The Mystery of the Economic Miracle in China

The Mystery of the Economic Miracle in China

Intrepid Sourcing has always observed and documented the manufacturing Purchasing Managers Index (PMI) of China. Recent gauge of custom manufacturing activity came in at 51.0. A static industry would come in at 50.0 which means China’s number is signaling an expansion. This trend of activity has continued to increase, spelling high times for Chinese manufacturing companies.

The real test for the Chinese economy is expected to come next year. Levels of heavy investment by the government is expected to decrease. As a result, stimulus will be weaker. Influential fiscal measures will be used by the Chinese government with the help of statistics and inspection companies.


PMI Measures

Regardless, all of the main measures, such as the Reuters, official and Caixin PMI data is expected to signal expansion. Analysts unanimously agree the figure should eventually fall but remain above the stagnation level of 50.0

It has been a great year for China. The root cause is the buoyant contract manufacturing industry. 40% of China’s GDP depends on lean manufacturing. Clearly, favorable trends within this industry will create economic boosts. Lean manufacturing was an area, experts were quick to identify as turbulent early on in the year. Foreign investors won’t need to fear a near future dip.

This year also returned growing levels of exports and imports. Activity levels were on the up as well, and despite firms still reducing employees’ numbers, it occurred at a slower rate. China now finds itself on a strong footing. In turn, China’s strategy for next year’s economy may alter. Risk & quality management and tighter controls may become a higher priority.

China’s PMI results bodes well, but it does not portray the entire lean manufacturing status. Services are becoming an increasingly important industry for the country. Agriculture still employs around 35% of citizens. Stability can come in the form of all three sectors. Long term, the transitioning economy will begin to rely further on services. Fortunately, the service industry is looking healthy as well.

Universally, experts are agreeing. China’s PMI data for this year is surprising and well received. China’s economy is slowly becoming stable and custom manufacturing has returned to highest activity levels last seen several years ago.


A Tough Nut to Crack: The Chinese Market

Even if China’s economy has witnessed stability, other facts still won’t change: Chinese market remains a tough nut to crack.

Just recently, a global fast food giant had agreed a deal to sell off thousands of its Chinese restaurants in a deal struck between the fast food corporation and a Chinese state-owned conglomerate. Initially, the news is surprising. Since entering the market in 1990, McDonalds saw rapid growth in China. With over 2000 stores currently open, there is still room for further growth. However, the fast food giant has decided to sell a 52 percent stake to Citic Capital Holdings, and 28% to US-based Carlyle Group. The remaining 20% will remain in the company’s control.

Exiting the Chinese market is nothing new for international companies. China is a tough market to penetrate. Vast cultural differences is a winning Western formula but doesn’t translate effectively here in China. Tough competition more in line with Chinese tastes also make the business environment difficult. Negative press attention on obesity in China is also seeing consumers turn their backs on fast food chains such as Mcdonald’s.

Fast food chains aren’t the only Western industry leaving China. Electronics manufacturers, clothing line manufacturers, plastic manufacturers, automobiles and energy plants are also slowly withdrawing from the country. Despite China being home to over 1 billion consumers, the market is not necessarily the most profitable. Western firms in particular initially had a technological advantage over their Chinese rivals. However, the Chinese government ruthlessly protected the domestic industries, helping create a level playing field. Trade barriers, regulations and restrictions have all stopped multinational corporations from making China a success.

Another famous brand is Uber, the smartphone taxi service. Acquired by their Chinese rival Chuxing in 2016. As a result, the company’s app was severely changed to suit local market tastes. Multinational corporation struggles are highlighted in these high-profile cases, but the real change is happening away from headlines.

According to a report from the American Chamber of Commerce in China, one in four US companies are in the process of leaving China. Rising labour costs, regulatory challenges, vague inconsistent laws and on-going protectionism concern many responders of the survey.


China’s Intentions

Undoubtedly, what attracted foreign firms initially was the cheap offer on contract manufacturing. Now, many Asian countries are just as accessible and can manufacture products cheaper. As China loses more international firms, Asia as a whole will benefit.

The wider picture may show a different outlook. China recognizes cheap just in time manufacturing is not sustainable over the long term. Chinese companies have caught up technologically to many international firms. Foreign investment is starting to become increasingly encouraged.

The tide may have started to turn towards other countries, but the future may see a reversal.  Deregulation appears to be on the agenda for the Chinese government. With stagnating growth, one way to restart the economy could be through attracting foreign investment. Industries that have previously been restricted to foreign firms, may incentivize future involvement.

Notorious news recently emerged wherein Apple will switch iPhone manufacturing to India. The attractive aspects of China may no longer be in lean manufacturing for foreign firms. The country’s greatest benefit will be the advanced services of the market, not the low-cost on offer. Cheap product pricing will continue to exist, but price sensitive firms will seek out the bottom barrel goods elsewhere. Specialized lean manufacturing fueled by China’s investment into research and development should attract a higher class of companies, especially for industrial design companies developing products.

McDonald’s struggles can also be learnt from. To effectively tackle the Chinese market, you need to know your demographic. McDonalds has also benefited from franchising the majority of their stores. Therefore, hearing news they are selling off many stores (but still retaining a sizable stake) is similar in nature to their current business plan worldwide.

Success is subjective. Experts could call one business plan a failure, while the manufacturing company itself could be happy with the results. Experience and knowledge can all be gained from a profitless venture which could be worth more than money itself. China should be seen as a difficult market. However, the greater the risk the higher the reward.

With continued growth and a rising level of disposable income among citizens, large profits can be made. Naivety and inexperience have stopped many over-arrogant multinational entities from solving the puzzle. As China continues to deregulate industries, and encourage foreign investment, the ease of access will continue to increase. In the past, many thought China could provide a risk-free market for profit. In reality, there is no instant success to be found. With a savvy business plan to develop a product for the right market, anyone can successfully enter the Chinese market.


Toxic Debt at Home Makes Chinese Firms Secure UK Assets

Good news all around for the China business world as confidence seems to be rising among manufacturing companies and entrepreneurs alike. According to China’s Central Bank the business confidence index continuously rises. The index is a measure used by the bank to indicate the amount of optimism by managers and workers about their company’s general outlook.

While the economy has been a little sluggish over the course of the year, owing due to a period of change, latest news suggests positivity. Wholesale clothing sales grew above expectations as did factory output levels. These areas have been helped by consistent government spending on infrastructure and good manufacturing practices as well as a strong housing market.


Nuclear Power

Official government expectations are still on track to be met, with the International Monetary Fund (IMF) suggesting a growth in the nations GDP, in line with the target originally set. The country has also hit international headlines around the world following the state firm CGN committing around $8 billion to help build a nuclear power station in the UK. However, the firm is not only providing a third of the overall investment, they have been awarded exclusive rights to design the reactor for the plant. This continues to show the advancements being made by China, and while the country has made its name on cheap exports, shows the countries specialized capabilities.

The deal agreed may also help further the relations between the UK and China. With the uncertainty surrounding the UK considering its exit from the EU, the country may be an attractive trading partner for China. While many experts suggested the relationship between the countries was a way for China to get access to the overall EU market, this move should be one of many to come which suggest otherwise.

CGN have already confirmed they continue their interest in another site planned by the UK for a nuclear power plant. While this current agreement has gone through turbulent times with many stops and starts, CGN is optimistic further agreements will happen more quickly. Others disagree though, with a decade being seen as a reasonable timeframe before any construction begins.

It is the continued frequency of moves by Chinese manufacturing companies entering into international markets that is really starting to make waves. The sheer size and power of the Chinese economy has enabled the country to strategically set up positions in other countries. While the UK government balked at the sheer manufacturing cost of a new power station, Chinese firms may continue to provide investment in other countries who are unwilling to pay themselves in the new product development process.

While many are questioning the long-term sustainability of the growth seen throughout China, there is no doubt that the country will make its mark internationally. It is true growth is beginning to slow down, but the changing basis of the economy may open up new areas which can revive the currently stuttering situation. As many other economies globally are still feeling the strain follow the financial crisis and shortly after Eurozone crisis, China continues to be the flame that burning


Notable Economic Events in China Recently

Retreat in Shanghai

Chinese stocks in Shanghai are poised for a temporary retreat after their valuation premium over Hong Kong-traded counterparts surged to a more than 5-year high based. In addition, the Shanghai Composite Index, comprised mainly of yuan-denominated A shares, is valued at about 12 times estimated earnings after surging 34 % in the past 2 months.

Mark Luschini, chief investment strategist at Janney Montgomery Scott in Philadelphia, said “We would look for a pause in the A shares and probably even a decline, a pullback that we would consider as healthy”. More important is the persistent discount demonstrates it is a good buying opportunity presently.

Bad Loans Heading North

Banks in the coal-rich regions of Inner Mongolia and Shanxi are dealing with high ratios of bad loans as miners deal with price slumps largely due to the slowdown in the Chinese economy. The ratio of bad loans in Inner Mongolia reached 2.2% while those of Shanxi exceeded 5%.

Based on the fact the bad loan figures have started to rise this year (mainly from manufacturing companies in the steel, shipbuilding and photo-voltaic industries in the Yangtze River Delta), Shang Fulin, chairman of the China Banking Regulatory Commission warned banks to take measures to control risks as slower economic growth became more common.

Shanghai Free Trade Zone Relaxing Car Import Restrictions

The Shanghai Free-Trade Zone allows the imports of foreign vehicles which could save consumers as much as 20%. The pilot program in Shanghai’s FTZ, which opened in 2013 has prompted speculation that prices for imported vehicles could fall by up to one-fifth.

For example, BMW sells an X5 xDrive35i model for 928 thousand yuan, but a parallel import in the FTZ is on sale for 760 thousand yuan. In addition, it is reported that the government is revising the 2005 rules on imports, which have been criticized for helping foreign manufacturing companies and their dealers control prices of vehicles and services.

Xi’s Silk Road

In cooperation with leaders of the Shanghai Cooperation Organization (SCO), President Xi Jinping proposed the establishment of a new Silk Road that would encompass free trade throughout Central Asia. The SCO is an official grouping that includes China, Kazakhstan, Kyrgyzstan, Russia, Tajikistan, and Uzbekistan, with Afghanistan, India, Iran, Mongolia and Pakistan as observer states; Belarus, Sri Lanka and Turkey as dialogue partners; and ASEAN, the Commonwealth of Independent States (CIS) and Turkmenistan as guests.

Xi is looking to both find new markets and leverage some economic clout over the region’s vast oil and gas reserves, as well as minimize the potential for conflict that could spill over into China’s Xinjiang Autonomous Region by raising local incomes and wealth throughout the region.

Zhuhai on the Rise

Located in the center of the Pearl River Delta (PRD), Zhuhai is one of China’s four original Special Economic Zones (SEZs) established in 1980. The city borders Macau to the south and is about one hour away from Guangzhou by car. In the past three decades, Zhuhai has experienced strong economic growth due to its geographical proximity to Hong Kong & Macau and is the only deep-water port on the western side of the Pearl River.

Zhuhai’s GDP is more or less RMB 160 billion every year. The 6 major industries of the city include custom electronic information, bio-pharmaceuticals, petrochemicals, electronics manufacturing, precision machinery manufacturing and energy. Moreover, the city is already connected to major metropolitan centers in the Pearl River Delta through the Guangzhou-Shenzhen-Zhuhai super high way. All in all, these factors will enhance the trade and economy in Zhuhai, making international trade easier among Zhuhai and Zhuhai-related areas in the near future.

How does the weak Pound affect Chinese companies?

Based on the China Foreign Exchange Trading System, the value of the RMB has been strengthened by 42 basis points to 6.1153 against the U.S. dollar in its central parity rate. In China’s spot foreign exchange market, the RMB is allowed to fluctuate 2% from the central parity rate each trading day. The central parity rate of the RMB against the USD is based on a weighted average of prices offered by market makers before the opening of the interbank market each business day.

On the other hand, while the RMB is strengthening against the US dollar, another major currency which is the Pound is facing an anxious status. We have already published an article which took a look into the possible side-effects of the United Kingdom’s announced exit from the European Union. During such time, it was difficult to predict what effects (if any) were going to happen, recent news has shown quantifiable damage.

Chinese Firms in the Business Market

The investment firm, Cheung Kong Infrastructure (CKI), suffered a decline in pre-tax profits, once taking into account special one-off items. While the financial performance of the firm within the UK remained largely flat, the company is exposed to the current volatile nature of the British currency. Currently, the firm is estimated to generate 73% of their revenue from the British market, meaning any movements in the currency directly impact against the firm’s profits.

However, the company CKI is not the only one with a heavy interest in the British market. Property has been an area many Chinese firms and citizens have invested in, particularly in London and doubts are starting to arise in the aftermath of the referendum vote. The UK’s property market has now started to stagnate, with property asking prices falling 1% post referendum.

Other companies include Chinese conglomerate Sinochem Group which owns the British company Emerald Energy. This is just one example of the many Chinese companies which have bought brands and corporations in the UK, primarily in the property market but also including energy, finance, custom electronics, food, transport as well as others.


The Weakening Pound

The weakening pound is starting to have the knock-on effect globally, and many Chinese firms such as manufacturing companies will see an impact upon their finances. While the majority will have well-diversified portfolios and very few will see critical consequences, a large amount will still see the damage come the end of their accounting years.

Many leaders and economists have urged the United Kingdom to invoke article 50 and proceed with their exit as soon as possible. However, it appears the countries new leader is going to wait and let the process drag out longer than needed. Chinese firms and many countries currently within the European Union are currently suffering from the side effects of the uncertainty priced into the financial markets. As soon as the picture is clear, it will be much easier for everyone to move forward. Even if after the eventual exit from the European Union happens and the pound continues to weaken, the recovery will be much closer than dragging the situation out.

Ultimately, the first signs have been seen in the recent financial performance of CKI. With many Chinese companies also relying on the British market for revenue, the weakening pound will become a recurring excuse by CEO’s when addressing shareholders. In our last article on the effects of Brexit upon China, we looked at areas like the two nations relationships. However, the biggest impact which will become a regular news piece, will be the weakening pound.

Questions will begin to arise about the long-term investment Chinese companies have within the United Kingdom. A weakening pound effectively means there is less profits to be had by foreign investment. Perhaps manufacturing companies will begin to look further afield for their investments, and begin to skip the country when they look at locations to invest in. While in the short term, no immediate results are clear, only time will tell whether intentions are starting to change.


2020 Targets Set by the Chinese Government

The release of the State Council Plan which lists various targets for science and technology between now until 2020. Within this plan also included information regarding how the Chinese government will help achieve these targets.

One key area that the country expects to continue its growth is knowledge-intensive services. This sector contributes more or less 15% of the country’s GDP, however, by 2020 the government aims this figure to be somewhere at 20%.

The plan also encourages the introduction of international big science plans and programs. Where the hope is that the country can lead the way in advanced basic fields of science as well as discover new breakthroughs in strategic areas.

Other key target areas include the number of patent applications, in which the volume to be achieved is double the current rate by 2020. Furthermore, by 2020 the level of workers within the research and product development sector should increase from the current level of 48 workers in every 10,000 to a level of 60 in every 10,000.

Selected areas will also see further funding and resources allocated to them, while the government also seeks to cut down on red tape which harms innovation and discourages creativity on industry design.

Research and development relating to areas of national strength and security should also receive substantial funding. This includes nuclear power, medicine, lunar exploration, custom electronics, integrated circuit equipment (PCB design), genetic modification among others.

However, it is not just in funding where the Chinese government looks to support the rapidly growing research and development sector. As mentioned earlier, reducing the level of red tape as well as creating favorable policies are planned. Specifically, the private sector will also be directly encouraged to invest further into research and development through preferential policies. Also, universities and research institutes have been identified to play a crucial part and will be encouraged to improve their efficiency.

The dedication shown by the government stretches further than just from within China. Joint research projects between foreign and Chinese institutes are to be encouraged, with the aim of attracting foreign experts into the country for work.

Currently China is ranked 18th in the world for comprehensive innovation abilities, and one of the targets include rising up to 15th by 2020. While 15th may still be relatively low down in the rankings, Chinese authorities believe this ranking to be the signal that a country has become a globally recognized innovative country.

Recent years have already seen many technological breakthroughs for the country, including manned space flights, super computers and quantum communication.

Overall, it is clear the Chinese government has an active role to play in achieving the goals they themselves have set out. Their commitment cannot be understated, and hopefully the plans they have should play dividends in time to come. There has been a wide variety of areas set out that the government wishes to achieve, and the government clearly sees research and development crucial to driving growth within the country. The future can certainly be considered to be exciting, and many people will be waiting eagerly to see what new advancements are waiting to be discovered in the forthcoming years.


Conclusion

All these economic developments in China including international news which directly affect them prove to be beneficial for China. The future definitely shines bright for the country and its economy. Even though nothing is really sure when it comes to economical status, everything points to the right direction for China and the best part of it is the country’s concern not only for its own welfare but for the Asian continent in general including their biggest partners in Europe and America. China will become a powerhouse player in the global economy for years to come.

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