Australia’s links to China set to broaden: HSBC's Paul Bloxham
GUEST OBSERVER
By any scale, China’s numbers are big. And although there is much angst about the recent slowdown in China’s growth, perspective is important.
Firstly, China’s growth is slowing from double-digit rates to still rapid high single-digit rates. Secondly, China’s economy is now much larger than it was when it sustained double-digit growth rates, which makes it harder to grow as quickly as it did and means that even high single digit growth rates deliver significant additions to global demand.
China’s growth is expected to have slowed to around 7% in 2015 from 10.6% in 2010. But because China is a lot larger than it was in 2010 (89% larger in USD terms and 69% larger in local currency terms), the IMF estimates that this year’s GDP growth is estimated to be equivalent to USD1,028bn, which is slightly more than the addition to GDP in 2010 of USD980bn (Chart 1).
Indeed, despite slower growth, China has continued to be the single largest contributor to global GDP growth in recent years. In USD terms, China’s economy became the largest contributor to global growth in 2007 and has maintained that position ever since (Chart 2).
China is also the world’s second largest importer of goods and services, making it a big source of global demand.
As Chart 2 shows, IMF forecasts suggest that China’s GDP growth could slow (in percentage terms) over the coming years and that US growth could pick up, but it still expects China to be the single largest contributor to global GDP growth in USD terms over the coming five years.
China is still set to contribute significantly more to global GDP growth than India, despite an expected pick-up in growth in that economy (to faster percentage change rates than in China). As Chart 2 also shows, despite slower growth in China, it is still expected to contribute far more to global GDP than the other Asian economies put together.
China’s growth is shifting. Of course, the nature of China’s growth is also changing.
As China develops, it is becoming less driven by its manufactured exports sector and infrastructure and housing investment and more consumer-driven. Although China will remain a big exporter and its continued urbanisation means there is still significant infrastructure investment needed, more growth is now starting to come from China’s services sectors.
As HSBC’s China economists have recently pointed out, this long-term trend of rebalancing towards services has been underway for quite some time and is unsurprising.
The tertiary industries (services) overtook the secondary industries (manufacturing, construction and utilities) as a larger share of growth and of GDP in 2012 (Chart 3). The tertiary industry accounted for 51% of China’s economy in the first three quarters of 2015, while the secondary industry accounted for 43%.
China’s recent Fifth Plenum, which included a significant focus on the 13th Five-Year Plan (2016-2020), saw policymakers set economic growth as a top priority. Policymakers reiterated the goal of “doubling GDP and people’s income by 2020”, which implies a minimum growth rate of around 6.5% a year over the next five years.
At the same time, the leadership has made it clear that China is entering the ‘new normal’ of slower growth. It is clear that China’s traditional comparative advantages of cheap labour costs and intensive resource inputs is weakening, so new growth drivers are needed.
Besides, an economy as large as China’s cannot be as driven by exports as a smaller economy as there aren’t enough other markets to drive continued rapid growth. China already dominates most of the major traded markets and is already the largest or second largest trading partner for over 50 countries.
The plenum saw the authorities emphasise necessary development in a number of key areas.
Perhaps the most significant announcement was the removal of the one-child policy. Every married couple will now be allowed to have two children. How much this will add to population growth is uncertain, but it is a logical step to take in addressing China’s rapidly-aging population.
In addition, it was announced that China’s social security programme will be extended to cover all elderly people. This should improve quality of life in retirement, as well as raise the spending power of the elderly. It may also have implications for China’s very high saving rate. Workers may not feel the need to save as much, which would have a positive impact on consumption.
Economic rebalancing and reform remain key priorities, of course. The Fifth Plenum communique included commitments to "significantly raise" consumption’s contribution to growth, as well as fostering "better allocation of resources". This is likely to include reform of
China’s state-owned enterprises. The State Council published guidelines for SOE reform on 11 September, aiming to bring more market forces into SOE management and improve efficiency. It is also likely that there will be moves toward evaluating local government officials based not on generating growth but on provision of public services and on environmental outcomes.
China’s shift has contributed to falls in commodity prices.
A consequence of the slowdown in construction in China has been weaker demand for hard commodities. The housing downturn has been a particular drag on commodity demand as dwelling construction in China, which has largely used ‘reinforced concrete’, is highly commodity-intensive.
At the same time, global commodity supply has ramped up, following a long period of significant investment. The combination of weaker commodity demand and rising commodity supply has resulted in a sharp decline in commodity prices (Chart 4).
While commodity demand has weakened, as investment growth has slowed, demand for consumer goods and services is picking up. Rising wages may take away some of the comparative advantage of cheap labour but they support growth in consumer demand. In China’s case this is a significant global event given China’s population and the economy’s size.
As has typically been the case when other economies have developed, rising middle-class incomes also drive a shift in consumer spending preferences.
As Karen Ward and Fred Neumann noted in Consumer in 2050: The rise of the EM middle class, October 2012, the average Chinese worker’s income is expected to increase seven-fold by 2050.
As a result, the number of Chinese upper middle class – that is, people with incomes from USD5,000-15,000 per year (in constant 2000 USD) – is projected to grow from 135m people in 2011 to 509m in 2050. The number of people classed as upper income (income over USD15,000) is expected to increase to 637m in 2050, from effectively zero in 2011. These are big numbers.
As consumer incomes rise, preferences also shift.
This becomes particularly pronounced when a country moves through the middle-income stages, at which point consumer spending grows rapidly and patterns of consumption undergo significant changes. Up until this point of economic development, households have little income left over after paying for the necessities. Then a threshold is passed after which disposable income and consumption start to grow rapidly. This stage is precisely where China is at the moment.
Typically, as countries’ incomes rise towards upper middle class levels and higher, consumption of more discretionary goods and services see particularly strong growth. HSBC projects that consumption in China will grow at a CAGR of 7.8% for recreational activities, 7.4% for restaurants and hotels, 7.3% for housing and energy and 6.4% for health between 2010 and 2050.
By contrast, food consumption is projected to grow at only 2.2% annually. However, this also masks a significant likely shift in the kinds of food that will be eaten. As incomes rise, countries typically see greater consumption of meat, fish, and dairy, whilst non-protein staples such as cereals and vegetables play a smaller role in meeting calorific needs (Chart 5).
China’s outward investment focus
A key strategy for Chinese policymakers is to encourage Chinese companies to invest abroad. An outward investment focus has been a part of China’s ‘going out’ strategy which has been in place since 1999. As China has been seeking to rapidly open up its financial system, part of the plan has been to boost overseas direct investment (ODI) significantly.
Chinese companies are increasingly buying real assets abroad, such as technology, brands and resources. Chinese ODI totalled USD140bn in 2014. As we discuss below, Australia is already the second largest recipient of Chinese ODI, behind the US.
Beijing’s ‘New Silk Road’ initiative (launched in 2013) should also help to strengthen investment and trade connectivity between China and its neighbouring countries and is expected to be a key driver of ODI in 2015 and beyond.
This strategy is encouraging the signing of trade and investment agreements with a range of trading partners and supporting the addition of major infrastructure, such as railways, highways, communications networks, and port logistics systems capacity in foreign countries.
A range of financial initiatives have also been undertaken to underpin these strategies, including establishing the Asian Infrastructure Investment Bank (AIIB) in late 2014, of which Australia is a founding member.
As a result of these initiatives and the further liberalisation of the Chinese financial system HSBC expects Chinese ODI to grow by around 20% a year, with China set to overtake the US as the world’s largest ODI investor in years ahead (see Qu Hongbin et al’s China Inside Out: Time to go shopping, 10 February and China Inside Out: Capital account reforms: From people’s bank to people’s hands , 2 November).
Australia’s ties to China have underpinned its growth
Australia has been a key beneficiary of China’s rapid emergence, particularly in the post-global financial crisis period. Australia was the only OECD country that did not see a technical recession during the global financial crisis.
Indeed, Australia is now in its 25th year of continuous GDP growth. A key reason for this has been its strong links to China. China is Australia’s largest trading partner, with AUD153bn of bilateral trade in 2014. China now accounts for 32% of Australia’s merchandise exports, up from only 5% at the turn of the century (Chart 6). Of the OECD economies, Australia has the single largest share of its exports destined for Asia.
In the past seven years, Australia’s economy has grown 20%. By comparison the US economy is only 10% larger, the UK’s is 5% larger and the euro area economy is the same size, having only recently just got back to its early-2008 level of output. Over the same period, China’s economy has grown by over 80%.
Even comparing Australia to other commodity producers paints a fairly positive picture. Over the past seven years, Brazil grew 13%, Russia grew 2%, while South Africa’s economy expanded 13% and Canada is 11% larger.
These economies have, however, seen weaker conditions recently. Brazil and Russia are in deep recessions and Canada and South Africa have recently had contractions in GDP. Australia’s strong ties to Asia and to China, in particular, have been a key support for local growth.
Australia’s export-weighted major trading partner GDP, largely in emerging Asia, grew far more quickly in the post-global financial crisis period (2009-2014) than the advanced economies, which has helped to support Australia’s growth (Chart 7).
Australia’s growing ties to China have been a major contributor to this growth. Although growth in Australia’s major trading partner GDP is slowing down, these economies are still expected to significantly outpace the advanced economies with Asia still expected to be the fastest-growing region in the world over the coming five years.
PAUL BLOXHAM IS CHIEF ECONOMIST (AUSTRALIA AND NEW ZEALAND) FOR HSBC.