As global investors are increasingly concerned about China’s slow
down and the revision of its GDP targets, the Middle Kingdom is having
to face up to a significant backlog of reform issues. China’s new
leadership is coming to grips with one of the most complex policy
agendas facing any government, including those in the Eurozone. The good
news is that the leadership are showing an appetite to tackle head-on
the major challenges and in doing so, should ensure that the country
continues to cement its position as one of the world’s leading
economies.
The major challenges which I believe China must address during the next decade are:
1) Capacity: As China makes the transition from being a low-cost manufacturer to a domestic producer and a high technology exporter, significant capacity is arising in factories across the country. The government continues to protect infrastructure projects and new developments, much of which remain ghost towns or unused highways. The legacy of the 2008 fiscal stimulus, which was so instrumental in rebalancing the global economy, has had a significant long-term cost to China’s economy. The focus must now become justifying return on investment and much more vigorous due diligence of projects, to ensure they are sustainable in the long term.
2) Environment: There has been a dramatic shift in the Chinese public’s perception of environmental issues. An increasingly vocal and social media savvy population are taking to the internet to complain loudly about the impact air quality is having on their day-to-day lives in many of China’s major cities. This is causing a rationalisation of industry and a focus on renewable and cleaner energy sources and the upgrading of a number of environmental standards – all of which comes with a financial cost.
3) Agrarian Business: China’s history shows a society which was primarily built out of farming. The shift of rural workers to the cities has boosted China’s productive capacity, but has put new strains on China’s food supply, security and created land ownership issues. Agrarianism is a critical resource which is deeply embedded in Chinese philosophy. As urbanization continues tensions are beginning to arise in development projects and communities across the country.
4) Shadow Banking: Availability of credit in China has expanded significantly beyond GDP growth. Much of this funding has come from an unsupervised sector of the economy which does not have the same degree of prudential constraints as mainstream lending. It is no wonder that the Government has initiated a major state audit to calculate the depth of the issue. This is however an opportunity to consolidate and centralise the banking systems within China and a number of measures have already been taken to stabilise the sector. Fortunately most Chinese banks are very well provisioned to cushion any significant financial loss.
5) Demographics: China’s ageing population has been well documented and the Government recently announced a number of revisions to the One-Child Policy. The Year of the Snake is not regarded as especially lucky, so there is no point in rushing these changes and the Government will likely target the coming Year of the Horse to initiate the rebirth of the population. Fortunately statistics in China are not always accurate and the population is probably more vibrant than reported, but there remains a need to overhaul this longstanding policy commitment of the Party.
6) Foreign Investment: China has lost some of its shine to foreign investors, particularly now that western economies have begun to show signs of a sustained recovery. I have found that costs and unclear policies, levels of corruption, changed controls, unexpected risks and labour force issues have all caused many problems for international investors. The economy is still highly regulated and controlled in sectors, making it very difficult to get adequate returns on investment. Currently, it is those who have been in China for a long time already or those who are purely exporting their database that are making money in China. There has yet to be a set of more pro-business policies at both a prudential and federal level to really ignite a new foreign investment phase. No multinational can afford to not be in China in the long term, but in the short term, some are looking at other options (with the exception of luxury consumer brands, and some MNCs focussed on pharma and high-tech manufacturing) and this sentiment needs to be changed. Chinese corporate governance standards have lagged those in the west, and issues such as back-door listings in the US, frequency of insider trading charges and the governance of SOEs have all had an impact on business sentiment in China.
7) Corruption: The Bo Xilai incident clearly exposed an endemic attitude to corruption throughout China (such an attitude still exists in many emerging economies). Corruption however is very foreign to the Party’s principles and values. Already the new leadership is tackling head on some of the excesses that have come to light in recent years by introducing tough restrictions and imposing high sanctions and penalties for those caught on the wrong side of the rules. These are all very constructive measures which will instil a lot of confidence in the Chinese economy, but they are not without political risk. It will take time to change several decades of embedded culture and educate a new class of Chinese entrepreneurs.
8) Political & Social Issues: Increasing tension and disputes over resources, the backlash against Chinese investments in Africa, tensions around cyber security and spying in the US and Europe have all increased international pressure on China’s new leadership. China’s immediate focus however is on the domestic economy and a set of key priorities. Not until these are underway and under control will China become a more active and engaged member of the international community. One area where China’s foreign policy is very clear is further BRICS cooperation, evidenced by the huge new gas and coal exports from Russia to China. Much has been written about China’s desire to surpass the US and become the world’s largest economy, in reality China is patient and its more immediate aspirations are to deal with the many domestic issues facing it. One of those being income inequality, which is being tackled by raising wages and introducing better pension systems. No country has undertaken an industrial transformation at the pace, and with the same level of success as China, the real question for China now is can it beat the middle income gap? Moving to a high technology, domestic service based economy is a much more challenging part of the task.
I would anticipate that in the next few weeks China will issue a major economic statement setting the tone for the next few years. China is at a critical inflection point in its reform process. It needs to start to execute some of the necessary reforms in order to sustain the economic miracle we have witnessed over the last three decades. The world will continue to watch closely as China enters probably the most critical period of its modern history.
The major challenges which I believe China must address during the next decade are:
1) Capacity: As China makes the transition from being a low-cost manufacturer to a domestic producer and a high technology exporter, significant capacity is arising in factories across the country. The government continues to protect infrastructure projects and new developments, much of which remain ghost towns or unused highways. The legacy of the 2008 fiscal stimulus, which was so instrumental in rebalancing the global economy, has had a significant long-term cost to China’s economy. The focus must now become justifying return on investment and much more vigorous due diligence of projects, to ensure they are sustainable in the long term.
2) Environment: There has been a dramatic shift in the Chinese public’s perception of environmental issues. An increasingly vocal and social media savvy population are taking to the internet to complain loudly about the impact air quality is having on their day-to-day lives in many of China’s major cities. This is causing a rationalisation of industry and a focus on renewable and cleaner energy sources and the upgrading of a number of environmental standards – all of which comes with a financial cost.
3) Agrarian Business: China’s history shows a society which was primarily built out of farming. The shift of rural workers to the cities has boosted China’s productive capacity, but has put new strains on China’s food supply, security and created land ownership issues. Agrarianism is a critical resource which is deeply embedded in Chinese philosophy. As urbanization continues tensions are beginning to arise in development projects and communities across the country.
4) Shadow Banking: Availability of credit in China has expanded significantly beyond GDP growth. Much of this funding has come from an unsupervised sector of the economy which does not have the same degree of prudential constraints as mainstream lending. It is no wonder that the Government has initiated a major state audit to calculate the depth of the issue. This is however an opportunity to consolidate and centralise the banking systems within China and a number of measures have already been taken to stabilise the sector. Fortunately most Chinese banks are very well provisioned to cushion any significant financial loss.
5) Demographics: China’s ageing population has been well documented and the Government recently announced a number of revisions to the One-Child Policy. The Year of the Snake is not regarded as especially lucky, so there is no point in rushing these changes and the Government will likely target the coming Year of the Horse to initiate the rebirth of the population. Fortunately statistics in China are not always accurate and the population is probably more vibrant than reported, but there remains a need to overhaul this longstanding policy commitment of the Party.
6) Foreign Investment: China has lost some of its shine to foreign investors, particularly now that western economies have begun to show signs of a sustained recovery. I have found that costs and unclear policies, levels of corruption, changed controls, unexpected risks and labour force issues have all caused many problems for international investors. The economy is still highly regulated and controlled in sectors, making it very difficult to get adequate returns on investment. Currently, it is those who have been in China for a long time already or those who are purely exporting their database that are making money in China. There has yet to be a set of more pro-business policies at both a prudential and federal level to really ignite a new foreign investment phase. No multinational can afford to not be in China in the long term, but in the short term, some are looking at other options (with the exception of luxury consumer brands, and some MNCs focussed on pharma and high-tech manufacturing) and this sentiment needs to be changed. Chinese corporate governance standards have lagged those in the west, and issues such as back-door listings in the US, frequency of insider trading charges and the governance of SOEs have all had an impact on business sentiment in China.
7) Corruption: The Bo Xilai incident clearly exposed an endemic attitude to corruption throughout China (such an attitude still exists in many emerging economies). Corruption however is very foreign to the Party’s principles and values. Already the new leadership is tackling head on some of the excesses that have come to light in recent years by introducing tough restrictions and imposing high sanctions and penalties for those caught on the wrong side of the rules. These are all very constructive measures which will instil a lot of confidence in the Chinese economy, but they are not without political risk. It will take time to change several decades of embedded culture and educate a new class of Chinese entrepreneurs.
8) Political & Social Issues: Increasing tension and disputes over resources, the backlash against Chinese investments in Africa, tensions around cyber security and spying in the US and Europe have all increased international pressure on China’s new leadership. China’s immediate focus however is on the domestic economy and a set of key priorities. Not until these are underway and under control will China become a more active and engaged member of the international community. One area where China’s foreign policy is very clear is further BRICS cooperation, evidenced by the huge new gas and coal exports from Russia to China. Much has been written about China’s desire to surpass the US and become the world’s largest economy, in reality China is patient and its more immediate aspirations are to deal with the many domestic issues facing it. One of those being income inequality, which is being tackled by raising wages and introducing better pension systems. No country has undertaken an industrial transformation at the pace, and with the same level of success as China, the real question for China now is can it beat the middle income gap? Moving to a high technology, domestic service based economy is a much more challenging part of the task.
I would anticipate that in the next few weeks China will issue a major economic statement setting the tone for the next few years. China is at a critical inflection point in its reform process. It needs to start to execute some of the necessary reforms in order to sustain the economic miracle we have witnessed over the last three decades. The world will continue to watch closely as China enters probably the most critical period of its modern history.
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