China Market Update October 2016

China has transformed itself from a poor agricultural country to a global manufacturing powerhouse within these 30 years. It has become the world’s second-largest economy by exporting “Made in China” products worldwide.

Just like competing in a marathon, it is unlikely for you to sprint throughout the race. As shown in Figure 1, China is facing an economy slowdown after “sprinting” for the past decade. One of the reasons contributing to the slowdown is the shift from an economy focusing on manufacturing and exporting to a more consumption and service-driven model. Therefore, the current priority of China is to grow household income and in turn stimulate private consumption and investment to offset the reliance on infrastructure and exports as shown in Figure 2. This is to support the expansion of the service sector and private enterprises, and develop a society promoting innovation and consists of highly skilled professionals.

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Figure 1: China GDP Annual Growth Rate since 1990

Source: www.tradingeconomics.com

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Figure 2: China Services vs Manufacturing Share of GDP

Source: The Wall Street Journal

Underlying Problems in China

  1. Accumulated about $25 trillion debts or 254% of GDP according to CNN Money
  2. Speed of debt mounting has quadrupled from 2007 to 2014 due to real estate and shadow banking according to McKinsey’s report as shown in Figure 3
  3. Some state-owned companies (zombie) are unable to operate as they are nearly insolvent due to over-production
  4. These zombies are still supported by the government who loosened the credit limit, while the latter refuses to write off certain receivables as bad debts and recognize losses
  5. Surplus production on minerals and steels which forced the European Union to impose anti-dumping policies

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Figure 3: China Government Debt to GDP

Source: Trading economies

Catalysts to boost economic growth

  • The “One Belt, One Road” initiative sets to transform its economy by connecting with trading partners along the ancient Silk Road and target five key areas which are infrastructure, trade, policy, finance and people.
  • China’s currency is admitted by IMF into the elite basket of reserve currencies which determines the unit value of Special Drawing Rights (SDR), effecting on 1st October 2016. In other words, it will be one of the main world currencies. This paves the way for broader usage in trade and finance which indirectly strengthens the infrastructure of its financial markets.

Summary

The reduction in production of steels and minerals could be a sign of the government trying to curb its mounting debt, and also to transform China into a private consumption and service-led economy. The “One Belt, One Road” initiative would be a great booster to economic growth. Also, the admittance into the SDR will internationalize China’s currency for broader use in international trade and finance.

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