Inside the dynamo
Published: 19 May 2008
While China's manufacturing muscle has become a critical factor in the industries of the developed world, the country has also become a driving force behind many of the world's developing markets. Today's China is key to any discussion on global trade and emerging markets.
Qu Hongbin, HSBC's Chief Economist for China, has been an economist in the financial markets for over a decade, and has followed the China market for HSBC since 2002. He also spent eight years as a senior manager for Bank of China and other institutions in China.
Global Banking and Markets Editorial Director Neil Taylor spoke to Mr Qu about the reasons for his confidence in the China market.
How do you view the outlook for investment in China?
We're very bullish and confident about China's long-term outlook. We believe China's economy will continue to grow at around 8-9 per cent per year for the next decade, mainly because of three or four factors that will continue to drive growth:
Firstly, there's China's market-oriented reforms. The continued process of market-oriented reforms has increased productivity and been a major factor in the past 25 years of China's economic growth.
Going forward, the major areas for growth will include financial services, telecommunications, energy supply, transport, and reforms will continue to be a positive factor for growth in those areas.
Secondly, you have structural factors. China's urbanisation and industrialisation processes are still in their early stages. Each year more than 10 million young people leave the countryside for better jobs in the cities.
The transition from traditional jobs in the countryside to modern, more productive jobs in the cities will continue to be a major driver for labour productivity.
China is already a major supplier of the world's consumer goods and capital goods. In the next ten years China will become a world leader in the provision of capital goods and equipment.
The third factor is globalisation. In the past five years, China has attracted more than USD60 billion of foreign direct investment every year. Every three minutes there is a new foreign joint venture factory set up in China.
China will continue to integrate itself into the global economy and this trend will also be a key factor to supply China's growth.
In summary, the engines are market-oriented reforms, urbanisation and globalisation.
How will China's economic growth be affected by the current turbulence in global financial markets?
The Chinese economy will experience some cyclical swings; for instance in the near-term, problems with the global economy will see China's own economic growth fall behind that of the last few years.
We also see signs of overheating and inflation in the market. China's consumer price index reached an 11-year high of over eight per cent in the first quarter. This is a clear sign that China in the near term has some inflationary problems and this will call for more tightening measures during 2008.
China will continue to keep its credit policy tight through measures such as raising foreign reserves and curbs on bank lending. At the same time, the economy is also facing the potential of external shocks to its growth because its integration with the global economy is deeper than it was a few years ago. Exports make up 36 per cent of GDP in gross terms, and eight per cent in net terms, so the US recession and the slowdown in the EU and Japan will inevitably slow export growth and hit China's GDP.
China is now so tightly integrated with international markets, how much control can policymakers exert over the economy?
We think 2008 will be a challenging year for policymakers in China.
They will face a dilemma of how to keep policies tight enough to contain inflation, but not too tight. They will try to achieve a balance this year, and this has been a challenge in the past.
They'll need to continue market reforms, and to use physical stimulus when necessary to mediate external shocks.
There will be some impact from the fall in overseas orders, so once exports slow, China is likely to increase its public spending and infrastructure development to cushion the slowdown.
In terms of growth, we're going to see a moderate slowdown, from 11.9 per cent last year to around 9.7 per cent this year. But the inflation rate this year is going to be higher simply because global food and energy prices will continue to keep rising. We think that China can still achieve high growth in this environment. This year we're a bit more cautious in the near term, we still see growth, but the country will experience a moderate slowdown rather than a hard landing. We're very optimistic about China's long-term growth potential.
Is inflation in China likely to prove a disincentive to foreign investors?
No. We have to understand the cost of raw materials, commodities prices and even labour costs are starting to rise, but we're still seeing the continuing influx of foreign investments.
China still has one of the best environments for global direct investment, and one reason for this is the country's consistent open door policy. They've been consistent about this policy for 30 years so foreign investors can be confident about investing in China.
Also there's the improving facilities and infrastructure, and despite the increased cost of labour, China still has huge rural labour resources that will continue to attract foreign investors.
You also have the economies of scale. When you have a huge domestic market like China, you can spread your cost base in a way that would be impossible to imagine in most western economies.
So you look at all the factors overall and I think China's still going to continue to be a major destination for global investment.
Are we likely to see a drop in investment from those companies manufacturing purely for export, for example to the US?
In today's world there's no clear difference between domestic and export markets. Most factories in China are catering to both domestic and international markets. Some companies which began in order to serve the domestic market now serve the export market as well, and vice-versa.
Take the telecom market for instance. Ten years ago, China's handset manufacturers were mostly working for the domestic market. Now most domestic handsets are produced for the export market. It's the same in the car industry. In three to five years, we'll see the foreign and Chinese joint ventures in China start to become important exporters of cars to the US and Europe.
Five years ago the most wanted items in Chinese urban households were PCs and DVD players. Now the most wanted items are cars and bigger houses. In five years' time we’ll see more demand for tourism, overseas travel and other services. The service sector will continue to expand.
China's domestic market will continue to expand - there’s no doubt about it. And going forward, it will keep growing fast as income and productivity continue to grow.
China is now a fully integrated part of the global market and any foreign investor must look at both the China market and the global market together.
China's integration with other emerging markets will grow deeper and deeper; not just regionally, but globally.
How do you see the role of China among emerging markets? Will emerging markets be able to help pick up the slack left by sluggish demand from developed economies?
We will continue to see increasing integration of trade and capital flows between China and other global emerging markets. This integration will be faster between emerging markets than between China and established markets.
Growth in developing markets is likely to continue in the next few years so China will have to increase its trade with other emerging markets in order to utilise the capacity they've developed.
At the same time if China wants to sustain its high growth rate they need to address the continued increase in demand for raw materials and energy. So China needs to establish a trade flow with other emerging markets to ensure it has access to a continued supply of raw materials.
China's trade surplus is likely stay for many years. Combined with FDI inflows, this means that the country needs to find ways to reinvest its trade dollars in global markets. China will continue to invest in new and emerging markets.
As a result China's integration with other emerging markets will grow deeper and deeper; not just regionally, but globally. The neighbouring countries will be first - Vietnam, South East Asia, India all have great potential but it's not just going to be linked to Asia. We will also see increased trade flows between China and the Middle East, Central Asia and Africa. Latin America is also a big market for Chinese products, and Latin America also has the energy and raw materials they need.
Over the past 30 years, China's globalisation has been mainly with the developed world, because China needed capital and technology. Today, the country needs to expand its investment to other emerging markets because China needs to open new markets for its established capacity. At the same time China needs additional sources for the raw materials and energy which the developed world cannot provide.
What other challenges will the Chinese economy face in the near future?
China does face potential challenges in the future. First of all would be the environment. In order to make their development path more sustainable, China should learn a lesson from the experience of other countries and learn that to grow first and then to clean up later would be more expensive than to start off by being clean - especially considering the population size in China.
There are those who say China cannot afford environmental controls because its population is much greater than those of other countries. However, we're in the 21st century and the technology is there, the clean technology is available already. The government needs to realise that it cannot just follow the mentality of GDP first and not be aware of the environmental cost.
The second challenge will be the energy and resources. If China continues to consume energy at its current level, for every dollar they produce, in 15 years time China will have consumed all the world's oil, so China cannot continue to consume at the current level. They must reduce the waste in the energy sector and in industry, for instance in the construction industry, where China lags far behind international standards in energy conservation.
The government needs to liberalise the price of energy, because energy prices are still politically in government control. They must pass the cost of energy on to the users in order to cut waste and to help cool economic growth and inflation.
Thirdly, China faces widening income inequality. The income gap between the coastal and inland regions and between the cities versus the rural areas is continuing to grow.
So the government needs to use fiscal policies to narrow the gap, to encourage more people to move from the interior regions to the cities.
And more importantly, China must continue to push forward financial system reforms so that capital can be allocated to productive users, especially the private small- and medium-sized enterprises that can generate jobs for the rural labour force.
Profile
Qu Hongbin is HSBC's Chief Economist for China. He has been at HSBC since 2002, and has worked in the financial markets for 15 years. Mr Qu also worked as a senior manager at Bank of China and other Chinese institutions.
He is a regular economics commentator on television and radio, and his views are often quoted by The Wall Street Journal, Reuters, Shanghai Securities Daily and other Chinese and international media.
Mr Qu got his first degree in Engineering from Northwest University of China and a postgraduate degree in Economics from the University of Glasgow in the UK.
His recent published research works include: Riding on China's recovery, From the Horse's Mouth and China's stimulus works.
To read the full report, go to the Global Research website and log on using your e-mail address and password. You will find the report using the filter by author.
If you are a first-time user, please contact your HSBC relationship manager to arrange access to the site.
The new centre of the world
Today's China is generating enough economic activity both to drive neighbouring emerging markets and to buoy developed economies during the current slowdown. In a series of special reports, we show how HSBC is serving as a bridge to the rest of the world for this emerging giant.
Global Research
HSBC Global Research, a division of HSBC's Global Banking and Markets group, specialises in macroeconomic, currency, fixed-income, company and sector research. Click on the product links below or visit our website to view research.
Articles
Brazil
Chile
China
Egypt
Czech Republic
India
Indonesia
Mexico
Peru
Philippines
Poland
Russia
Taiwan
Thailand
Turkey
UAE
Vietnam
