13th Five-Year Plan and Its Implications For Business China’s Economic Development Strategy - 13th Five-Year Plan 1.0 Introduction to the Five-Year Plan 1.1 Innovation-Driven Development

DBS Group Research • October 2016DBS Asian Insights14n

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COUNTRY BRIEFING

Where’s China Headed? 13th Five-Year Plan and Its Implications For Business

DBS Asian Insights COUNTRY BRIEFING 1402

Where’s China Headed? 13th Five-Year Plan and Its Implications For Business

Authors:

David CARBONManaging DirectorChief Economist, Group [email protected]

Chien Yen GOHSenior Vice PresidentEditor-in-Chief, Asian Insights OfficeGroup Research [email protected]

Contributions from: Institutional Banking Group Global Transaction Services

Production and additional research by:Asian Insights Office • DBS Group Research

go.dbs.com/research @dbsinsights [email protected]

Chien Yen Goh Editor-in-ChiefJean Chua Managing EditorGeraldine Tan EditorMartin Tacchi Art Director


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Executive Summary

Where is China Headed?

China’s Economic Development Strategy - 13th Five-Year Plan

1.0 Introduction to the Five-Year Plan 1.1 Innovation-Driven Development

1.2 Green Development

1.3 Regional Development – The Economic Geography of the 13th FYP

1.4 New Urbanisation: City Clusters

1.5 Inclusive Development 1.6 SOE Reform – Getting to the Root of the Problem

1.7 Yuan Still on the Straight and Narrow 2.0 Plans Are Nothing; Planning is Everything

China’s 13th FYP: Implications for Businesses

1.0 The Need for Strategy2.0 Rise of Innovation and Higher Value Add3.0 A Land of Opportunities – Infrastructure

4.0 Rising Expectation for Companies’ Social and Environmental Responsibilities

5.0 Deepening Market Reform is Changing Business Environment For Companies6.0 Bigger Market – Doubling of GDP Per Capita

Postscript: Evidence of a Cyclical Bottom is Mounting


t is no hyperbole to describe China’s economy in superlative terms. It is after all, the world’s most populous nation, second largest economy and the biggest trader of merchandise goods and exporter of financial capital.

Needless to say, China plays an important and influential role in the global economy. Not too long ago, it more or less propped up global demand when the developed economies of the US and EU faltered in the aftermath of the global financial crisis. More recently, the yuan is made part of the IMF’s special drawing rights, affirming somewhat belatedly its de facto status as an international currency. The familiar marketplace adage: “When America sneezes, the world catches a cold” will be increasingly true of China too.

Hence, the ongoing economic slowdown in China, after a protracted run of heady growth, is cause for concern. The ramifications are felt around the world. Global news headlines talk of falling sales to China from Chilean copper to German cars and Italian luxury products. The fallout from a slower China would be even more pronounced in Asia, given the strong inter-regional trade and production linkages. From advanced manufacturing countries such as Korea to commodity exporters such as Indonesia, the impact will vary, but they will all be affected.

Within China, this “new normal” of slower growth is formally acknowledged and has been codified in the government’s most elaborate policy document to date – the 13th Five-Year Plan – as the new baseline growth target of 6.5% for its economy from now to 2020. Notably, if this were achieved, real GDP per head will be doubled from 2010 levels, realising the FYP’s broader goal of getting China to be a “moderately prosperous society.”

For some, this is still overly optimistic and the official growth target belies fundamental problems with the Chinese economy. They argue the decline will be steeper and longer.

The structural challenges confronting the Chinese economy are not lost on its leaders. The need to rebalance the economy to one driven more by consumption and services rather than state-led investment has been recognised for some time and is duly reflected in the 13th FYP. Other problems associated with decades of rapid growth such as environmental pollution, rising inequality and low productivity are also dealt with in the FYP.

Executive Summary

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However, the 13th FYP is not just about fixing bugbears, it is far more ambitious. At its heart, it has pulled together several major policy strands, to reinforce ongoing efforts aimed at transforming the very nature of its economic system. China will literally see a transformed economic landscape with synergistic urban agglomerations under its “new urbanisation” strategy and a materially more advanced and connected interior via the Yangtze River Economic Belt. From being the factory of the world it aspires to become a global manufacturing power through “indigenous innovation” and to do so in an environmentally sustainable manner as it seeks to usher in a low carbon economy.

So, quite apart from the slowdown, the impact and implications of China’s deep structural transformation will be far more widespread and profound. In this new normal of China’s development, businesses will have to rethink their China strategies. Economies and businesses that have benefitted previously from its stellar growth, can continue to do so, if they are able to adapt quickly to these emerging realities.

aybe people think China is still headed south. They’ve worried for four years now about a hard landing. Does one still lurk? Wouldn’t appear so. In any event, a hard landing now would have to be the softest one in history, wouldn’t it?

Cyclically, China is probably still slowing, and that could continue for another year or two. If it is still slowing, it hardly comes as a surprise. The government cut investment very sharply several years ago and private consumption – the chosen (but unlikely) driver of future growth – was never going to take up the slack in the short run. The economy was always going to slow a little more than the government had hoped. The government was always going to have to ante up a bit of stimulus.

This is cyclical hoopla – no more, no less, and mostly irrelevant in the broader scheme of things. Cycles occur in all countries; always have, always will. What matters is not whether the manufacturing sector purchasing managers index (PMI) drops by another tenth of a point this month. In five years’ time, today’s cyclical drop will be but a blip on an upward-sloping line of structural growth. At least that’s the hope.

Plainly, what matters is whether that upward-sloping line of structural growth continues to move northward or takes a right turn to the east. The latter is what matters to global growth; it is the risk to the global economy. The latter is what markets and analysts and media and investors should all be paying attention to. And it all hinges on whether the government is effectively pursuing the reforms necessary to keep long-term growth as strong as it can possibly be. Is it?

The record is spotty. For the past two years, most of the effort has been placed on the internationalisation of the yuan and opening up of the capital account. By most accounts, these reforms have been implemented much more quickly than most imagined five years ago. And the fact that capital has flowed out of China over the past year neither surprises nor makes this reform any less successful. Open means open. If some capital moves out after being locked up for 65 years, it’s not a bad thing. Moreover, to the extent outflows force officials to pursue consistent, sustainable policies, that’s an additional plus.


Where is China Headed?*

MStill Slowing, But No

Surprise

A Mixed Bag

Reforms, Reforms, Reforms

Elsewhere, progress has been less impressive. “Hukou” (migration / residency) reform is running slowly although in fairness, migration / urbanisation is among the most complex and risky reforms on the table. Western investors would also like to see faster closure of state-owned enterprises and reduction of excess capacity. But the government has never claimed to be in a hurry on this score because the higher unemployment implied by plant closures is another problem in and of itself. While slow, few would argue that progress is not being made.

A goods and services tax (GST) was expanded to the construction, real estate, financial, and consumer services industries starting May 1. China’s GST/value-added taxes will go a long way towards putting fiscal policy on par with that of developed countries. Income tax is notoriously hard to monitor and collect in less-developed countries and the GST will provide a stable and efficient source of revenue for the government. The government has also announced deeper regulation and reform of the shadow banking sector. Capital adequacy ratios are being raised and tougher definitions of risk assets are being employed.

In short, things are moving in the right direction. One always wishes reform and structural change happened more quickly but these longings aren’t limited to China. They apply to the rest of the world too, probably more so. When push comes to shove, is any other country in the world pursuing reform and structural change more than China is today? The US isn’t. Europe isn’t. Japan isn’t. Only China seems to be eating the bitter medicine necessary to ensure that growth doesn’t fall more than it inevitably will.


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* Excerpted from David Carbon, ‘Where Lies North’ in Economics Markets Strategy - 3Q 2016. DBS Group Research, June 9 2016

Right Signals

Reform Is Tough

Introduction to the Five-Year Plan

Largely modelled on the Soviet Union’s five-year plans, China’s version of the plan revolves around strategies, growth priorities, and guidelines for industry that are geared towards medium- and long-term economic objectives. Since the first plan in 1953, China’s government has refined its economic thinking in each subsequent iteration, transforming the target-based system to one that focuses on more holistic development. While some targets have been dropped along the way; the success or failure of officials depends upon their ability to achieve these targets.

China formally adopted the 13th FYP (2016-2020) on March 14, 2016 – approved by the National People’s Congress – although much of the plan had been announced during the Chinese Communist Party’s Fifth Plenum in October 2015. This was after a long drafting process led by the National Development and Reform Commission with contributions from all ministries, as well as provinces, academics, and industrial associations. The ministries and local governments then filed their own five-year plans that align with the national strategy.

At the heart of the 13th FYP (2016-2020) is China’s ambition to become a “moderately prosperous society”1, a goal that the country hopes to achieve by 2020. This means that GDP per capita will double by 2020 from 2010’s number and absolute poverty will be a thing of the past. Achieving these ‘centennial goals’2 by 2020 – the official deadline to demonstrate results in many of the country’s economic and social plans – will give credence to President Xi Jinping’s long-term ‘China dream’ of national revival.

While the final economic destination has not changed, the journey to get there and circumstances have. And the latest blueprint, which is also Chinese President Xi Jinping’s first, attempts to steer the country through this “new normal” terrain with a set of economic priorities and a development paradigm that is consistent with where China is today. In many respects, the 13th FYP is a mirror to Xi’s development thinking3 and a collation of existing key policies and ongoing reform agendas into an overarching master blueprint.


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China’s Economic Development Strategy - 13th Five-Year Plan

Target 2020

1.0

Xi’s Grand Plan

1. Phrase first coined by Deng Xiaoping in 1979. 2. A highlight of the 100th anniversary of the Chinese Communist Party in 20213. Xi was intimately involved in the drafting of the 13th FYP. Amongst other things, China watchers point to the fact that it was him rather than the

Premier who typically delivers the draft at the fifth plenum. See Lance Gore, “Xi Jinping’s Five-Year Plan”. EAI Bulletin Vol17 No.2 Nov 2025. East Asia Institute, National University of Singapore and Scott Kennedy and Christopher K Johnson, Perfecting China Inc – The 13th Five-Year Plan, May 2016. Center for Strategic and International Studies

Most media reports picked up on the official embrace of a lower GDP growth rate of 6.5% per annum from now to 2020, versus the annualised 7.8% over the last five years covered by the 12th FYP. For some pundits4, this is a cause for concern, seeing this as a sign of risk rather than of bullish confidence that may compound the excesses that already plague the Chinese economy.

This target however is a concession by the Chinese leadership that the country’s economy is decelerating; they need to keep the growth engine chugging along at a “medium high” pace to achieve their objectives of doubling incomes, maintaining social stability via relatively full employment, and having enough leeway to shift the economy away from investment-driven growth to one led by consumption, services, and advanced technology.

And it is this motivation that course through the 80-chapters plan. The emphasis on quality rather than the quantum of China’s growth is clear. It paints an economy that is socially more inclusive, geographically more evenly developed and on the whole environmentally sustainable5. There are by far, more quantitative targets set for improving the environment and expanding social welfare than economic growth.

It hopes to lift over 55 million people out of poverty; build 20 more million units of affordable housing; and increase old age pension coverage to 90%. Even more impressive are the ‘binding’ targets set for the environment. The “green development” goals are higher, more detailed and cover a wide range of hot button issues from improving water and air quality, to limits for discharge of pollutants, to increasing forest coverage6.

Innovation-Driven Development

By no means, however, is the plan to be defined solely by making the outcomes of growth more palatable. At the core, is a concerted effort to establish and entrench “new” and “powerful” drivers of growth, where the innovation agenda takes centre-stage.7

Premier Li Keqiang in his speech to the 12th National People’s Congress makes clear, “innovation is the primary driving force for development and must occupy a central place in China’s development strategy…our goal is that by 2020, advanced manufacturing, modern services, and strategic emerging industries as a proportion of GDP will have risen significantly…. and the contribution of scientific and technological advances toward economic growth should come to reach 60%.”8

One aspect of what this means that the country will adopt ‘priority’ technologies such as the “Internet of things”, “big data”, smart manufacturing, in order to definitively


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1.1

Quality, Not Quantity

6.5%: Too High, Too Low?

4. The Economist Intelligence Unit, EIU China country summary page growth forecast of 5.8% See also Nicholas Consonery, “Wall Street, Financial Markets and the 13th FYP,” in State and the Market in Contemporary China – Towards the 13th Five-Year Plan, Scott Kennedy (Ed). Center for Strategic and International Studies. March 2016.

5. See statement by Cai Fang, Vice President of the Chinese Academy of Social SciencesASS, and Member of the Advisory Board of the 13th FYP on the National Economic and Social Development of China, cited in report on China’s 13th FYP – Priorities, Goals and Opportunities by Friends of Europe. Winter 2016. See Dr Wendy Hong, Denise Cheung, and David Sit, “China’s 13th FYP – Redefining China’s Development Paradigm Under the New Normal,” Nov 2015. China’s Policy Think Piece Issue No. 3. Fung Business Intelligence Centre. Scott Kennedy and Christopher K Johnson, Perfecting China Inc – The 13th Five-year Plan, May 2016. Center for Strategic and International Studies. Pg 20

advanced material research, and push China up the production value chain in several key sectors. There are approximately 75 priority technologies, more than the 57 highlighted in the 12th FYP.9 And these 75 technology areas contain subsets of more specific technologies and products. The innovation agenda of the 13th FYP incorporates other technology-related initiatives, among them the Strategic Emerging Industries, Sci-Tech Innovation 2030, Internet Plus, and Made in China 2025.

Billions of yuan – or 2.5% of GDP10 – has been earmarked to fund scientific and technological research and development, specifically on “building science and technology programs, build first-class national science centres and technological innovation hubs, and help develop internationally competitive high-innovation enterprises”11. The investment will bring China’s R&D spending in line with other OECD countries’, and top the league in terms of absolute amount. It hopes to see major breakthroughs, and concretely in the FYP a doubling of patents per 10,000 people from 6.3 to 12 by 2020.

Unlike the technological push under the previous FYP, this innovation-driven development will be broad-based and encompass all aspects of economic activities aim at “improving the overall quality and competitiveness of the real economy”12.

To unleash this creative energy and mobilise the “whole country’s potential for starting businesses and making innovations”, Li promised active state support which include: “tax relief for R&D and corporate incubators; setting up of development zones devoted to high-tech


Source: China’s State Council

Diagram 1. SEIs versus Made in China 2025’s ten key industries versus Circular Economy

SEI Made in China 2025 Circular Economy

1 Energy Saving & Environmental Protection Energy Saving & Clean-Energy Vehicles Coal

2 New Energy Power Equipment Power

3 Biotechnology Biomedical & High-Performance Medical Devices Steel

4 New Materials New Materials Textile

5 Next-Generation IT Next-Generation IT Non-ferrous Metals

6 Clean-Energy Vehicles Advanced Rail Transportation Equipment Petroleum & Petrochemicals

7 High-end Manufacturing Advanced CNC Machine Tools & Robots Chemicals

8 Agricultural Machinery Food

9 Aerospace Equipment Building Materials

10 Marine Engineering Equipment & High-Tech Shipping

Paper

6. See targets in the 13th FYP7. More pages and chapters are dedicated to this theme of innovation driven development than others in the plan itself. 8. Li Keqiang, supra n.3 pg 10 9. Scott Kennedy and Christopher K Johnson, supra n.4. for an in-depth analysis see also Tai Ming Cheung et al., Planning for Innovation --

Understanding China’s Plans for Technological, Energy, Industrial and Defense Development: A report prepared for the US-China Economic and Security Review Commission. Institute of Global Conflict and Cooperation, University of California. 2016

10. Li Keqiang, supra n.3 pg 1011. Li Keqiang, supra n.3

development as a showcase for innovations, and encouraging technopreneurship by funding ventures, creating a service sector that supports them; attracting foreign talent; protecting intellectual property; and offering tax incentives for profit sharing and stock options.”13

Ultimately not just the economy but social values will be changed to “create an enabling environment for innovation in which people venture to break new ground and failure is tolerated”14.

Made in China 2025

The strategy of being a labour-intensive, low-cost manufacturing base for the world has served its purpose and ran its course. As China levels up economically, so have wages, at a juncture when working age population growth has turned negative. Productivity has also not kept pace. Chinese companies are operating at 15-30% the OECD average.15

Invariably, China faces competition from cheaper producers in neighbouring emerging markets on the one hand and more efficient manufacturers of advanced economies on the other.

To be sure, China has become a savvier and upmarket producer over the last two decades of its development. The changing composition of its export basket reveals China’s gradual shift from labour-intensive products since the 1990s.16

More sophisticated products such as machinery and transport equipment now make up about 46% of its exports today from 21% in 1995.17

But this may not be happening fast enough. High-tech production accounts for only about 12% of the country’s industrial production activities.18

And while industries such as autos, computers, and medical equipment contribute to one-tenth of China’s GDP, the profitability of Chinese firms in these sectors tends to be about one-third that of global leaders19 because they operate at the lower end of the value chain.


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SEI Made in China 2025 Circular Economy

1 Energy Saving & Environmental Protection Energy Saving & Clean-Energy Vehicles Coal

2 New Energy Power Equipment Power

3 Biotechnology Biomedical & High-Performance Medical Devices Steel

4 New Materials New Materials Textile

5 Next-Generation IT Next-Generation IT Non-ferrous Metals

6 Clean-Energy Vehicles Advanced Rail Transportation Equipment Petroleum & Petrochemicals

7 High-end Manufacturing Advanced CNC Machine Tools & Robots Chemicals

8 Agricultural Machinery Food

9 Aerospace Equipment Building Materials

10 Marine Engineering Equipment & High-Tech Shipping

Paper

12. Li Keqiang, supra n.3 13. Ibid, pg 19-2014. ibid15. China’s Choice: Capturing the $5 Trillion Productivity Opportunity. McKinsey Global Institute. June 2016, pg 4716. IMF, Regional and Economic Outlook: Asia and the Pacific. International Monetary Fund, April 2016. Pg 9017. HSBC18. HKTDC Research, “China’s 13th Five-Year Plan: The Challenges and Opportunities of Made in China 2025”. HKTDC Research,27 May 2016.19. China’s Choice: Capturing the $5 Trillion Productivity Opportunity. McKinsey Global Institute. June 2016

1.1.1

China continues to import key parts and components for its high-tech manufacturing. Even in the semiconductor space, where China dominates global sales, it imports more than 90% of the chips it uses.20

According to World Bank economist, Karlis Smits, “As you become richer, you move up the value chain and you expect low-end manufacturing to move “But the data shows this is not happening [in China] nearly as much as you’d expect”.21

In short, China needs to up the ante and upgrade its manufacturing industry and do so quickly.

This is not lost on Chinese policy makers. Inspired by the Germany’s Industry 4.0 plan, the Ministry of Industry and Information Technology formulated its own “Made in China 2025” playbook, with inputs from 150 experts from the Chinese Academy of Engineering.

The plan was formally adopted in 2015, after two and half years of deliberations and more explicitly embraced in the recent 13th FYP, making “Made in China 2025” a key blueprint in the roll-out of China’s new innovation-driven development paradigm spelt out in the FYP.22

Under the previous administration, China’s ascent up the technological ladder was focused on building capacity in leading-edge advanced technologies.

“Made in China 2025” is more down to earth but no less ambitious. It plans to overhaul the entire manufacturing process down to the design and branding of products and is not confined to technological innovations. It promotes the development of not only advanced industries, but traditional industries and modern services as well. And while state direction is still overt, more room for market mechanisms and private sector participation is clearly recognised. Progress in “Made in China” is also made more transparent and accountable by adopting measureable milestones, benchmarks, and targets.23

In a nutshell, “Made in China 2025” attempts to comprehensively upgrade Chinese industry, making it more efficient and integrated in order to “elevate China’s position in the global industrial division of labour and value chain”.24

Please see Annex 1 for more details on Made in China 2025


20. Ibid, pg 7221. “China is Changing its Manufacturing Strategy”, Wall Street Journal. 7 June 201622. See 13th FYP23. “Made in China 2025” by See CSIS, Scott Kennedy, Center for Strategic and International Studies. June 201524. “Made in China 2025


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Green Development

This has been described as China’s greenest FYP yet. Ten out of the 25 priority targets in the plan are related to the environment and they are all “binding” rather than “predictive” targets, which means that they must be achieved by 2020 For the first time, a “binding” target for the reduction of the controversial PM 2.5 levels of air pollution is also included.25

Most of the 13th FYP’s energy and environment measures are taken from the Energy Development Strategy Action Plan 2014-2020, and the Environment Protection Law (2015) although China’s subsequent adoption of more demanding goals (its Intended Nationally Determined Contribution to COP 21) raised some targets from the 2014 master plan. The Environment Protection Law gives greater authority to environment officials to impose heavier fines and close down polluting plants.26

According to the 13th FYP’s targets, China’s energy consumption and carbon emissions per unit of GDP (carbon intensity) are to be cut by 15% and 18%, respectively. A national emissions trading scheme is to be introduced in 2017 and a Green Development Fund is to be established to help finance industrial upgrades.

With China’s new target for an 18% reduction in carbon-intensity from 2015 levels, it has been estimated that China will actually reduce its carbon intensity 48% from 2005 levels by 2020, exceeding its original target of a 40-45% reduction by that year. It will also be a first step toward achieving its Paris Agreement pledge to reduce carbon intensity 60-65% by 2030.27

25. Chinese authorities once objected to the PM2.5 air quality monitoring system planted on top of the US embassy. 26. The Economist Corporate Network, China’s 13th Five-Year Plan: Opportunities for Finnish Companies.27. “5 Questions: What Does China’s New Five-Year Plan Mean for Climate Action?” by Geoffrey Henderson, Ranping Song and Paul Joffe - March

18, 2016. World Resources Institute

1.2


Overall, the country will cut its reliance on coal and promote clean energy, notably through commitments to nuclear energy (58 GW by 2020, with an additional 30 GW under construction). During the course of the 13th FYP, this will mean between six and eight nuclear reactors are to be commissioned each year. Wind capacity will be expanded to 250 GW, and solar energy to 150 GW by 2020. The 13th FYP also includes a reduced logging quota (6.3% reduced) for domestic timber, and expands the ban on commercial logging in the northeastern provinces to all natural forests by 2017. Wood imports from Southeast Asia, Africa, and Russia are likely to fill the gaps.28

Management of China’s water resources is to be strengthened through a national conservation plan, with quota-based management for industrial and household water use in China’s arid provinces, while water recycling and water efficiency labelling are to be introduced. Sewage and solid waste treatment in industrial parks, cities and rural areas is to be upgraded and monitored, and a green tax system will be set up.

All in all, this is a “big shift in how China is thinking about its economy, as the 13th FYP “attempt[s] to decouple economic growth from energy consumption”.29

28. EIU. See also United Nations Development Program (UNDP) Issue Brief No15 on China’s 13th Five-Year Plan. April 2016 and DBS Vickers.29. Quote from Kate Gordon of the Paulson Institute reported in “China Unveils Vision of Greener Future in its Five-year Plan”, New Scientist March 2016

Cumulative carbon-intensity reductions are calculated based on the methodology articulated in the World Resources Institute’s working paper ‘Assessing Implementation of China’s Climate Policies in the 12th Five-Year Period’.

*2015 is calculated based on China’s announcement of achieving around 20% carbon-intensity reductions during the 12th Five-Year Plan.

**The percentage reduction of carbon intensity from 2005 levels by 2020 under the 13th Five-Year Plan is calculated from the plan’s target to reduce carbon intensity 18% from 2015 levels by 2020.

Diagram 2. China Sets Stronger 2020 Carbon Intensity Target

Reduction of China’s carbon intensity from 2005 levels

Source: World Resources Institute


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Source: Scott Kennedy and Xinhua

Environment and Resources

Reduction of major pollutants (%)

Chemical oxygen demand

Ammonia nitrate

Sulphur dioxide

Nitrogen oxide

-

-

-

-

[10]

[10]

[10]

[10]

Mandatory

Mandatory

Mandatory

Mandatory

Forest growthForest coverage (%)

Forest coverage (billion sq. metres)

23.04

16.5

[1.38]

[14]

Mandatory

Mandatory

Recently developed land (billion sq. metres)

Reduction of energy consumption/GDP (%)

Reduction of water consumption/10,000 yuan GDP (%)

Reduction of carbon dioxide emissions/GDP (%)

Cultivated land (billion sq. metres)

Non-fossil fuel/primary energy consumption (%)

-

-

-

-

1,243

15

[<21.7]

[15]

[23]

[18]

[0]

[3]

Mandatory

Mandatory

Mandatory

Mandatory

Mandatory

Mandatory

Air quality (%)

Days of good-moderate air quality in cities at and above the prefecture level

Decrease in PM2.5 concentration in cities at and above the prefecture level

76.7

-

>80

[18]

Mandatory

Mandatory

Surface water quality (%)Equal or better than Grade III water

Grade V water

>70

<5

-

-

Mandatory

Mandatory

Diagram 3. Green Development Targets in the 13th FYP

Regional Development – The Economic Geography of the 13th FYP The stark disparities between the booming Eastern coastal cities of China and her poorer inner regions are notorious.

Ongoing state efforts in addressing geographical imbalances through regional and rural development are given a hard push in the 13th FYP. Of the various initiatives mentioned, the spotlight is on the “Development of the Yangtze River Economic Belt (YREB)”, with a whole lengthy chapter dedicated to it in the FYP.30

Guided by the developmental tenets of innovation, social inclusion and sustainability, the plan speaks laudably of cleaning up the river and rehabilitating its ecology before how it would

30. Other government policies on the development of the YREB: Plan for the Three-dimensional Integrated Transport Corridor of the YREB (2014-2020), 2014; Plan for the Development of City Clusters in the Middle Reach of the YR (2014-2020), 2015; Policy Plan for Promoting Industrial Shift and Upgrading of the YREB though Innovation, 2016. State Council’s approval to the Plan for the Development of Chengdu-Chongqing City Cluster, 2016

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serve as a transport corridor linking up the area and play host to mid and high-end industries. This vision is not new and is well supported by other policies to develop the Yangtze River area.

Getting the YREB right, “is vital to China’s overall development.”31 The area after all spans some 2 million square kilometers, roughly 21% of the country and is home to 580 million people contributing to 46% of China’s GDP.32

The prioritisation of the YREB in the 13th FYP is all the more significant when seen in the context of other policies in particular the “Yangtze River Economic Belt innovation-driven industrial restructuring and upgrading program33,” issued about the same time as the FYP.

The programme is remarkably detailed; specifying where each of the “Strategic Emerging Industries”, top 10 emerging industries of the Made in China 2025 plan, and the top 5 priority industries, is to be organised along the upper, middle and lower reaches of the Yangtze River.

Diagram 4. Yangtze River Economic Belt

SICHUAN

Chengdu-Chongqing city cluster

City cluster in themiddle reaches ofthe Yangtze River

YUNNAN

GUIZHOU HUNANJIANGXI

ZHEJIANG

SHANGHAI

JIANGSU

ANHUI

HUBEI

CHONGQINGCity cluster in

the lowerreaches of theYangtze River

31. Yang Kai Zhong, Professor of regional economy at Peking University in “Economic Belt to Drive Development Westward, China Daily.” 29 April 201432. Figures cited by the National Development and Reform Commission (NDRC) and the Chinese Ministry of Transport33. Issued by the National Development and Reform Commission

Source: National Development and Reform Commission, Ministry of Transport, China Daily


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It also details the product focus and the type of enterprise for each of these industry clusters. Take for instance the next generation IT industry, one of the ten industries identified in the “Made in China 2025” initiative. Shanghai, Nanjing, Chengdu, Wuhan, Chongqing, Hangzhou and Guiyang would be the main drivers for these technologies such as IoT, big data and cloud computing.

For the aviation industry, the Chang-Zhu-Tan region, together with Anshun, Wuhu, Chongqing, Chengdu and Shanghai will become the centres for the design and building of aircrafts while Wuhan and Nanchinag will be focusing on aviation services.

The planners hope to see the YREB help in the process of technology transfer from coastal to inland regions, with differentiated industrial clustering around key urban centres in 11 provinces with the central Yunnan city cluster on the one end of the Yangtze and the Yangtze River Delta city cluster on the other.

New Urbanisation: City Clusters

Furthermore, the Yangtze River is a key plank in the government’s “two horizontals, three verticals”34 new urbanization strategy. The idea is to have large city clusters centered around the YREB, where cooperation and coordination between these urban agglomerations would create a synergistic regional economy.

As a matter of fact, city clusters35 are viewed in the plan as a primary driver of overall development across the country. Aside from those along the YREB, the plan also talks of the building world-class city clusters in the Beijing-Tianjin-Hebei36 (Jing Jin ji), Yangtze River delta, and Pearl River delta areas that would act as growth poles for their respective geographical regions.

City clusters will be at the heart of this new urban ecology supporting the development of smaller cities and towns to form thriving metropolitan areas and facilitate rural development. As a FYP target, 60% of the population should be living in urban areas by 202037 compared to roughly 56% today.

Cities themselves are also to be transformed to be green, wired to be smart, and generally to be more thoughtfully planned with adequate and appropriate urban infrastructure, so that they are “harmoniously livable” in the parlance of the 13th FYP. The controversial hukou system of social welfare will also be reformed to better serve rural migrant workers.

Consequently, the new urbanisation strategy would entail a tremendous amount of infrastructure spending for airports, sea ports, high speed trains, subways and expressways

34. The two horizontals: The continental land corridor and the The Yangtze River corridor. The three verticals: The coastal corridor; The Harbin-Beijing-Guangdon corridor and The Baotou-Kunming corridor

35. “City clusters” as they key spatial strategy is stressed in 4 chapters in the 13-5 Outline: • Chapter 33, Optimize the structure and layout of urbanization • Chapter 37, The comprehensive strategy for regional development • Chapter 38, Coordinated development of Beijing-Tianjin-Hebei • Chapter 49, Optimize the opening up strategy

36. The 13th FYP dedicates chapter 38 to the further development of the Beijing-Tianjin-Hebei city cluster. 37. See 13th FYP

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to tie the country together as regional municipalities are merged into megacity clusters of 100 million people or more.

Inclusive Development

A conscientious attempt to distribute the benefits of economic growth was a key theme of the previous 12th Five-Year Plan (2011-2015). Taking the notion of “inclusive growth” further in the current 13th FYP, the government seeks to ensure a more equitable provision of basic public services.

Notably, the FYP has made the alleviation of poverty a binding target, pledging to lift at least 56 million rural people above the national poverty line (defined as Rmb 2,300 in annual income) by 2020.

In addition, China’s household registration (hukou) system – long blamed for many social ills – will see further reform, and urban welfare services will be extended to all residents.

Other social welfare and development targets in the 13th FYP include the building of 20 million units of affordable housing, the extension of medical insurance coverage to 95% of its population and increasing the years of schooling. The plan even seeks to improve longevity metrics by adding an extra year to the current average lifespan of a Chinese (76.34).

38. “China’s 13th Five-year Plan: Infrastructure” complied by KWM, 14 April 2016

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• Constructing 3,000 km of new urban rail lines

• Expanding the high-speed rail network from 20,000 to 30,000 km, covering 80% of major cities

• Building or upgrading 20,000 km of rural roads

• Constructing and operating 30,000 km of new expressways – seven of which will start in Beijing, 11 which will go from north to south, and 18 of which will go from west to east

• Building more than 50 new civilian airports and upgrading airports in Harbin, Kunming, Urumqi, Shenzhen, Chongqing, Chengdu and Xi’an, so that they can become international hubs.

• Constructing 152,000 km of cement or bitumen roads in rural villages

• Investing over 800 billion yuan in railway construction and 1.65 trillion yuan in road construction

• Carrying out 20 water conservation projects38

Diagram 5. Infrastructure Investment in the Pipeline

SOE Reform – Getting to the Root of the Problem*

Overcapacity and its accompanying consequences are blamed on the country’s unprecedented credit boom in 2008, itself a response to the global financial crisis. The root cause of the glut can however be traced back further to a unique feature of the Chinese economy: the state-owned enterprise (SOE). Bloated and uncompetitive SOEs have been propped up for too long by local protectionism and overly easy access to credit via the state banks; they have been shielded from the true costs of doing business.

Sorting out the SOEs has therefore been a key element in China’s ongoing economic reforms and restructuring strategy. Attempts to do so in the past have waxed and waned. Xi, however, has made this a focus of his economic directives dubbed loosely as “supply-side reforms”.

To be sure, Xi is no Thatcherite, he firmly believes that state companies should remain a pillar of the Chinese economy. But he has also seen for himself first hand, as party chief of Shanghai, the economic benefits when state enterprises are able to transform themselves successfully to behave more like modern corporations. SAIC Motor, a big state auto company is a case in point. It eventually went public in 2012 and became one of the most profitable companies owned by the Shanghai city government.

Xi’s plans for the reform of SOEs can be summed up as thus: “using market discipline to improve SOE performance without relinquishing state control”.


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Diagram 6. Social Welfare Targets for 13th FYP

Social Welfare

Per capita disposable income (%) - >6.5 Predictive

Development of affordable housing in units (million) - [20] Mandatory

New urban jobs (million) - [>50] Predictive

Poverty alleviation in rural areas (million people) - [55.75] Mandatory

Coverage of urban basic old-age pension (%) 90 [8] Predictive

Average years of schooling for working-age population (years) 10.8 [0.57] Mandatory

Increase in average life expectancy (years) - [1] Predictive

Source: Scott and Xinhua

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To do so, SOEs will first be categorised into “for profit” and “welfare/public service”. Separating “for profit” SOEs from those providing welfare services will help remove resistance against restructuring efforts imposed on the former.

Second, the modern corporate system will be continually adopted to align shareholder and employee incentives. This includes delegating more powers to company boards, including the hiring of professional managers instead of rotating bureaucrats. Compensation will also be market-driven.

Third, the supervisory system of state assets will be changed. The State-Owned Assets Supervision and Administration Commission will focus on overseeing the management of these entities’ financial capital rather than their operations. Capital management investment companies will also be set up to ensure adequate returns on capital. SOEs will repatriate at least 30% of their earnings to the state to minimise the misallocation of funds.

Fourth, mixed-ownership for SOEs. We have seen innovative tie-ups recently, such as the tie-up between China Resources and Phoenix Healthcare. The introduction of private shareholders can bring in expertise and a greater emphasis on profitability.

Fifth, regulation will be strengthened to prevent the loss of state assets. This directive is aimed at preventing the kinds of setbacks which China experienced in previous attempts at reform.

Finally, the party’s leadership of the state-owned economy will be improved. We interpret this to mean that the state will remain a large shareholder in SOEs. Hence no full privatisation is on the cards. Yet, the party’s leadership will need to be improved to support reform directives. Please see Annex 2 for the summary of reforms

Yuan Still on the Straight and Narrow*

Despite the capital regulations imposed earlier in the year, China has not deviated from its long-term goal to globalise the yuan. This continues to be an explicitly stated objective in the 13th FYP. Concretely, their commitment is evidenced by recent efforts to liberalise its onshore bond market. According to a recent statement by the People’s Bank of China, investment quotas for

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* Alexander Lee Research Director, DBS Vickers

the Chinese Interbank Bond Market (CIBM) are now lifted for eligible foreign investors, who had been previously limited under its qualified investor schemes.

In addition to cash bonds, investors have also been granted permission to participate in onshore interest derivatives such as interest rate swaps, bond forwards, bond lending, and forward rate agreements.

Rules on cross-border remittances in yuan and foreign currencies have been further relaxed.

More encouraging to see is the growing acceptance of the yuan by the international community. The UK, for example, has made great strides in establishing yuan linkages and developing capabilities. As the second-largest offshore yuan centre, the UK handles 6.3% of global yuan payments. An estimated US$39 billion of yuan deals are conducted through London daily while 40% of all payments between the UK and China/Hong Kong are now made in yuan.

Australia is also adopting more yuan-denominated payments and striving to use the currency more frequently in finance. The Export Finance and Insurance Corporation, the Australian government’s risk agency, stated that Australia would eventually move into long-term export credit deals involving the yuan.

A third cross-border yuan connectivity programme between China and Singapore was recently launched. Under the Singapore-Chongqing connect program, corporations and individuals in Chongqing are allowed to undertake cross-border yuan transactions with financial institutions and corporations in Singapore. Chongqing-based companies can also issue yuan bonds in the city-state and repatriate the funds, whilst equity investment funds in Chongqing can make direct investments in Singapore and the ASEAN region.

Even Washington appears to be warming to the yuan. On top of establishing a clearing bank in New York, China and US are working towards creating a Working Group on US RMB Trading and Clearing to strengthen financial cooperation.

The overarching trend of yuan globalisation is clear and remains intact; the formal adoption of the yuan in the IMF’s SDR basket of currencies on October 1, 2016 affirms this.


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* Nathan Chow Economist, DBS Bank


“Plans Are Nothing; Planning is Everything”39

Foreseeably, the grandeur, ambition, and aspirations of the FYP has attracted its share of critics and doubters. Some see it as relic of Stalinist central planning, which at best, does not work and at worst end up impeding rather than advancing genuine economic development. Others see the plan as an expression of Kafkaesque bureaucratic processes that is largely irrelevant outside government circles40.

But this is to ignore the fact that the FYP has also evolved with the times. It is no longer a mandatory planning document, but one that offers guidance and provides coordination for implementing and evaluating policies. There is merit to the view that the FYP should be seen as a continuous cycle of policy making, and not an immutable set of instructions for the Chinese economy.41

Substantively, the FYP’s innovation agenda to deepen indigenous industries has attracted allegations of protectionism. Promoting national industrial champions may not lead anywhere42 and end up “cut[ting] China off from global innovation and markets”, cautioned former US Trade Representative, Robert Zoellick. He cited the “poor results” of a similar domestic strategy Japan had adopted for its telecoms sector.43

Several of the key projects highlighted in the plan would require serious cooperation between central and local governments. This may be tricky as local governments vie for funding, investments, and choice technologies. Its new urbanisation strategy and plans for regional development, could still lead to unsustainable competition among the local governments and ill-advised infrastructure overspending.44

For foreign observers, China’s resolve to deal decisively with the state-owned enterprise (SOE), is a bellwether for the government’s true appetite to address underlying risks to its economy and commitment to market fundamentals. In this regard, the 13th FYP disappoints. There is no talk of bankruptcy for unsuccessful SOEs in the FYP when Li has previously been more unequivocal, “no matter how painful, we must bring down the knife.” There are also no targets and timelines unlike other FYP priorities, only a repeat of what has been promised previously.

The seeming lack of political will around SOE reforms, coupled with Beijing’s intervention to stem capital outflows and short-selling of the yuan earlier in the year have called into question China’s reform credentials. There is concern that when the going gets tough, the government will soft-pedal the more ambitious and challenging reform promises in the FYP.

39. Quote from Dwight D. Eisenhower40. D.D. Wu, “How China’s FYP Benefits Different Interests”, in State and Market in Contemporary China: Towards the 13th FYP, Scott Kennedy (Ed). Center

for Strategic and International Studies. March 201641. Oliver Melton, “China’s Five-year planning system: Structure and significance of the 13th FYP”, ibid.42. Supra n. 4, pg 8.43. “The conflicting currents of Beijing’s five-year plan” by Robert Zoellick in Financial Times Opinion, May 20, 2016 44. Supra n.19

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Still, the response is not to dismiss the plan as made up of just “beautiful words” or “ghost words”; that is to throw the proverbial baby out with the bathwater. Even for the sceptics, the plan is potentially too important to ignore. Its impact, if it succeeds would be profound and far-reaching. The sober assessment of China’s challenges and the “new normal” refrain in the FYP demonstrate the acknowledgement that it is not business as usual, and the time has come to transform the very character of the world’s second-largest economy.

The Need for Strategy

There will hardly be any area of business activity that will not be touched and shaped by the 13th FYP, given its scope and ambition. How companies will be affected depends on where they are in the vast landscape of the plan.

Some will be adverse. The FYP’s innovation drive to promote more homegrown and sophisticated manufacturing capacity could spell trouble for companies that are benefiting from existing supply chains to China. For instance, China intends to wean itself off the reliance on imported semiconductors. Currently about 90% is imported. Its wants to be self-sufficient in this sector and targets to domestically supply 40% of the national market by 2020 and 70% by 2025.

Companies should also rethink their locational strategy as city clusters play a lead role in the FYP’s urbanisation and regional development blueprint. Take for instance, the potential connectivity between the Yangtze River Economic Belt and the “One Belt One Road” programme outlined in the FYP, which would accelerate the growth of China’s western inland cities. Chongqing would be established as a central node in the upper part of the Yangtze River stretching eastwards towards the coastal cities and serve as a logistics gateway in the Chongqing-Xinjiang-Europe Railway network.45

China’s 13th FYP clearly creates not only different prospects for different industries but also a diversity of strategic environments.46 Consequently, some businesses will have to restructure, others need to take advantage of enhanced manufacturing capacity, and others must seize fresh opportunities in new markets. In this new normal of China’s development, business will have to rethink their China strategies and adapt quickly to these emerging realities.

Rise of Innovation and Higher Value Add

The ten high-tech sectors that are specifically identified in the “Made in China 2025” template and reaffirmed in the FYP represents deep pools of opportunity. These sectors can see active


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45. Chongqing government’s “Policies on Implementing One Belt One Road National Strategy and Yangtze River Economic Belt Development Plan”46. Martin Reeves & David He, “What China’s FYP means for business?” Harvard Business Review, 7th Dec 2015.

China’s 13th FYP: Implications for Businesses

government support and funding. Even if there will be greater competition from Chinese companies and a ‘Buy Local’ push, foreign companies will still be needed to provide critical components, technology, and management for the FYP to work.

More broadly as China ascends the manufacturing value chain and upgrades its industries, its appetite for more sophisticated business processes and advanced technology will invariably grow.

Technological personnel, well-versed in foreign advanced technologies and proficient in using technologies developed to international standards, can provide mainland players with the necessary support in technological and management systems applications and solutions, and help promote commercialisation of the projects to meet the demand for technologies arising from the 13th FYP.47 Firms that align themselves with these sectors and the “innovation” goals of FYP can benefit from its focus.

A Land of Opportunities – Infrastructure

Realising the urbanisation and regional development initiatives outlined in the FYP will require a tremendous amount of infrastructure spending for airports, sea ports, bullet trains, subways, and expressways to tie the country together as regional municipalities are merged into megacity clusters of 100 million people or more.

Increased urbanisation and urban transit systems are already boosting business opportunities for suppliers of high speed and subway rolling stock, industrial automation, and signaling equipment. And as the government plans to expand the high-speed railway network from 19,000 km to 30,000 km by 2020 this market is enormous. Another transport-related wish list includes 50 new airports – these will likely include greenfield projects, extensions of existing facilities, or the conversion of military airports to civilian.48

Furthermore, as the scope of urban construction continues to expand in the mainland, infrastructure enterprises with full-service capabilities will be needed to satisfy demand for infrastructure and overall planning.

Rising Expectation For Companies’ Social and Environmental Responsibilities Companies operating in China will face stricter environmental regulations in order to achieve the green targets set in the FYP, such as on carbon emission and wastewater treatment.


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47. Wing Chu HKTDC Research | 8 Apr 2016 Opportunities Arising from China’s 13th Five-Year Plan: An Overview48. China’s 13th Five-year Plan: Infrastructure” complied by KWM, 14 April 2016

This is likely to increase compliance cost and necessitate investments in energy-efficient machinery, technologies, and production processes. However, the plan will also bring huge business opportunities in green industries, including renewable energy, fuel-efficient automobiles, environmentally-friendly materials, and recycling.

Pollution control and pollution amelioration products and services will be a strong focus of business development, particularly as pollution targets are now taken much more seriously by Chinese local officials (with their “binding targets” for carbon emission reductions) and enterprises, and as pollution taxes become more onerous.

The renewable energy sector has suffered from overcapacity problems in the past, particularly for domestic manufacturers of rudimentary models of solar panels and wind turbines, so the key emphasis for new market opportunities will be for higher-grade products. Water treatment and water conservation products will be in demand at both the large-scale city level and for rural use.

Deepening Market Reform is Changing Business Environment For CompaniesThe deregulation measures and the reforms of SOEs would permit private companies to enter most industries other than those related to national security such as banks, infrastructure, public services, new energies, telecom, and medical services etc. This would significantly boost the growth of the private sector.

The adoption of the negative-list approach in market access and pre-establishment national treatment system for foreign investment, more clearly defined boundaries between the government and the market, and expanding the proper rule of law such as protection for intellectual property would mean more investment opportunities as well as a more open, efficient, and transparent business environment for foreign investors.

Bigger Market – Doubling of GDP Per Capita

Despite the lower growth target, it is still very much the intention of the government to double GDP per capita by 2020 from 2010 levels. This will represent roughly a third of US incomes measured in PPP terms. Hence, the middle class will continue to grow and enjoy greater discretionary spending power. Chinese consumers themselves are generally optimistic that their incomes will increase significantly over the next five years, according to a recent consumer survey.49


49. Daniel Zipser, Yougang Chen and Fang Gong, The Modernization of the Chinese Consumer. Mckinsey & Company, March 2016

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As economies develop, the pace and pattern of consumption will change accordingly. The percentage of income spent on essentials such as food items will fall, while lifestyle-related expenditure such as that on transport, travel, and recreational activities will increase. The survey confirms these developments. The 50% surge in box office receipts in China is one clear sign of this shift. Chinese consumers are also trading up for more expensive items in the same categories. From rice to milk to cosmetics, the Chinese are switching to more premium products.50

Foreign companies selling to China will should pay attention this shift when formulating their business strategy.


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50. Yuval Atsmon and Max Magni, “Chinese Consumers: Revisiting Our Predictions.” Mckinsey Quarterly, Oct 2016 and ibid.

vidence of an economic bottom continues to mount. GDP expanded 6.7% year-on-year in the third quarter. As most are aware, however, on-year growth statistics never capture a turn. On the margin, sequential growth rose for a third consecutive quarter. Now, at 7.2% (quarter-on-quarter, seasonally adjusted

annualised rate), growth is the fastest in three years.

Retail sales grew by 10.7% on-year in September, up from 10% in May. In the first nine months of the year, consumption accounted for 70% of GDP growth, nearly twice as much as the 37% share contributed by investment.

A decline in the trade surplus knocked a half-point off of third-quarter growth. Put differently, domestic demand has grown by 7.3% year-to-date, five-tenths more than the 6.8% GDP per se has grown by. As should be the case, the upturn in China’s GDP figures is corroborated by the high-frequency data.

Manufacturing and service sector PMIs both bottomed in late 2015 and early 2016 and have risen steadily since. The manufacturing sector PMI returned to 50+ territory in June from 48.5 at the start of the year. The service sector PMI is now running just shy of 53, up from 52-and-change nine months ago.

Consumer price inflation rose to 1.9% y-o-y in September. Headline and core measures continue to trend north as they have for the past 18 months. On a three-month moving average basis, headline inflation has risen to 1.8% from 1.2% in early 2015. Core (ex-food and energy) inflation has risen to 1.7% from 1.2% on the same time frame. At the factory gate, producer price inflation has risen steadily throughout the year and returned to positive territory in September.

While much was made of a ‘sharp drop’ in September’s exports, the fact remains that after adjusting for seasonal effects both exports and imports appear to have bottomed six months ago. After grinding lower through most of 2015, seasonally adjusted exports are


Purchasing Managers’ Indices

Consumption is thriving

Inflation

Trade

Postscript: Evidence of a Cyclical Bottom is Mounting*

E


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up by 3% over average first-quarter levels. Imports – always more relevant to domestic demand – are up by 6% on the same time frame. Trade growth isn’t strong but it’s returned to positive territory.

It’s doubtful that a weaker yuan is responsible for the stabilisation in the trade date but it certainly didn’t hurt exports. When the dollar went sharply north in mid-2014, and the Japanese yen and euro went sharply south, most Asian currencies did the right thing and swam down the middle. Not so China’s yuan. In an attempt to show ‘global leadership’ and gain inclusion in the IMF’s SDR basket, the authorities effectively pegged the yuan to the rising dollar. It rose by some 15% against a simple basket of dollars, euros and yen. Since the middle of 2015, the authorities have allowed the yuan to fall back to where it was in mid-2014 in tri-currency basket terms. This has conserved no small amount of foreign reserves. Like China’s other high-frequency data, foreign reserves hit an apparent bottom in early 2016. Since February, reserves have held steady at about US$3,200 billion.

In spite of its 15% fall versus the dollar, euro and yen over the past 18 months, the yuan has still risen by 40%-45% in trade-weighted terms since 2005, the Bank for International Settlements. The drop since mid-2015 did nothing but offset the unwelcome rise the year before, something the authorities should probably have not allowed in the first place. In the event, the yuan remains a very strong currency today in real and nominal trade-weighted terms.

One thing that never slowed at all after the global financial crisis was China’s push for regional integration. After rising at a 16% annual pace between 2009 and 2015, outward foreign direct investment (FDI) has shot the moon this year, rising by nearly 50% year-to-date. At the current pace, outward FDI will rise to US$180 billion this year, financing investments in Europe, North America, Latin America but mostly Asia. Some 76% of all outward FDI is destined for the Asia-10 itself (which excludes Japan). Latin America comes in a distant second with a 9% share.

A cyclical bottom in China is as good for the rest of Asia as it is for China itself. Trade flows regionally are already showing the same signs of stabilisation as they are in China. As noted, investment flows are surging.

Within China, a cyclical bottom means authorities can focus more fully on reform and structural change, things they never really took their eye off of in the first place. Investors hope the next phase will centre on real economy reform – e.g., further cutting steel and cement capacity and the dominance of state-owned enterprises more broadly – as

The yuan

Regional integration


opposed to financial sector reform where most of the effort was concentrated over the past five years. Few imagined five years ago that financial sector reform would have progressed as far as it has. Hopefully the same can and will be said about real economy reform five years hence.

Beyond reform per se, further efforts toward the ‘One Belt, One Road’ (OBOR) initiative are on the cards, as the surge in outward FDI noted above demonstrates. The OBOR is all about investment, not consumption, and in our book that’s a plus, not a minus. Saving and investment drive growth, period. Consumption slows it. ‘Twas ever thus. But if it isn’t clear already, the conflict and contradiction between China’s desire for the OBOR on one hand and consumption-driven growth on the other will all-too-soon force authorities to choose between one or the other.

The good news is, a cyclical bottom will allow them to consider this and other far more important questions than where the PMI went last month.

* David Carbon, ‘China: Cyclical bottom’, DBS Group Research, 0ctober 19 2016


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2025Enhancing the manufacturing industry’s innovation capability, advancing industrialisation, and informatisation integration to a new level, and elevating China’s position in the global industrial division of labour and value chain.

1. Enhancing innovative capability of the manufacturing industry: This includes encouraging OEM enterprises to shift to designing and exporting own brands’ products

2. Advancing closer integration of informatisation and industrialisation: Devote great efforts to developing smart equipment and smart products, as well as advancing smart production

3. Strengthening fundamental industrial capabilities: Strengthening development of basic core parts and components, advanced basic processes, basic key materials and basic industrial techniques

4. Enhancing quality and brand building: Encourage enterprises to develop brand products with proprietary intellectual-property rights, and implement action plans to enhance the quality of industrial products

5. Proactively developing service-oriented manufacturing and producer services: Advance innovative business models and innovative business formats, and accelerate the development of producer services

6. Fully promoting green manufacturing: Strengthen R&D of advanced energy conservation and environmental protection technologies, and quicken the pace of transforming and upgrading the manufacturing industry to green production

7. Actively achieving development breakthroughs in key areas: Focus is put on 10 key areas: new-generation information-technology industry, high-end numerical control lathes and robots, aviation and aerospace equipment, ocean engineering equipment and high-tech vessels, advanced rail transportation equipment, energy-saving and new-energy vehicles, electrical equipment, agricultural machinery and equipment, new materials, biomedicines and high-performance medical devices

8. Deepening restructuring of the manufacturing industry: Promote traditional industries to move towards medium- and high-end manufacturing to gradually solve the problem of excessive production capacity

9. Elevating development of the manufacturing industry to international level: Devote greater efforts to integrating the “bringing in” and “going out” development strategies, and raise the level of international cooperation

2035Reaching the medium level of the world’s manufacturing powerhouses, raising innovation capability significantly, and enhancing overall competitiveness considerably

2049Comprehensive strength to rank among the upper echelons of the world’s manufacturing powerhouses, a leading technological and industrial system will be built

The Made in China 2025 plan intends to put China on a path of industrial transformation to become a world leader in industrial manufacturing by 2049. This roadmap is divided into three key milestones – from moving up the value chain to being transformed into a manufacturing powerhouse.

To achieve this, the plan lists nine strategic tasks that should be carried out.

Annex 1 Made in China 2025

Source: Made in China 2025

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Direction for reform Action Expected Result

Develop modern corporate systems

Implement board of directors system and specify director’s powers and authorities (落實董事會職權)

Partial solution to the free-rider problem because board will theoretically be incentivised to monitor SOE managers on behalf of shareholders

Use market mechanism in the hiring and remuneration process of managers (市場化選聘經營管理者)

Partially solves the principal-agent problem because managers hired in a competitive process are theoretically more talented

Professional managers will gradually replace bureaucrats as managers of SOEs (推行職業經理人制度)

Partially solves the principal-agent problem because managers’ incentives can be set by the board on behalf of shareholders

Remuneration system reform will involve differentiated allocation (企業薪酬分配差異化改革)

Partially solves the principal-agent problem if remuneration is based on merit (profitability)

Refine SOE supervisory institutions

Begin operations of state asset management companies (國有資本投資運營公司)

Partial solution to soft budget constraint problem if state asset management firms do not bail out failing SOEs

Capital management will be the focus rather than operational management

Enhance transparency and public disclosure of SOEs (國有企業訊息公開工作)

Partially solves free-rider problem because enhanced disclosures reduces monitoring costs, excluding cases of fraud

Develop mixed-ownership economy

Mixed ownership reforms for SOEs in certain “important industries” (部分重要領域混合所有制改革)

Partial solution to the principal-agent problem if private sector owners can effectively influence the operations of the SOE. SOE managers should have incentives that are increasingly aligned with the private sector, i.e. profit maximisation

Employee stock ownership program to be rolled out in mixed-own companies (混合所有制企業員工持股)

Same as above

Create a favourable environment for reform

Mergers and restructuring of central SOEs (中央企業兼併重組)

Partial solution to soft budget constraint problem if weak SOEs exit the market from being acquired

Cash-flow rights Remove SOEs legacy assets related to social functions that it previously performed (剝離企業辦社會職能和解決歷史遺留問題)

Partially solves soft budget constraint problem because the government is no longer incentivised to bail out failing SOEs in fear of social instability

Summary of reforms

Source: DBS Bank

Annex 2

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Disclaimers and Important Notices

The information herein is published by DBS Bank Ltd (the “Company”). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee.

The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof.

The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies.

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