Cementing Economic Ties

With more than £30 billion contracts in the retail, energy, financial and aerospace sectors on offer, President Xin Jinping’s visit to the UK marked a significant moment in the cementing of ties between the UK and China. China has been the one of the major powerhouses for global economic growth in the past few years and is now the second largest economy in the world.

Following the inclusion of the Chinese Renminbi (RMB) in the International Monetary Fund’s Special Drawing Right Basket, the country is expected to play an increasingly active role in global finance. Therefore, it is crucial for businesses and investors in the UK to research the Chinese market so they can make the right strategic decisions in the future.

After the impressive, very high growth in the past two decades, it is important to recognise that the Chinese economy is entering a phase of much slower growth. Financial analysts and commentators have been warning about high debt levels and the stock market fragility of China, and events in 2015 seem to have vindicated these concerns. 

Factory of the world

China’s economic growth rate in the third quarter of 2015 stood at 6.9 percent, the lowest since the financial turmoil in 2009. It is also slightly below the Government’s official projection, which is rare for China. Some analysts are warning about a hard landing and believe growth in 2016 could be 5.5 percent or lower. As wages have risen, manufacturing growth has definitely slowed. 

The “factory of the world” has been facing increasing challenges from new rising competitors in Southeast Asia, such as Vietnam. Moreover, the dollar value of Chinese exports has fallen since March and this trend is likely to continue. The Chinese Government is likely to be concerned about this, which explains the three percent devaluation it allowed in early August.

The financial and stock markets have experienced even greater turbulence. In the three months to August, the Shanghai Composite Index fell by 40 percent bringing a red-hot rally, which started in mid-2014, to a halt. Public confidence in the stock market plummeted and it was a big shock to local investors of who had come to believe that the Chinese government’s monetary policies and market interventions would support the market and prevent sharp declines in stock prices.

The negative consequences of the Chinese Government’s supportive and lenient lending policies are also becoming apparent. Since the global financial crisis in 2009, China’s banks and bond markets have increased their exposure to many sectors including manufacturing, where many companies are inefficient and barely profitable, even at the best of times. Banks are unable to tackle non-performing corporate loans as they are heavily influenced by state decisions. Given the weak stock market, businesses cannot easily repair their balance sheets by issuing more equity. As a result, the Chinese economy is weighed down by underperforming businesses which face poor demand prospects while they struggle with very high debt levels. 

Transition period

However one should not be too pessimistic. Even if China’s growth slows to 5.5 percent, this will still be much higher than the growth experienced by the major developed economies. The challenge ahead for China is to maintain economic growth by engaging in sustainable growth policies while managing the difficult transition from a manufacturing and export-led mode to one more oriented towards services and domestic demand.     

Where there are some challenges, there are also many opportunities for UK businesses. UK companies should seize the opportunities presented by China’s move towards more sustainable growth. The RMB’s inclusion in IMF’s SDR (special drawing rights) basket marked an important milestone in international finance. With London’s position as a global financial centre, it should serve as an important platform for the trading of the Chinese currency and related financial products.

London’s expertise, experience and established financial infrastructure could help to bring Chinese financial products on par with other international counterparts.

The UK’s exports to China have perhaps focused too much on the high value luxury sector. China is a huge market with 1.3 billion people and a steadily growing middle-class. Among the middle-class in China, there is great demand for better goods, professional services, investment options and quality education. The spectrum of consumers in China is much wider than the people who shop at Harrods and buy property around Hyde Park. There is a huge untapped potential market in China for UK businesses and investors.

The recent slowdown of China’s economic growth is an issue that UK businesses and investors should be aware of. However, China will become an increasingly influential player in the world economy and will be a growing market for many years and UK companies should review their strategies so they can align with this viewpoint and subsequently benefit from China’s mid to long-term growth outlook. 

By Sanjiv Shah, Chief Investment Officer at Sun Global Investments

Read this story, and more in December's issue of Asia Outlook here.