The Chinese economy is in a period of flux: what emerges will have profound significance for global business
If one word aptly describes informed reaction to recent Chinese economic data, it is probably ‘confused’. The powerhouse economy that enjoyed three decades of extraordinary growth has entered a period of flux, but what that means for both China and the world remains unclear.
Figures released at the end of July neatly encapsulate the dilemma for economists wanting black and white answers to a tricky conundrum. Two key measures of factory output painted an entirely conflicting picture, with large state-owned businesses appearing to underperform while smaller private companies enjoyed notable success.
What is clear is that the era of stratospheric investment-led growth is over. The Chinese economy grew by an average of 10% annually between 1980 and 2011. Predictions for 2016 top out at 6.7%.
A HARD LANDING?
The key question is, where does China go from here? Is the economy heading for a ‘hard landing’, potentially tilting the world back into recession, or will efforts at modernisation bear fruit? “The problem now is that exports are reducing, but domestic consumption is not yet a force to push the economy forwards,” says Yong Sun, managing partner of UHY’s Chinese member firm, Zhonghua Certified Public Accountants LLP. “That means investment is still a very important part of the economy, but it is not sustainable. At the moment the government wants to sustain growth at 6.5% or 7%, so it has no choice but to invest.”
Most economists agree that state investment – spectacularly successful in the past – will have to play a smaller part in the Chinese economy in the future. “In recent years there has been no real problem for the Chinese economy,” adds Yong Sun. “But now there is a question of direction.”
In what direction China travels, and how quickly it moves, is a question of global significance. Stephen S. Roach, former chairman of Morgan Stanley Asia and a senior fellow at Yale University’s Jackson Institute of Global Affairs, has calculated that, despite its slowing expansion, China remains the single largest contributor to world economic growth. If forecasts prove correct and its economy grows by 6.7% in 2016, China will contribute 1.2 percentage points of a predicted global GDP growth of 3.1%, or 39% of the total. By comparison the US will account for just 0.3 percentage points.
With those figures in mind, it is easy to see why Roach believes the widely feared economic hard landing for China would have a “devastating global impact”. But there is another possibility, and a more likely one in his view. He writes: “The world stands to benefit greatly if the components of China’s GDP continue to shift from manufacturing-led exports and investment to services and household consumption.”
A report by the McKinsey Global Institute, entitled China’s Choice: Capturing the USD 5 Trillion Productivity Opportunity, attempts to put a figure on what a successful rebalancing of the Chinese economy might mean. Shifting to a productivity-led economy could generate up to USD 5.6 trillion of additional GDP by 2030, the report claims.
Such a shift “will not be easy” and will involve some hard decisions on the part of the Chinese state. One concern is that the government, worried by rising unemployment and focused on unsustainable growth targets, is rowing back on commitments to speed up the transition from an investment-led to a consumer-driven economy.
A CHANGING ECONOMY
But despite central inertia, there are encouraging signs from the Chinese private sector. Recent research by UHY revealed that 1,609,700 new businesses were formed in China in 2014, nearly double the number created in 2010. It is not yet known what effect economic slowdown has had on new business creation in the last 18 months, but Yong Sun says that Zhonghua is continuing to see a positive shift in its client base.
“We can see the economy slowly changing from heavy industry to service industries, and we are also seeing more clients in high tech sectors, internet businesses and other innovation sectors. Previously, most clients would be large, state-owned businesses. Now we deal with many SMEs, and the newly established companies we work with are growing very quickly.”
These kinds of businesses are crucial to a successful rebalancing of the Chinese economy, the McKinsey report states. Sustainable jobs in innovative industries, along with increased efficiency and more widespread digitisation, will help to grow the Chinese middle class and, at the same time, serve it more successfully. At the moment, says Yong Sun, middle class consumers tend to buy cheaper goods from abroad rather than supporting domestic markets.
NEW OPPORTUNITIES, NEW RESPONSIBILITIES
Another important element of China’s restructuring will be “deepening global connections”, says McKinsey, and China is continuing to reach out to the world. Again, state investment remains a major driver. Chinese state-run companies are winning major infrastructure contracts around the world, perhaps most successfully in Africa. Then there is the much vaunted One Belt, One Road initiative, a potentially massive infrastructure programme to develop trade routes in Asia and beyond.
But China is also continuing to open up its internal markets to foreign investment, even if it is not yet doing so quickly or completely enough to realise the most optimistic predictions in the McKinsey report. In fact, China is not just more open, it is also becoming a safer and more sophisticated destination for foreign companies.
“Ten years ago and more, foreign companies saw a huge market, but mainly cheap labour and cheap land,” says Yong Sun. “China is no longer cheaper, so companies who come here are usually focused on serving the Chinese market or they already have clients in China who they want to serve better.”
With new opportunities come new responsibilities. New labour laws, tax regulations and transfer pricing policies make China a more complex proposition for foreign companies than it was a few years ago. In return, they have access to a vast and growing middle class (an estimated 116 million households), an increasingly skilled labour force and better protection for their intellectual property.
As UHY’s member firm in China, Zhonghua helps companies negotiate the country’s more complex tax and labour laws, and can advise on the best investment vehicles for particular businesses. Its expertise also helps a growing number of private Chinese companies looking to expand into global markets.
GLOBAL NETWORK, LOCAL KNOWLEDGE
In both areas, Zhonghua is able to enlist the services of UHY’s extensive international network. UHY has offices in over 320 major business centres in the world, as well as a number of dedicated China desks that focus on helping Chinese firms move into new markets and foreign companies establish a presence in China. Member firms offering China-specific services through their China desks include, among others, UHY Haines Norton in Australia, UHY Lee Seng Chan & Co in Singapore, UHY LLP in the US, and UHY Hacker Young in the UK.
Cross-border collaboration between member firms, combined with appropriate local knowledge and expertise, are key parts of UHY’s service offering. When United Initiators, a chemical company headquartered in Germany and with operations in China, the US and elsewhere, wanted a global accountancy solution, it turned to UHY LLP, Michigan in the US. By doing so, it automatically tapped into the expertise of German member firm, UHY Deutschland AG, as well as Zhonghua Certified Public Accountants LLP in China, and a number of others.
Melanie Chen, partner at UHY Advisors in New York, is head of the firm’s China desk. She believes that facilitating business between China and the rest of the world requires that kind of cooperation, along with specialised experience.
“I am sure many Chinese natives in the UHY network have similar backgrounds and experiences to mine,” she says. “Often we have not only completed college educations in both countries, but also have significant working experience in both countries. We know very well about the differences in business cultures, regulations, GAAP requirements and business operations. We are able to bridge those differences with our experience and knowledge.”
“We support many Chinese companies entering the market in Singapore and across South East Asia, working in close collaboration with our UHY colleagues across the globe,” says Kelvin Lee, partner at UHY Lee Seng Chan & Co, Singapore, and its resident China expert. The firm has recently helped a large Chinese retailer of baby and children’s products prepare to expand overseas, assisting with financial management, tax planning, branding and strategy, and is continuing to explore further collaboration opportunities with Zhonghua.
Melanie Chen believes that clients will seek out advice even more regularly in the coming years, as the Chinese economy matures and Chinese companies seek competitive advantage outside the country’s borders.
“China is like Japan and Korea in the ‘70s and ‘80s, with companies that need to go beyond their domestic market to acquire new technology, brands and markets, to sustain development and growth,” she says. “I believe that in the next few years we will see more Chinese companies making investments all over the world.”
Yong Sun of Zhonghua also sees opportunities as Chinese businesses spread their wings. He believes many will take their first steps into foreign markets through mergers and acquisitions, while others will require training and consultancy services from firms like Zhonghua, working with the international expertise of the UHY network.
UHY member firm UHY Haines Norton in Sydney, in collaboration with UHY in Malaysia, is currently assisting with the listing of a large Chinese chicken production company on the Australian Stock Exchange (ASX). Mark Nicholaeff, a director at UHY Haines Norton Corporate Finance Pty Ltd, says: “We are currently getting a large number of enquiries from Chinese companies seeking investment opportunities in Australia. Our firm alone is in talks with more than six Chinese companies wishing to list on the ASX and many more seeking to invest in Australia, particularly in the mining and agricultural sectors.”
And those opportunities will most likely increase, as China continues to drive global economic growth and reach out to the world. The kind of innovation and efficiency improvements that come from open markets at home and expansion abroad will be essential for the future health of the Chinese economy. Government priorities can slow or speed the process, but the direction of travel appears set.
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Notes for Editors
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