from a
GDP-proportional way of allocating voting rights, but to
a much lesser proportion. To the contrary, countries such
as Saudi Arabia, Belgium, Germany, Netherlands, the UK
and France are among the most over-represented.
Figure 5: Shares of global GDP (in 2014 Purchasing
Power Parity terms) and voting rights in the
International Monetary Fund in 2014
25
20
15
10
5
0
US
China
India
Share of global GDP
Russia
Brazil
South Africa
Share of IMF voting rights
Source: International Monetary Fund, Cebr analysis
Perhaps motivated by this imbalance between economic
size and influence in the Bretton Woods institutions,
China is now establishing a number of new initiatives,
such as the New Development Bank (or BRICS Bank), to
be based in Beijing and with a capital of $41bn, as well as
the $100bn Asian Infrastructure Investment Bank (AIIB).
However, the creation of these two bodies does not
necessarily imply that China is trying to break away from
the Bretton Woods institutions completely.
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In contrast, China continues to push for reform in these
institutions, especially the IMF. Not only this, but it is
also trying to integrate itself closer into these institutions
as is demonstrated through its ambition to include
the renminbi in the IMF’s currency basket, the Special
Drawing Right (SDR). At present, the SDR is a basket of
four currencies: the dollar, the euro, sterling and the yen.
At first sight, the PBOC’s decision to devalue the yuan in
mid-August can be seen as derailing the chances for the
currency’s inclusion in the SDR. However, it is more likely
that the fact that market forces are being allowed to have
a greater say in the currency’s exchange value is more
important than the actual direction of the movement,
and that this is in fact strengthening the renminbi’s
chances for SDR inclusion. After all, policymakers have
continuously emphasised that the August developments
should be received as a one-off correction, and that they
expect the renminbi to stay strong.
Infrastructure investment has a large role
to play in China’s outward-looking vision
Shifting the attention back to the AIIB, many have
questioned the importance of having a bank dedicated
to financing infrastructure in particular. Yet investments
in infrastructure such as energy, water, transport,
communication and waste management facilities are
essential inputs for economic development and for the
success of any competitive economy. Economic research
has shown that investment in infrastructure complements
other forms of investment and raises the value of other
economic resources such as property.
However, in practice the private sector and governments
tend to underinvest in infrastructure, mainly due to the
nature of such investments. Infrastructure investments
tend to be costly and to carry high risks. For the private
sector to undertake high risk activities there usually
needs to be high returns. While this is true in the case of
infrastructure investments, the benefits are usually realised
over a longer term, which makes them unappealing to
governments facing a short-term political cycle horizon.
Given this, having a development bank specifically
dedicated to infrastructure can act as a solution by
removing this time-inconsistency policy issue. In Asia in
particular, more financing is plainly needed in light of the
region’s large backlog for infrastructure development.
This is largely a legacy of the Asian financial crisis of the
late 1990s. The Asian Development Bank for example
has said that the Asia-Pacific region needs $8 trillion
in infrastructure funding between 2010 and 2020 to
overcome this legacy.9
China has already demonstrated an impressive capacity
of outward infrastructure investment. As displayed in
Figure 6, over the past decade its outward investment in
the infrastructure sector alone10 has risen 10-fold to reach
over $105bn in 2014.
ECONOMIC INSIGHT – GRE ATER CHIN A
Q3 2 015
Figure 6: China’s outbound Foreign Direct
Investments, by sector,11 in current US$bn
from an interventionist approach in the stock market
raises questions regarding their commitment to the
fundamental reforms that China’s economy needs in order
to successfully rebalance, mature and develop. While we
continue to expect a gentle and managed slowdown over
the longer-term horizon, the bands of uncertainty have
risen. The baseline scenario is one for 6.3% growth next
year and 6.2% growth in 2017.
180
160
140
120
100
80
60
40
20
0
Production and
raw materials
Infrastructure
Services
Other
Source: Heritage Foundation China Global Investment Tracker, Cebr analysis
Another big project in the infrastructure realm is of course
China’s much anticipated and ambitious One-Belt-OneRoad (OBOR) project. The initiative is a two-fold project
which includes a Silk Road Economic Belt and the 21st
Century Maritime Silk Road, aiming to create a northern
road corridor and a southern maritime corridor to connect
China with Europe. This project is expected to be a
central element of China’s ambitions to increase its global
economic influence and soft power, with China’s massive
currency reserves setting a promising background to
potential investments.
Stock market has started to correct but
policymakers still have tools to prevent
a hard landing
The economy of mainland China posted annual growth
of 7.0% in Q2 2015, unchanged from the pace seen
in Q1 and in line with the target set by the country’s
policymakers for the economy’s performance as a whole
this year. However, weak economic data in Q3 (such
as export performance and the Purchasing Managers’
Indices) suggest that growth will be slower in the
remainder of this year. The extent of the slowdown
crucially depends on how strong the spillovers from the
stock market correction to the overall economy will be.
As noted at the beginning of this report, equities hold a
small part in China’s overall household wealth and we do
not expect the impact on the real economy to be as great
as could be implied by the stock market volatility we are
witnessing. Another crucial determinant will be the impact
of expansionary monetary and exchange rate policies,
such as the yuan’s mid-August movements that marked
the sharpest devaluation seen in 20 years. This should
positively impact exports but not greatly so – much of
China’s exporting activity relies on the importing of
semi-finished goods, which tend to be priced in dollars.
Overall, we expect the economy to expand by 6.6%
in 2015, missing the official target. Importantly, the
risks have now been shifted to the longer run. In
particular, policymakers’ reluctance to break away
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The slowdown in China is expected to weigh slightly
on the economy of Hong Kong in 2015 and the years
ahead, through its negative impact on trade in goods
passing through. However, there are still reasons to be
optimistic: robust growth in the US and the UK, together
with a continued recovery in the eurozone, are expected
to boost Hong Kong’s outward-looking economy. Overall,
we see the pace of economic expansion remaining steady
and close to the 2.0% mark throughout the forecast
period. A harder than expected slowdown in mainland
China remains the key risk to Hong Kong’s economy,
as well as stock market turmoil that could likely follow
monetary tightening in the US and the UK.
Efforts in mainland China to contain corruption include
tighter visa restrictions for travel to Macau, which has
heavily impacted the island’s leisure and tourism industry.
Revenues in the gaming sector, for example, have been
recording annual falls of around 36% on average over the
first five months of 2015. With this sector constituting
a large share of Macau’s economy, overall GDP has
suffered significantly as a result: economic output over
the first quarter of 2015 contracted by 24.5% on a yearon-year basis, building on a 17.2% contraction over Q4
2014. Looking ahead, we expect the slowdown to ease
somewhat in the remaining quarters of the year and the
economy to contract by 17% over 2015 as a whole. A
modest return to expansion is expected in 2016 as the
impact of weaker tourism phases out of the year-on-year
comparison and the economy starts growing again from
a low base. Today’s negative shock is also expected to have
a dampening effect on investment with projects such as
big casino developments on the Cotai Strip being delayed.
However, the opening of the Hong Kong-Zhuhai-Macau
Bridge and further integration with the mainland are
expected to support a slight acceleration in growth in 2017.
Figure 7: Greater China GDP growth forecasts,
annual % change
10
5
0
Mainland China
Hong Kong
Macau
-5
-10
-15
-20
2015
2016
2017
Source: Cebr forecasts
ECONOMIC INSIGHT – GRE ATER CHIN A
Q3 2 015
ENDNOTES
1 The five permanent United Nations Security Council members plus Germany
2 This is based on the latest data at the time of writing (27.08.2015)
3 Source: http://www.chinadaily.com.cn/business/2015-07/13/content_21255618.htm
4 Source: http://news.xinhuanet.com/english/2015-08/23/c_134546986.htm
5 Brazil, India, Russia, South Africa
6 In fact, according to the International Monetary Fund, China already did so in Purchasing Power Parity terms in 2014.
7 Power emanating from society, specifically cultural, political, and social values as defined by political scientist
Joseph Nye (1990), Bound to lead: The Changing Nature of American Power and J. Nye (2004), Soft Power: The Means
to Success in World Politics
8 A full exposition of the methodology is provided here:
http://softpower30.portland-communications.com/pdfs/the_soft_power_30.pdf
9 Source: http://adb.org/sites/default/files/pub/2009/2009.08.31.book.infrastructure.seamless.asia.pdf
10 Includes Energy, Transport and Communications
11 Production and raw materials include: agriculture, chemicals and metals. Infrastructure includes: energy, technology,
transport and utilities. Services include: finance, real estate and tourism.
For enquiries or additional information, please contact:
Juni Ngai
T +852 2287 7277 / 6381 1687
E [email protected]
Cebr
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