China’s Great Rebalancing Act eurasia group

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China’s Great Rebalancing Act
China’s rise will shape the future of manufacturing, competiveness, and innovation. The country is poised to exercise
greater influence both in Asia and globally. Eurasia Group is closely following the pivotal political and economic changes
that will determine the future of Chinese industry. We are also watching China’s choices in strategic sectors—namely, the
auto, aviation, consumer electronics, and energy sectors.
Report issued 20 October 2010
Prepared for PricewaterhouseCoopers Co., Ltd.
This confidential report is intended solely for the internal use of PricewaterhouseCoopers Co., Ltd. and is based on the opinions of Eurasia Group analysts and
various in-country specialists. Eurasia Group is a private research and consulting firm that maintains no affiliations with governments or political parties.
© 2010 Eurasia Group, 475 Fifth Avenue, 14th Floor, New York, New York 10017
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China’s next leaders
In 2012, China will replace nearly all of its top leaders. Before President Hu
Jintao and Premier Wen Jiabao depart, they will seek to cement their legacies
and ensure that China’s new leaders preserve their policy priorities. Even
though Xi Jinping is expected to be the next president, competition for the
other top posts will intensify in 2011. China’s new leaders will be less bold,
take fewer risks, and seek to balance an array of competing interest groups.
The new generation’s less assertive nature may jeopardize the economic
restructuring that Hu and Wen are currently trying to initiate, however, since
major reforms require strong political resolve.
A blueprint for the future
Hu’s and Wen’s legacy will be enshrined in the 12th Five Year Plan (FYP),
2011–2015, to be released at the end of 2010. This blueprint will almost
certainly guide China’s economic development for more than just five years,
likely even for a decade or more. The plan will likely emphasize shifting industrial activity away from coastal provinces, outline programs to spur domestic
consumption, and promote clean energy as a source of economic growth.
Investments in infrastructure coupled with tax breaks to attract foreign investors
to central and western China will facilitate industry’s move inland, but policies
aimed at income redistribution will be tougher to execute. Beijing’s ability to
implement policies that redirect savings to households away from companies
and the government, as well as its willingness to accept the slower growth that
this requires, will indicate how credible the redistribution push is.
Xi Jinping
Vice President
Li Yuanchao
Chairman,
Central
Committee
Organization
Department
Li Keqiang
Chairman,
Central
Committee
Organization
Department
Wang Qishan
Vice Premier,
finance and
economy
Zhang Dejiang
Vice Premier,
industry
Zhang Gaoli
Party Secretary
of Tianjin
Wang Yang
Party Secretary
of Guangdong
The 12th Five Year Plan in figures
Eurasia Group expects China’s next Five Year Plan to promote:
Liu Yunshan
Director, Party
Propaganda
Department
• An annual GDP growth target of 7.0%
• An increase in per capita GDP to $5,000 by 2015
• An energy-intensity reduction target of 15%–20% by 2015
• Measures to reduce carbon intensity by 40%–45% by 2020
China’s Great Rebalancing Act
Prepared for PricewaterhouseCoopers Co., Ltd. | 20 October 2010
Bo Xilai
Party Secretary
of Chongqing
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China’s main policy priorities
• Shifting the driver of GDP growth from investment and exports to consumption
• Increasing household income as a share of GDP by boosting wages and taxing
companies more heavily
• Improving the country’s social security system
• Promoting the services sector
• Encouraging urbanization, low-cost housing, and infrastructure investment
• Shifting manufacturing inland and pushing the country up the value chain
• Developing the so-called emerging strategic sectors
• Saving energy and reducing emissions
• Boosting China’s human capital by reforming the education system
Currency internationalization without appreciation
The yuan will one day become an international currency, but this is still a long
way off. China’s economic and financial planners are promoting the yuan for use
in trade transactions—especially in Asia—in order to integrate China’s economy
with the larger Asian economy and to protect the domestic export sector. But
China will ease restrictions on the inflow of foreign capital only incrementally and
over many years. Efforts to promote the yuan are likewise unlikely to be joined by
rapid appreciation in the near term. On 19 June, Beijing signaled that it would
allow the yuan to resume only very gradual appreciation against the US dollar.
The announcement followed months of bureaucratic wrangling over how to
manage such a move, and the currency’s rise will be tempered in coming months
by Beijing’s fears about the economy’s vulnerability to weak global demand.
6.85
0.085
6.80
0.083
0.081
6.75
0.079
6.70
0.077
6.65
Yuan per 1 yen
Yuan per 1 dollar
Dollar and yen rates for the yuan since the June depeg
0.075
6.60
e
n
Ju
ly
Ju
Left axis
Dollar
r
t
Au
s
gu
r
e
mb
pte
Se
2010
0.073
e
tob
Oc
Right axis
Yen
Source: China Foreign Exchange Trade System
China’s Great Rebalancing Act
Prepared for PricewaterhouseCoopers Co., Ltd. | 20 October 2010
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Real GDP growth, select Chinese provinces, 2009
Russia
Kazakhstan
Mongolia
Kyrgyzstan
Tajikistan
Xinjiang
Inner Mongolia
North
Korea
Beijing
Pakistan
South
Korea
Hebei
Shanxi
GDP growth
year-on-year
Japan
< 10%
Henan
Shaanxi
1014%
> 14%
Shanghai
Hubei
Sichuan
Chongqing
Nepal
Bhutan
Burma
India
Bangladesh
Guangdong
Taiwan
Autos
Vietnam
Laos
Source: China Statistical Yearbook
Thailand
Philippines
More expensive labor could mean more consumers
China’s effort to shift to a more consumer-led growth model will make the average
Chinese person richer and more inclined to spend. To facilitate this shift, Beijing
is extending welfare and pension schemes that will allow people to save less. But
increasing the contribution to growth of household incomes will be tricky. Wages
will need to rise faster than productivity and in a more regulated manner as
workers become more conscious—and demanding—of their rights. While foreign
manufacturers can look forward to a (slowly) growing Chinese market, they should
also expect a more costly and challenging work environment. Some foreign firms
will respond by diversifying their supply chains and expanding inland—where
new urban hubs will emerge—while other firms will rethink China’s place in their
regional strategies and diversify their operations to other countries.
Household incomes
20,000
Urban per capita disposable income
Yuan
15,000
Rural per capita net income
10,000
5,000
0
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
Thanks to a number
of stimulus measures
that Beijing rolled out
in 2009, China is now
the world’s largest
auto market and is
likely to remain so. A
major source of longterm growth for the
industry will be hybrid
and electric vehicles
(EVs), supported by a
decade-long subsidy
program that Beijing
will unveil before the
end of the year. But
cost and technology
constraints in the EV
sector suggest that
traditional internal
combustion vehicles
will remain the industry’s primary source
of growth, accounting
for more than 95%
of China’s car fleet in
2020. Public transportation vehicles and
two-wheelers are likely
to see the biggest
gains among EVs in
the medium term.
Source: China’s National Bureau of Statistics
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Making investment strategies work
China’s leaders want to move rapidly up the value-added chain and are promoting
national champions and domestic content. Foreign investment in China is therefore
likely to be most successful when it converges with the government’s desire to become
an innovation powerhouse. Chinese leaders, most of whom are technocrats, believe
that China missed the industrial revolution, sat idly while the information revolution passed, and must now spearhead the energy technology revolution. They view
transformative energy technologies as a way to catapult the Chinese economy and
alter the country’s industrial landscape, while achieving more environmentally sustainable economic growth. This strategy will pose challenges to many companies and their
proprietary technologies. But it will mean unique opportunities, too, especially for
companies that can help China embrace foreign technologies in order to achieve its
national goals. For some foreign investors, technology transfers to Chinese partners
will mean creating a new crop of Chinese competitors. Investors will need to hedge
against these risks and stay several steps ahead of the Chinese market—for instance, by
separating design from production or moving even faster up the value-added chain.
FDI in China
Utilised FDI (Billion dollars)
100
80
60
40
20
0
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
Source: National Bureau of Statistics; Dragonomics
China’s Great Rebalancing Act
Prepared for PricewaterhouseCoopers Co., Ltd. | 20 October 2010
08
20
09
20
10
20
Aviation
The aviation industry
is at the forefront of
China’s push to utilize
state-backed firms to
promote indigenous
innovation and high
value-added research
and development.
China’s two main
aviation firms,
the Commercial
Aviation Company of
China and Aviation
Industries of China,
are working diligently
to produce China’s
first viable commercial
regional aircraft, the
ARJ21-700. The
first aircraft deliveries are expected
early next year. Beijing
likely aims to have its
entire aircraft supply
chain dominated
by domestic firms,
from basic parts and
machinery to engine
suppliers. China may
also hope to export
aircraft. But in light
of the technological
edge that foreign
players hold, they will
be able to contribute
to, and therefore
benefit from, China’s
commercial aircraft
boom for at least the
next few decades.
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Shifting investment toward the emerging strategic
industries and away from the coast
Beijing revised its FDI framework in April to encourage foreign-invested enterprises to expand to central and western China. Accordingly, local governments are
introducing preferential tax policies to encourage the movement of labor-intensive
industries inland. Foreign companies investing in industries designated “encouraged” will be granted preferential land use fees. To simplify and expedite the
approval process, local authorities will be able to authorize projects of up to $300
million, compared with the previous cap of $100 million, except in sectors such
as steel and cement. At the same time, coastal governments will aim to cultivate
investments in the services and emerging strategic industries.
Beijing would like FDI to play a more notable role in China’s interior, just as
foreign financing did in shaping the growth of the now relatively developed coast.
With China’s ambitious high-speed rail project linking Wuhan, Hebei, and Hefei,
Anhui, in central China, the government is already signaling where it wants to see
new growth.
China’s emerging
strategic industries
• New energy
• New materials
• Information
technology
• Biotechnology
• Energy conservation
• Environmental
protection
• Aerospace
• Marine
• Advanced
manufacturing
• Hi-tech services
Consumer electronics
China is a bonanza for consumer electronics manufacturers. While not a source
of cutting-edge invention, China is excellent at deploying existing technology on a
scale and at a speed that is hard to match elsewhere and adapting it to the Chinese
market. The rate of product obsolescence in China is fast, which forces domestic
companies to continuously introduce new products and models. The consumer
electronics sector is beset by intellectual property violations, however, with no easy
solution in sight. The shanzhai, or pirated, product market has grown substantially
over the past few years, as has the quality of fake goods. For global manufacturers,
a solid brand is crucial to contending with piracy: brand identification is important to
status-conscious Chinese consumers and helps to distinguish legitimate products
from their look-alikes.
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Energy development
Beijing’s dedication to developing renewable energy and increasing energy efficiency
heralds energy-price reforms and higher taxes on natural resources such as oil and gas.
It will also mean higher energy costs for industry. Additional efforts to pursue lowcarbon economic development will almost certainly be incorporated into the 12th
FYP. Policies will be aimed primarily at diversifying the country’s energy mix away
from coal and using energy more efficiently to reduce the country’s carbon footprint.
By 2020, Beijing wants non–fossil fuels to account for 15% of its energy mix.
China’s energy mix, 2010
Renewable 0.4%
Nuclear 0.9%
Natural gas 5.3%
Hydro
6.8%
Oil
20.5%
Coal
66.1%
Source: China’s National Development and Reform Commission
The country’s ambitious alternative energy plans enjoy high-level political
support. Vice Premier Li Keqiang is reportedly a particularly strong advocate.
And Hu Chunhua, the newly minted party secretary of Inner Mongolia—the
province that boasts the greatest growth in wind power in all of China—has an
excellent chance of returning to Beijing in 2012 as a top official, suggesting that
clean energy will remain at the forefront of the country’s political agenda.
Clean energy technology
Nuclear power
China has big
ambitions for nuclear
power. With nearly
10 gigawatts installed
so far, China hopes
to make a seven-fold
jump in nuclear capacity by 2020. Even if
Beijing falls short of
that goal, China will still
be one of the world’s
most bullish markets
for nuclear power
over the next decade.
China also wants
to indigenize thirdgeneration nuclear
technology and, once
mature, to export it.
This would put China
in competition with
South Korea and
Japan. One risk for
China’s nuclear sector
is that rapid expansion
could compromise
safety standards. If
that were to happen,
the industry could be
set back for years if
not decades.
China is one of the world’s leading producers of clean energy products, including
solar panels and wind turbines. So far, however, the solar sector is overwhelmingly
geared toward manufacturing higher value-added products rather than deploying its
technologies in the domestic market. 90% of China’s solar panels are destined for
export. As a result, the sector’s vulnerability to external market conditions is high. If
countries such as Germany and Spain reduce their demand-side solar subsidies,
China’s industry could suffer. While China has developed wind power principally for
domestic consumers, the country’s grid system has been unable to keep pace with
expanding supply. Eurasia Group expects China to unleash a multibillion, decadelong investment package in green technologies by the end of the year.
China’s Great Rebalancing Act
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