2 Political Outlook
Economic Outlook
SWOT Analysis
Strengths
China is the fastest-growing major economy in the world, and this has lifted hundreds of millions
of people out of poverty over the past generation.
China has a massive trade surplus, and its US$1.9trn of forex reserves serve as a major cushion
against external shocks.
China’s economic policy-makers are committed to continuing their gradual reform of the economy.
Weaknesses
China’s economy has been growing too fast for its own good. This has led to major imbalances,
and environmental degradation.
China’s dependency on exports to boost growth has made it vulnerable to the global recession.
Private consumption remains weak, at less than 40% of GDP.
The close relations between provincial leaders and local businesses are fostering corruption, and
are making it harder for the central government to enforce its policies.
Opportunities
China’s economic growth is slowly becoming more broad based, with domestic consumption likely
to rise in importance vis-a-vis exports, thanks to a middle class of 200mn-300mn people.
China’s ongoing urbanisation will be a major driver of growth, and new cities will emerge in the
less-developed inland provinces. The UN forecasts China’s urban population rising from 40% in
2005 to 73% in 2050, a gain of 500mn people.
As China moves up the value chain, it will develop its own global brand name companies, fostering
innovation and growth.
Threats
There are fears that the global recession of 2008-10 will mean an end to China’s double-digit
growth rate.
Despite a halt to the appreciation of the yuan currency, the recession is leading to job losses in
China’s export sector, and thus increasing social instability.
Relatively high food price inflation could become structural, as farmland is lost to industry or pol-
lution, and farmers migrate to cities.
Economic Activity
Q408 GDP Data Confirm Our Fears BMI View
As anticipated, Q408 GDP data confirmed that China is far from immune from the unfolding Economic growth dipped to a seven-year low
global recession, with real growth dropping to 6.8% y-o-y. This marked the weakest out- of 6.8% in Q408, dragging full-year growth for
turn in seven years and dragged full-year growth to 9.0%, a sharp decline from the 13.0% 2008 to 9.0% – a sharp decline from the 13.0%
recorded in 2007 and the first time since 2002 that the world’s third largest economy had recorded in 2007 and the first time since 2002
failed to register double-digit headline growth. With things expected to get worse before that the world’s third-largest economy had
they get better, we are anticipating further grim news from China in H109, and reiterate failed to register double-digit headline growth.
our below-consensus 5.6% growth forecast for the year. However, the bad news does not stop there.
Recent macroeconomic data has shown that
Indeed, trade data for December revealed that both imports and exports suffered a second economic activity continues to cool, and we do
consecutive month of contraction, with exports falling by 2.8% y-o-y, accelerating from not foresee any turnaround in fortunes for the
the 2.2% decline recorded in November, while imports plummeted by 21.3% y-o-y having Chinese economy until the second half of 2009
dropped by 17.9% in the previous month. Notably, Exports to the US (which purchased at the very least, highlighting that is more likely
17.7% of China’s total exports in 2008) fell by 4.1% y-o-y in December to compound to be 2010 before a recovery gets under way.
November’s 6.1% decline, while shipments to the EU (which, with a 20.5% share, was With this in mind, we expect real GDP growth
China’s single biggest export destination in 2008) fell 3.5% y-o-y in December after re- to slow to 5.6% in 2009.
maining flat in the previous month.
We have recently revised down our 2009 growth forecasts for both the US and the EU – from
-2.0% and -1.6% to -2.3% and -2.5%, respectively – implying that export growth is likely to
remain in negative territory (or at least remain very weak) over the near term. Meanwhile,
imports are likely to follow suit as commodity prices continue to trend lower, demand for
inputs for manufacturing exports decline and domestic demand remains sluggish.
estate investment continued its rapid slide in December, with growth decelerating for a Souce: National Bureau of Statistics
sixth month in a row to 20.9% y-o-y, having hit a record high of 33.5% in June.
Property price growth dipped into negative territory in December, and leading property
market indicators suggest that the slowdown has further to run. The quantity of land pur-
chased – an indicator for future property development – fell by 5.6% y-o-y in November,
according to the most recent data available from the National Statistics Bureau, compounding
the previous month’s 2.6% decline, while growth of floorspace of commercial buildings
sold spent a ninth straight month in negative territory after it contracted by 16.5% y-o-y in
November. Perhaps most worryingly though is the fact that despite growth of floorspace of
commercial buildings under construction continues to slow (it registered growth of 18.7%
y-o-y in November, down from a peak of 32.1% in February 2008), it is still expanding.
This means that the gap between supply and demand is rising at a rapid rate, implying that
property prices will remain subject to strong downward pressure throughout H109. Given
Downturn Has Further To Run that real estate investment accounts for approximately 20% of all urban FAI, and that FAI
Property Sector Leading Indicators (Top) and Prices
(Bottom), % chg y-o-y in turn accounts for more than 40% of GDP, this bodes very ill for headline growth.
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Furthermore, with investment in manufacturing contributing an even bigger slice to urban
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FAI than real estate, there seems little reason to hold out hope that FAI growth in 2009
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can maintain anywhere near the 20%+ levels witnessed during China’s recent boom pe-
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riod in 2009. Although industrial output growth rebounded slightly in December from the
Floorspace Of Commercial Buildings Under Construction
Land Area Purchased
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Floorspace Of Commercial Buildings Sold
record low of 5.4% y-o-y registered in November, it still remained lacklustre at just 5.7%.
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To put this in context, full-year average industrial output growth in 2007 was 18.0%, and
was 16.1% in H108, and official sources have been quoted as saying that factory output
All Property
New Homes 12
Existing Homes
Non-Residential
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needs to grow at at least 12% if the government is to meet the 8% growth target which is
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6 widely seen as the minimum required to ensure sufficient job creation. Meanwhile, year-
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to-date growth in secondary industry slowed to 9.3% in Q408, according to the National
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0 Bureau of Statistics, marking a sixth straight quarter of decelerating growth after peaking
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at 13.7% in Q207.
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8 However, given the lagged effects of any such moves, and the immediacy of China’s
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problems, we fear that they will not have the desired effect. Indeed, with approximately
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CNY3.1trn of China’s mammoth CNY4trn (US$585bn) fiscal stimulus package ear-
0 marked to be spent on infrastructure projects in their various guises, it seems difficult
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to see how Beijing will be able to successfully front-load its additional spending given
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the length of time required to put construction projects into action. Thus, although we’re
Source: National Bureau of Statistics
not saying that government initiatives will have no effect, we maintain our 5.6% growth
forecast for 2009.
ambitious spending plans. According to the SIC, the government funded only 3.88% of 56
FAI projects in 2008, with 77.43% financed by companies’ own funds and the rest by bank 54
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loans and foreign investors. Amid the current global economic climate, Chinese and for- 50
eign companies alike are very unlikely to be able to increase capital spending to the extent 48
46
required. The SIC has said that while local governments were eager to start new projects, 44
most planned investments would stay on the drawing board without corporate support. 42
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More worryingly, however, are previous comments made by Liu which suggested that Source: National Bureau of Statistics
growth below 7% could trigger social unrest. We are now already at this point, and with
mounting anecdotal evidence and official data highlighting the rapidly weakening of the
country’s job market, social unrest is worryingly close to becoming a reality. Indeed, an
estimated 10 million migrant workers have reportedly already lost their jobs, while the
latest purchasing managers’ index revealed that employment prospects weakened further
in December with the employment sub-index falling to 43.3 from 44.3 in November.
While many other governments will be facing similar pressures, the lack of any outlet for
citizen dissatisfaction in communist-ruled China makes the current situation a particularly
volatile situation.
Fiscal Policy
Fiscal Shortfall To Widen Sharply In 2009 BMI View
Having recorded a surplus of CNY1.2trn in the first eleven months of 2008, China’s China’s fiscal balance swung sharply into deficit
full-year budget balance plunged into the red in December as the combined spending of in December 2008 as Beijing ramped up spend-
central and local governments climbed by 30.8% y-o-y to CNY1.66trn (US$243bn). With ing in the final weeks of the year in an attempt
revenues lagging way behind at CNY325bn (a meagre 3.3% increase over the equivalent to counter the ongoing economic slowdown.
year-ago period), a CNY111bn full-year deficit was recorded, reversing the CNY154bn With economic activity forecast to slow further
surplus registered in 2007. in 2009, China’s fiscal shortfall is expected to
widen from the 0.4% of GDP estimated for
While this was equivalent to a still very manageable 0.4% of GDP, it nonetheless represents 2008 to 2.6% in 2009, as the government tries
a sharp reversal in fiscal policy direction. Since reaching a multi-year high of 2.6% of GDP to spend its way out of the current crisis. Mean-
in 2002, China’s fiscal deficit had narrowed in each of the following four years, and actu- while, with such a heavy focus on infrastructure
ally reverted into surplus for the first time in over 18 years in 2007. Thus, the 2008 budget spending, we continue to question the efficacy
figure signifies an end to fiscal consolidation and the dawning of a far more aggressive of the government’s CNY4trn (US$585bn) fiscal
approach to fiscal policy. Indeed, December’s data underscores Beijing’s intent to throw stimulus package.
all its available resources at propping up rapidly sagging growth, and with this in mind,
we expect to witness a sharp widening of China’s budget deficit in 2009.
China has already announced a CNY4trn fiscal stimulus package aimed at boosting eco-
nomic activity over the next two years, and Prime Minister Wen Jiabao was quoted in
the Financial Times as recently as February 1 saying that Beijing ‘may take further new,
timely and decisive measures’. Indeed, with real GDP growth slowing to a seven-year low
of 6.8% y-o-y in Q408, and 20 million migrant workers having lost their jobs, according
to Chen Xiwen, the director of the Office of the Central Rural Work Leading Group, it
appears that further fiscal stimulus is very much on the cards.
At the same time, the Chinese government must contend with slowing revenue collections.
Among a number of moves to ease the tax burdens on its citizens, Beijing has cut income
and stock-trading taxes, lowered taxes on property transactions, scrapped the withhold-
ing tax on interest income and raised rebates for exporters, while taxes gathered from
corporates also continue to weaken as corporate profits deteriorate in line with softening
economic activity.
Consolidation Efforts Taking A Backseat Against this backdrop, we are forecasting China’s fiscal deficit to widen sharply in 2009, to
Budget Balance (% of GDP) CNY740bn (or 2.6% of GDP), as revenue growth slows from 19.4% to 17.0% and expenditure
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0.5 growth moves in the opposite direction, accelerating from 25.3% to 26.8%. However, with
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risks to government spending weighted to the upside, and risks to revenues firmly skewed
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-1 to the downside, we highlight that China could be facing a far larger shortfall.
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Nonetheless, we remain confident that China’s budget position will remain within man-
-3 ageable parameters. The central government has been running a fairly conservative fiscal
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policy in recent years, meaning that scope to expand expenditure exists, even at a time
e/f = BMI estimate/forecast; Source: Ministry of Finance
when revenues are forecast to suffer. Indeed, central government debt has been estimated
at around 18% of GDP at the end of 2008, suggesting that additional borrowing would be
a viable option to fund the anticipated rise in government spending. Moreover, Wen has
said that a plan to use of some of China’s foreign currency reserves for domestic purposes
is under discussion, and with more than US$1.9trn at its disposal, Beijing’s reserves should
provide an ample source of extra funds.
Although this will have significant positive effects on employment and the construction
industry over the near term, it is, as we have previously suggested, likely to have a far more
muted impact on growth – at least in the short term – than if the money were to be chan-
neled into tax cuts or subsidies, which would have a far more direct impact on consumers.
Moreover, with such a vast amount being thrown at boosting infrastructure, there is a not
insignificant risk of building ‘bridges to nowhere’ (i.e. projects which serve little purpose
upon completion, and whose only raison d’être is to boost short-term employment). While it
is true that China may be able to make those ‘nowheres’ into ‘somewheres’, given the vast
number of underdeveloped settlements outside of the eastern seaboard, the construction of
‘bridges to nowhere’ would nonetheless provide substantial reason for concern.
Indeed, it could suggest that policymakers in Beijing appear to have learnt little from Time Lag Will Be A Key Issue
Fiscal Stimulus Package Breakdown (%)
the ongoing global economic meltdown. China’s growth model of aggressively boosting Ecology and Independent
Environment, Innovation, 4.0
fixed investment and exporting its excess capacity, which has yielded such phenomenally Rural
8.8
Affordable Health, Culture
Development
Housing, 7.0 and
successful results over the past decade, is ultimately unsustainable – a fact underscored and
Infrastructure
Education, 1.0
Projects, 9.3
by developments witnessed over the past year. To be sure, if China is to achieve a more
balanced growth path over the longer-term horizon, it must shift its focus away from its
external sector and towards building a base for private consumption. However, on this Post-Disaster
Railw ays,
Highw ays,
Reconstructio Airports and
front, precious little progress has been made in recent years. n, 25.0 Pow er Grids,
45.0
Moreover, this is merely one of our concerns. The actual size of the planned additional
spending is still under debate, as is the source of financing for the additional spending,
while inherent corruption also remains a key concern. Thus, we remain sceptical as to the
ability of Beijing’s announced fiscal stimulus package to rescue the economy from its
current doldrums.
bust in China. The years of persistent double-digit growth now look firmly behind us as the
collapse of the Western consumer continues to weigh on demand for Chinese shipments,
which in turn is seeing investment – which has been firmly focused on the export sector
during China’s recent boom period – take a tumble. Despite Beijing’s considerable efforts
– which have included the unveiling of a mammoth CNY4trn (US$585bn) fiscal stimulus
package and 216bps worth of interest rate cuts since September 15 2008 – we remain
sceptical of their efficacy, and as such we have once again revised down our 2009 growth
forecast. Having previously been anticipating a below-consensus expansion of 6.8%, we
have become even more bearish and are now expecting growth to dip to just 5.6%.
Indeed, recent data releases have underpinned our view. Exports fell 2.8% y-o-y in Decem-
ber to compound the previous month’s 2.2% decline, which marked the first since since
February 2002 and the biggest drop since April 1999. Meanwhile, imports plunged by a
Rangebound For Now, But Risks
mammoth 21.3% in December having dropped 17.9% in November, and while plummeting
Weighted To the Downside
Exchange Rate, CNY/US$
8.4
commodity prices will to an extent have been responsible, the dramatic fall nonetheless
8.2 underscores not only weakening domestic demand but also a dearth of demand for inputs
8.0
7.8
for manufacturing exports. In addition, industrial output growth slowed to 5.4% y-o-y in
7.6
November, down from 8.2% in October, marking a fifth straight month of deceleration and
7.4
7.2 representing the worst monthly reading – excluding the months of January and February
7.0
when the Lunar New Year distorts industrial output data – since the monthly data series
6.8
6.6 began in 1999. Furthermore, growth in urban fixed asset investment decelerated for a third
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consecutive month, slowing to 26.1% y-o-y in the January-December period, from 26.8%
Source: BMI
in the first 11 months of the year, having peaked at 27.6% in September.
Finally, there is increasing anecdotal evidence that unemployment and factory closures are
both rising at a rapid clip. Reportedly, more than 60,000 businesses closed down in 2008,
while in the province of Shandong alone, nearly 700,000 people lost their jobs. With the
liklihood that y-o-y inflation is poised to turn negative in Q109 also thrown into the mix,
there appear few good reasons to expect anything other than a weaker yuan in 2009.
Risks To Outlook
If anything, we suggest that risks to our CNY6.9000/US$ forecast are weighted to the
downside. If growth really slows sharply, and in particular too far below the government’s
8% target, the People’s Bank of China (PBoC) could allow the unit to drop further in
order to try to boost export competitiveness and counter the negative effects of deflation.
Indeed, a one-off devaluation still cannot be completely discounted, although we stress
that this remains a low-probability scenario.
To be sure, a competitive devaluation of the yuan would be a very risky strategy that would
not only risk drawing the ire of the rest of the world – and the US and its new president in
particular – but also potentially provide the catalyst for a series of regional devaluations and
an ensuing trade war. Thus, we continue to believe that the political implications of letting
the currency fall too far will continue to prevent China from pursuing such a policy.
Balance Of Payments
BoP Position To Remain Secure BMI View
China’s all-important external sector ended 2008 on a distinctly sour note after trade data China’s current account will suffer at the hands
for December revealed that both imports and exports suffered a second consecutive month of the global recession, with the country’s overall
of contraction. Exports fell by 2.8% y-o-y, accelerating from the 2.2% decline recorded trade balance shrinking from an estimated
in November, while imports endured a similar fate, plummeting by 21.3% y-o-y having 9.5% of GDP in 2008 to 8.3% in 2009. This will
dropped by 17.9% in the previous month. These developments saw China post a trade sur- see China’s current account surplus fall from
plus of US$39.0bn in December, just shy of November’s all-time high of US$40.1bn, and an estimated 11.8% of GDP to 10.9% over
brought the full year surplus to a record US$295.5bn, 12.7% higher than the US$262.2bn the same time horizon. Meanwhile, mounting
Exports to the US (which purchased 17.7% of China’s total exports in 2008) fell by remain confident that despite the mounting
4.1% y-o-y in December to compound November’s 6.1% decline, dragging the full-year downside risks, China’s overall balance of pay-
growth figure down to 8.4%. This marked a notable decline from the 14.4% expansion ments position will remain secure.
recorded in 2007 and a fourth consecutive year of decelerating export growth to the
US, but, most significantly, it marked the first time since 2001 that growth had come in
below double digits.
Meanwhile, exports to the EU (which, with a 20.5% share, was China’s single biggest
export destination in 2008) fell 3.5% y-o-y in December after remaining flat in the previous
month. However, most significantly on this front, the full-year growth figure plummeted to
19.5% from a whopping 49.1% in 2007. With the eurozone forecast to contract by 2.5% in
2009, this figure is likely to fall even further over the coming year. Finally, having already
plunged by 20.1% y-o-y in November, exports to Hong Kong (China’s third largest export
Trade Surplus Has Reached A Peak
destination with a 13.4% share) tumbled 15.4% in December. Trade Balance (% of GDP)
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This latest data merely underscores our bearish view on the world’s fourth largest economy, 8
and adds weight to our sharply below-consensus 2009 growth forecast of 5.6%. Indeed, 6
5
although plummeting commodity prices will to an extent have been responsible for the 4
sharp drop in imports, the dramatic falls witnessed in both November and December also 3
underscore not only weakening domestic demand but declining demand for inputs for 1
manufacturing exports. Moreover, with demand for Chinese goods continuing to weaken
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across its key export markets, the current trends appear to have further to run. e/f = estimate/forecast; Source: National Bureau of Statistics,
BMI
Indeed, we are forecasting growth of total exports to slow from the 22.3% clip estimated in
2008 to just 12.0% in 2009, with services buoying the headline figure as growth in goods
exports slows from 21.7% to 10.9% over the same time horizon. Meanwhile, although
import growth is also forecast to slow in 2009, it will nonetheless outpace that of shipments.
Imports of goods are forecast to rise by 16.8% in 2009, down from 21.9% in 2009, while
imports of services are expected to increase by 19.3%, slowing from an estimated 30.7%
rise recorded in 2008. These developments will see China’s balance of goods shrink from
an estimated 9.9% of GDP in 2008 to 8.6% in 2009, while the overall trade balance will
fall from an estimated 9.5% of GDP to an anticipated 8.3%.
Although still-strong net transfers and income from abroad will continue to buoy the overall
figure, the weaker performance of exports will drag China’s current account surplus lower
from the 11.8% of GDP figure estimated for 2008 in 2009. However, China’s current ac-
count will nonetheless remain in healthy surplus at 10.9% of GDP.
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pressures and cool rampant economic expansion. Indeed, the yuan gained 6.4% against the
10 dollar in the first six months of 2008, up from a 4.1% rise in the previous six months and
0
a 2.6% increase in H107, while the spread of spot CNY over 12-month CNY non-deliver-
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able forwards (NDFs) – a leading indicator of investor sentiment towards the Chinese yuan
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While it is nigh on impossible to get hold of accurate figures reflecting the actual amount of
speculative capital entering China, Michael Pettis and Logan Wright, writing in the Financial
Times in July 2008, suggested that the trade surplus, FDI and interest on China’s reserves
accounted for as little as 39% of the country’s reserve accumulation in the January-May
2008 period. This implies that hot money inflows totalled almost US$165bn in the first
five months of 2008. Now, however, as economic boom rapidly turns to bust, the Chinese
authorities are in fact facing the opposite problem: potentially damaging capital flight.
Indeed, Hu Xiaolian, the head of the State Administration of Foreign Exchange (SAFE),
has warned that China faces a threat of ‘abnormal’ cross-border capital flow because of
global financial tumult, cautioning that more money flowing out of the country could in-
C/A To Remain In Healthy Surplus crease the risk of liquidity strain in the economy. In addition, October 2008 saw China’s
Current Account (% of GDP)
foreign exchange reserves fall for the first time since December 2003 when they dropped
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to US$1.880trn, having stood at US$1.906trn in September.
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8 In a sign of how concerned Beijing is becoming over this issue, the Ministry of Commerce
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has proposed in new draft rules that Chinese companies will have to seek ministry ap-
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proval if they want to invest US$100mn or more overseas. Under the planned new rules,
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which would replace the existing ones promulgated in 2004, companies may also need the
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ministry’s approval if they want to invest in countries that have no diplomatic relations
e/f = estimate/forecast; Source: National Bureau of Statistics, with China, foreign infrastructure projects or highly risky countries or regions. Existing
BMI
rules require China’s central government-controlled companies to apply for the ministry’s
approval if they want to invest overseas, while other firms need only ask for the permis-
sion of the ministry’s provincial bureaus. These rules do not restrict applications by any
monetary threshold.
In a statement made on its website, the Ministry of Commerce said that ‘the regulations
are drawn up to promote and regulate the development of overseas investments’, after a
few major Chinese companies reported big book losses on investments abroad. However,
it seems that fears surrounding an outflow of capital at a time when economic growth is
slowing at an alarming pace is also likely to be a prime motive. Indeed, the draft rules also
deleted an existing provision that said that ‘the state supports and encourage companies with
various sorts of advantages and ownerships to go abroad to invest and establish new firms’,
underscoring Beijing’s apparent policy shift. The ministry said the new rules would take
effect after their formal publication, but it did not say when this would happen. However,
Chinese authorities typically issue new rules within a month after seeking public feedback,
which in this case ran until January 20.
While the move will not necessarily stop money leaving China, it nonetheless underscores
Beijing’s growing concerns, and highlights the possibility that a more draconian clampdown
could be implemented going forward. Moreover, it suggests that China’s secure balance of
payments position may be under threat. However, given that China has posted an average
financial account surplus in excess of US$40bn since the end of the Asian financial crisis,
and that its current account is forecast to stay in healthy surplus, we remain confident that
the country’s overall balance of payments position will continue to be secure throughout
the global recession.