The old saying used to be “if the US sneezes, the world catches a cold”. But whilst the new White House administration might be hogging all the headlines, international business leaders will be far more concerned about what is happening in China. In the second part of our three-part series, we look ahead to the economic challenges that China will face over the coming year.
Orchestrating a stable slowdown
As the Chinese economy continues its gradual slowdown, Beijing will focus on carefully managing a deceleration that is expected to persist in 2017 and well beyond, while also continuing to steer the country’s economic restructuring away from its historical dependence on exports and investment towards a model more oriented around innovation, consumption, and services.
China’s enduring growth decline, having slid from a peak of 14.7% in 2007 to 6.7% last year, has captured an enormous amount of international attention due to persistent fears that the Chinese economy is poised on the brink of precipitous slowdown. Such concerns are understandable given that China continues to maintain its role as the world’s primary economic locomotive despite its slowdown, having contributed well over a third of global GDP growth in 2016. A sudden derailing of the Chinese economy would likely have a devastating impact on global growth. Fortunately, most forecasts do not envision a dramatic slowdown occurring this year, with the World Bank forecasting China’s growth will slide marginally to 6.5% and the Organization for Economic Co-operation and Development projecting a decline to 6.4%.
Ahead of the all-important political transition at the 19th Party Congress in the autumn, Beijing has prioritized keeping the economy on level ground. In December, the leadership’s central economic planning session made clear that the main theme for the economy in 2017 would be “seeking progress while maintaining stability.” Specific tasks identified on the national economic agenda included efforts aimed at tackling industrial over-capacity, lowering corporate costs, reducing debt levels, curbing the property bubble, and attracting foreign investment.
Although coverage of China’s slowdown often focuses predominantly on national GDP growth, international businesses need to be aware that it is inadvisable to view the country’s growth rate as a single figure. A two-track economy has emerged in recent years, with the slowdown having been highly disproportionate. Some sectors are shrinking, particularly those in heavy industries, while others continue to plough ahead, such as retail and e-commerce. Similarly, the divergence in performance among different sectors is mirrored by stark growth variations between regions. For instance, the north has been hit hard by much weaker growth in recent years, but the southern and eastern coastal economies have been far less affected.
Keeping the debt crisis at bay
China’s mounting debt burden continues to fuel concerns about the risk posed to economic stability by excessive lending and the need to rein in credit growth. After the onset of the financial crisis, the central government launched a colossal credit stimulus – officially, a four trillion yuan package – between 2008 and 2010. The total debt has now grown by 150% since the financial crisis to reach roughly 250% of GDP, most of which is corporate debt and local government debt. If left unchecked, China’s spiraling debt levels could lead to serious economic trouble in the future.
Managing stock market gyrations
2016 was a disappointing year for the performance of Chinese stocks, with the shares of mainland Chinese companies listed in Hong Kong declining around 5% and stocks listed in Shanghai falling about 12%. China’s financial markets were hit especially hard by a weaker yuan and growing capital outflows.
However, the historic debut of the long-awaited Shenzhen-Hong Kong Stock Connect in December did mark another significant step forward in China’s market liberalization. For global investors, the new cross-border trading scheme allows them to trade shares in nearly 900 Chinese firms, providing them with a unique opportunity to expand their exposure to China’s new growth sectors, particularly the dynamic cluster of Internet and technology companies in the Pearl River Delta. Last year, Shenzhen’s incredible economic dynamism was illustrated by the fact that it put up more skyscrapers than any other Chinese city – and more than the U.S. and Singapore combined.
Looking ahead, more volatility is expected in 2017, although forecasting the future of the Chinese stock market is an exercise of notorious uncertainty. The outlook for Chinese shares will likely be weighed down by factors including concerns about the yuan’s continued depreciation, a cooling real estate market, and the forbidding prospect of a U.S.-China trade war erupting.
Cooling the overheated property market
It would be difficult to understate the importance of real estate to the Chinese economy, with many economists estimating that housing and related sectors contribute about one-fifth of all economic activity. Proving both a blessing and a migraine for central policymakers last year, the surging property sector created an alternative source of growth that picked up the slack left by faltering sectors, such as manufacturing, and propped up the weakening economy, allowing the government to hit its annual targets. However, the boom in real estate also quickened pulses about the devastating consequences that could be unleashed by an abrupt meltdown.
Chinese decision-makers are clearly concerned about the deluge of speculative money sloshing around the housing market. At the central economic planning session in December, the leadership set cooling the housing market as one of the top priorities for 2017, emphasizing that, “homes are built to be lived in, not for speculation.”
The dilemma faced by Beijing is how to achieve the delicate balance of curbing speculation without intervening too aggressively and sparking a sudden housing collapse. Such a bust would have dire implications not only for China but the global economy as well.
Slowing overseas investment while countering political headwinds abroad
Since the beginning of the new millennium, the spectacular growth of China’s overseas investment has unfolded as a relatively new chapter in the Chinese economy’s development and swiftly emerged as a game-changing phenomenon for global markets. These outward investment flows continued apace last year, rising more than 40% to reach a record 1.1 trillion yuan (US$170 billion), with the intensifying efforts of many Chinese companies to build brand value worldwide now forming one of the most powerful currents driving the country’s outbound investment. In particular, Chinese firms have embarked on a buying binge in European and North American geographies in recent years, seeking to acquire the assets of leading Western corporates in a bid to strengthen their international stature and competitiveness in their home market over the long term.
In the Year of the Rooster, however, the journeys of Chinese investors abroad may be knocked off course by the rougher waters now rolling up under both domestic and international headwinds. Last year, nearly US$75 billion worth of Chinese overseas deals were canceled as tightening regulatory scrutiny at home and abroad resulted in 30 acquisitions in Europe and the U.S. falling through. Looking ahead, a leading Chinese think tank recently predicted that China’s overseas investment will drop to about US$118 billion this year due to heightened regulatory scrutiny from Chinese authorities and greater political risks abroad. Following nearly a decade and a half of rapid gains, such a decline would mark a striking deflation of the steadily mushrooming global footprint of Chinese corporates.
On the domestic front, Beijing has been increasingly unsettled by a huge exodus of Chinese capital flowing abroad and moved to impose tighter controls over local firms’ overseas acquisitions in the midst of their aggressive offshore spending spree. Towards the end of last year, the central government consequently imposed more restrictive measures aimed at taming the growth in capital flight, such as closer regulatory scrutiny of foreign acquisitions valued at US$10 billion or more and investments over US$1 billion by Chinese firms in offshore entities not related to the investor’s core business. In the short term, such regulatory constraints look set to curb Chinese outbound investment, but the outward push of Chinese companies will likely bounce back if Beijing eases restrictions later this year as expected.
Internationally, Chinese investors’ expansion plans in Europe and the U.S. have been increasingly buffeted by tightening regulatory regimes and rising protectionist sentiment over the last year. The surging volume of Chinese acquisitions appears to have prompted many Western governments to erect greater roadblocks to such investments due to competitive and national security concerns as well as in response to domestic electorates that are more and more skeptical of the benefits of keeping their economies open.
In the U.S., it remains to be seen what impact the Trump presidency will eventually have on the realization of China Inc.’s global ambitions. If Mr. Trump actually follows through on the hard economic line that he took towards Beijing on the campaign trail, Chinese companies will likely find the space for their deal-making severely constrained in the U.S. over the coming four years. However, it is possible that President Trump’s overwhelming focus on generating employment and reviving U.S. manufacturing could result in a more favorable environment for Chinese companies that demonstrate their commitment to helping achieve these policy priorities.
Shortly ahead of his inauguration, for example, Mr. Trump held what he declared was a “great meeting” with Jack Ma, the executive chairman of e-commerce behemoth Alibaba, at his office in New York. During the encounter, Mr. Ma, one of China’s most iconic business leaders, unveiled his new plan to bring a million small- and medium-sized U.S. businesses onto Alibaba’s online marketplaces to sell to Chinese consumers over the next five years, an initiative that is expected to create a million new U.S. jobs. By pitching Alibaba’s business strategy as directly supporting greater American entrepreneurship and increased exports, Mr. Ma demonstrated a pragmatic recognition of the need to adapt to the new U.S. political climate and appeal directly to the incoming president’s focus on his job creation agenda. In the coming years, many more Chinese investors will likely follow suit and work to closely align their U.S. expansion plans with strengthening local employment in order to avoid being caught in the crosshairs of a more nationalistic administration.
As the risk of a protectionist backlash looms ever larger in the West, especially with President Trump now in power and hard-right European parties likely to further expand their influence through the E.U. elections this year, Chinese companies need to focus on mitigating the potential for more aggressive government interference that could derail their spending overseas and negatively impact their brand development. In particular, China would be well-advised to continue emphasizing the win-win nature of its investment overtures and the considerable benefits enjoyed by recipient countries, such as boosts to local economic growth, expanded job creation, higher tax revenues, and the renewal of troubled acquisitions. Successfully telling the positive story of globalization through the contributions of Chinese investments to local prosperity will go a long way towards ensuring that the welcome mat stays rolled out for China Inc. in developed economies.
Rolling out the welcome mat for foreign investors
Perhaps most importantly, ensuring the doors of developed economies remain open to Chinese investment will require that Beijing delivers on its promises of further liberalizing its foreign direct investment (FDI) regime and achieves genuine progress in terms of correcting the asymmetry in market access between China and the West. While the E.U. and the U.S. are generally very open to inward investment, China still has not significantly eased restrictions on foreign investment since its accession to the WTO in 2001, with many of its sectors remaining relatively closed to FDI, including financial services, media, telecoms, logistics, and healthcare.
This lack of reciprocity has resulted in mounting criticism from foreign governments and international firms over China’s comparatively closed markets. According to the American Chamber of Commerce’s latest annual survey of business conditions in China, four out of five companies said they felt less welcome than before, expressing concerns, in particular, about what they perceived as rising Chinese protectionism.
As Beijing continues to struggle with a slowing economy, the central government has moved to reassure and restore confidence among foreign investors that market access will continue to widen further in the future. For example, in January, the State Council, China’s cabinet, unveiled a series of new measures aimed at accelerating the economy’s opening-up process, including specific pledges such as reducing market barriers for overseas financial services firms and facilitating greater foreign investment in the manufacturing and energy sectors.
The release of the policy pronouncement on the same day as President Xi’s speech in Davos indicates that Beijing is keen to communicate that it is working towards building a friendlier business environment for foreign firms. As always, questions remain as to whether the implementation of the planned reform agenda will actually match the progressive rhetoric. International businesses will now need to closely follow developments to take full advantage of the new opportunities that emerge in the months and years ahead.
By Benjamin Cooper & Philippe Healey
This is the second part of a three-part series looking at the changes and challenges China will face this year. You can read the first part here.
H+K’s dedicated Government & Public Affairs (GPA) practice offers a wide range of services, including strategic counsel, stakeholder engagement monitoring and analysis services to a range of national and international leading companies.
 “Global Economic Prospects: weak investment in uncertain times,” World Bank Group, January 2017; “Economic Outlook for Southeast Asia, China, and India in 2017,” OECD Development Center, 2017.
 “China pledges stability, reform in 2017 as key economic meeting ends,” Xinhua, 16 December 2016.
 Daniel Shane, “Chinese stocks outlook: the four big issues for 2017,” Barron’s Asia, 29 December 2016.
 “Shenzhen’s Business Zones,” Silk Road Associates, January 2017.
 “China vows to curb real estate bubble in 2017,” Xinhua, 16 December 2016.
 “China to encourage overseas investment,” Global Times, 10 February 2017.
 Claire Jones, Javier Espinoza, and Tom Hancock, “Overseas Chinese acquisitions worth US$75 billion cancelled last year,” The Financial Times, 06 February 2017.
 “Chinese foreign investment to drop,” The Real Deal Magazine, 13 January 2017.
 “China Business Climate Survey Report,” American Chamber of Commerce in China, January 2017.