www.chinaeconomicreview.com FEBRUARY 2014 VOL. 25, NO. 2 China Mobile is learning to China Mobile is learning to live with WeChat and Weibo live with WeChat and Weibo Q&A: Chinese universities lead Q&A: Chinese universities lead their emerging world peers their emerging world peers Feeding China Feeding China Keeping 1.3 billion people full at Keeping 1.3 billion people full at mealtimes is now a global matter mealtimes is now a global matter 中经评论:营销新浪潮 中经评论:营销新浪潮
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China Mobile is learning to China Mobile is learning to live with WeChat and Weibolive with WeChat and Weibo
Q&A: Chinese universities lead Q&A: Chinese universities lead their emerging world peerstheir emerging world peers
Feeding ChinaFeeding ChinaKeeping 1.3 billion people full at Keeping 1.3 billion people full at mealtimes is now a global mattermealtimes is now a global matter
中经评论:营销新浪潮中经评论:营销新浪潮
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MONTH IN REVIEW10 NEWS BRIEF | Th e biggest China news stories in January
COVER STORY18 FEEDING CHINA | Not enough food at home
MARKETS & FINANCE37 FALSE START | China is trying to reopen its IPO market, but it’s not going according to plan
BUSINESS 26 DELIVERING THE GOODS | Alibaba is on a long march to get consumer products into homes throughout rural China28 ON TRACK | Chinese high-speed trains go global30 RUNNING THE DOCKS | Chinese managers will probably be coming soon to a port near you32 AUTOMATED LABOR | Foreign fi rms are expanding their eff orts to play a role in Chinese robotics34 COMING TO TERMS WITH CHANGE | Messaging apps like WeChat are here to stay. China Mobile needs to face this reality
ECONOMICS & POLICY22 YUAN VERSUS DOLLAR | Th ere is little consensus on the direction of the yuan in 201424 GROWING PAINS | Lower GDP rates the new norm
Q&A12 THOUGHT LEADERS | Chinese universities dominate emerging world rivals14 PILLOW TALK | 7 Days founder Chien Lee talks budget hotels 16 HOVERING BELOW | Companies are still waiting for the helicopter market to take off in China
THE HOUSE VIEW6 GROWTH CONTRADICTIONS | China’s continued growth is in many ways a contradiction, but that’s how we like it8 BUYERS BEWARE | Wealth management products can be dangerous for investors. Bad ones must be allowed to fail
THE HOUSE VIE W
Speculation abounds on how China’s leaders will engineer the economy, markets and social
sphere in 2014. Every pundit has their take on the direction of the world’s second-biggest economy, but the country has a record for proving both naysayers and optimists wrong.
Atlantic writer James Fallows got it right when he said late last year that analysts and forecasters must start “rec-ognizing that incompatible-seeming observations may all be accurate.”
CHINA ECONOMIC REVIEW has com-piled a list of what we feel are the best predictions for 2014 while also assuring readers confidently that the world will continue to look at China with awe, antipathy, disgust and envy all at once this year.
Local debt: Roll over, play deadLocal governments in China in 2014 will need to repay about 40% of the US$2.9 trillion they owe in debt, a huge sum. Does that mean an escalation of the debt crises at the local government level?
Probably not. As in the past, Beijing will likely allow many regional officials to rollover the debt. This, as Financial
Times pointed out, is already happen-ing.
Many analysts have argued that if economic growth can outpace the growth of credit, local governments should be able to service their debt appropriately. Junheng Li, head of re-search at JL Warren Capital, said in
a note to investors that the notion is flawed.
“The argument that China can grow out of the credit bubble is valid if and only if GDP growth increases the debt service capacity of the debtors,” she says. The central government, not local governments, is the main benefi-ciary of GDP growth through tax rev-enues. Higher growth will hardly help regional cadres, who bring in revenues primarily through land sales, Li says.
So while Beijing can certainly bail out troubled localities, China won’t be able to count on the economy to per-manently grow its way out of a debt crisis in 2014.
GDP and stocks: Edging upwardIt may not pay off regional debt, but GDP growth in 2014 is still front and center in determining how new lead-ers will run the country this decade. Higher growth means more invest-ment, more debt and less change; lower growth will show a willingness to push through much-needed – and painful – reforms at the cost of growth.
The consensus points to 7.5% growth or above this year, which is a letdown for anyone waiting on reform. That also happens to be the GDP tar-get senior leaders are expected to have set for 2014 at a meeting in December.
The Economic Observer, a leading Chinese business newspaper, polled 105 experts on 85 questions pertaining to China’s economy in 2014. Those ex-perts said China will grow between 7.5-
Growth contradictions8% this year. Some said leaders will try to lift growth from the expected 7.5% in 2013 to around 7.8%.
This year will not be “China 7.0,” as Chinese media suggested six months ago. The ever-expanding figure is truly a snub to reform but it should help mainland stock markets after disap-pointment in 2013.
The Shanghai Composite Index fell 6.75% and the Shenzhen Component Index fell almost 11% last year. More than 50% of the experts surveyed by The Economic Observer said the Shang-hai index would end 2014 above 2,200 points with factors such as the reopen-ing of IPOs on the mainland contrib-uting to the rise. Other Chinese media
WALKING CONTRADICTION: Power in the hands
of a few could actually push reform forward
China’s continued growth is in many ways a contradiction, but that’s how we like it
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China Economic Review | February 201406
said that there was little hope of break-ing 3,000. The index was at 2,044 on Monday morning, compared to a peak of 6,000 points in October 2007.
Housing prices and land reform: Nothing newWhile mainland exchanges weren’t wel-coming to investors in 2013, the real estate market certainly was. After rapid year-on-year growth in prices continued for a 19th straight month in December, according to the Chinese Index Acad-emy, industry watchers have questioned whether or not 2014 will be the year that the China housing bubble pops.
A major burst is unlikely, according to a panel of 10 top experts surveyed by Southern Weekly, a Guangzhou-based paper known for its investigative re-ports. But the market could see some dips around the country, especially in areas where supply has far outpaced demand.
“Ordos will fall. Other hot areas will still grow, grow, grow,” Shao Gensong, vice chairman of the Hangzhou City Management Committee, was quoted saying in the weekly. Ordos, a city in In-ner Mongolia Autonomous Region, has been labeled by many Western media as a “ghost town” for its vast number of real estate projects but few residents. In 2013, rapid overdevelopment in Wen-zhou, a center for commerce in eastern China, led to the first drop in prices in a major city.
The Economic Observer predicted 10% price growth this year.
At the heart of China’s property market lies the method in which rural land is converted by local governments into urban space where developers can build. In 2013, media buzzed with pros-pects for opening a market for some forms of rural land, particularly after a big government meet in November.
But the experts that shared their thoughts with Southern Weekly were not optimistic about this. While a few pre-dicted slow progress, others held tight to the conservative line.
“It can’t. The land is the state’s,” Bai Yunping, a public servant in Beijing, told the paper.
Pollution, censorship and cen-tral control: Getting thickerIf the financial and economic outlook for 2014 is somber to negative, won’t things get better at least for the average Chinese citizen this year? Unfortunately, the outlook isn’t much better.
By many counts, the cloud of smoke that enveloped east and northeast Chi-na last year is here to stay, experts said. “There will be progress on cleaning up the environment though the problems are so huge that not much will change
substantively in a year,” Bill Bishop, a China commentator, said last week in his newsletter “Sinocism.” Chinese-lan-guage publications by and large agreed, with some saying that it will take at least 10 years to truly clear up the problem.
Anyone wanting to complain about smog-induced coughs may find it more difficult this year to voice such opinions online than they did in 2013. Beijing has cracked down on the use of social media such as Sina Weibo, China’s version of Twitter, and some fear that the increased level of control could extend to media such as WeChat, China’s most-used mobile messaging application.
“The stepped up control of the inter-net will continue [as] part of the broader, ongoing ideological tightening,” Bishop said in the newsletter.
Western media were thoroughly convinced that President Xi Jinping would continue to consolidate power throughout 2014. The power transition in March was followed by what those outside Beijing political circles take to be the centralizing of control in the hands of the new administration.
For Chinese people, that has several implications, the tightening on online speech being one of them. Another ef-fect has been Xi’s apparent crackdown on corruption, which has mainly taken down the new leader’s political rivals.
Yet Xi’s power grab might actually bode well for Chinese people in 2014. Without solid support, the party boss has little chance of pushing his reform-minded agenda through a sea of vested interests and conservative caution. So, there is hope that the more power that is consolidated by a small group of people, the closer China will get toward reform and opening. Call it a contradiction if you like.
THE HOUSE VIE W
China Economic Review | February 2014 07
THE HOUSE VIE W
It’s time to let China’s wealth manage-ment house of cards fall apart. A poten-tial US$500 million default at China
Credit Trust (CCT) is the place to start.The 345 investors who bought CCT
trust products through Industrial and Com-mercial Bank of China (ICBC) in 2011 aren’t sitting on buried treasure. Rather, the under-lying assets for those products are a few di-lapidated coalmines in Shanxi province. The price of coal has dropped 40% since a group of hungry investors poured their cash into the trusts, a form of wealth management prod-uct (WMP). The plant and equipment at the mine have also no doubt fallen in value.
CCT, a major trust firm, is now trying to liquidate the coal operation, Zhenfu Energy Group, in an attempt to pay back investors. The product carried a 10% investment re-turn. Zhenfu Energy is tied up in lawsuits and hasn’t been in operation since 2012. Needless to say, without a bailout from above, there will be little for investors to collect on the due date, the last day of China’s lunar cal-endar, usually a time for celebration.
At press time, a bailout is still not out of the question. When a US$22.5 million wealth product sold by Huaxia Bank de-
faulted in December 2012, the guarantor of the product, Zhongfa Investment Guarantee, paid back 91 investors, giving the risk-laden industry, which by that time had an estimated US$1 trillion value, an implicit guarantee.
The industry has grown rapidly since then, to an estimated US$1.5 trillion at the end of June. The stakes have been raised with CCT’s US$500 million impending default.
This time around, it’s unlikely ICBC will get behind the toxic products. China’s big-
Buyers beware
China’s wealth management
products have been plagued by
an increasing number of prob-lems. The house of cards appears
ready to fall
For the more pessimistic observers,
China is starting to slow dangerously.
The economy expanded 7.7% last year,
which although strong in global terms
was the weakest pace since 1999 for
the second year in a row.
Yet despite the economic diffi cul-
ties China is still popular with expats.
It’ll become even more attractive as
salaries increase at a higher pace than
among Asian peers and more foreign
professionals come to see it as a place
to jump up the career ladder.
A new survey by Hays, a UK-based
recruitment consultancy, indicated
that 67% of employers on the main-
land are likely to give pay rises above
6% this year. That compares to just
17% in Singapore and Hong Kong and
29% in Asia overall.
In the following 12 months, 71% of
employers in China expect business
activity to increase and 43% plan to
add staff.
If the allure of rising salaries
wasn’t enough, for many expats the
chance to work in China offers a fast-
track for their career back home.
China is becoming a key market for a
whole range of industries.
Unsurprisingly, those fi elds that
are vital to China’s future economic
development hold the best promise,
according to the survey.
An ever-expanding service sector,
particularly in top-tier cities, is creat-
For rising salaries and fast-track to promotion, expats turn to China
NO GOLD HERE: Allowing CCT to default would force
investors to see that some WMPs are worthless pits
China Economic Review | February 201408
gest bank told the media that it has no plans to bail out the investors. If regula-tors such as People’s Bank of China and China Banking Regulatory Commission don’t lean on ICBC, an institution that could pay out the cash without flinching, that will signal the start of the end for an industry that should have never grown to the size it is today.
Policymakers at the top might even let that happen.“We believe that the reg-
ulators and government would probably allow the trust product default because … the government appears fairly deter-mined to reform the financial system and instill proper risk pricing so there is a decent chance for this to happen,” Barclays Research said in a note.
Unlike the Huaxia case, investors in CCT don’t appear to be short on cash in the first place. Because the default is un-likely to put anyone out on the street, the
government will be more likely to allow a default, Junheng Li, head of research at JL Warren Capital, wrote to clients.
“Wealthy investors are less likely to protest so there would likely be less so-cial impact,” Barclays said.
By doing so, the government would paint a very clear picture that many of the gold mines that investors thought they were sitting on are actually shabby coal pits.
A default at CCT could be just the beginning of a complete shake up of the industry, said Lu Ting, China economist at Bank of America Merrill Lynch.
“We do believe the chance of trust product defaults is to rise significantly in 2014 as about a third of the outstanding [US$760 billion] trust loans will mature this year, while a more confident govern-ment with successful power consolida-tion in 2013 sees the need to break the so called ‘implicit guarantee’ on trust and bond products,” he said.
This is exactly what the central gov-ernment needs to do. It would be do-ing everyone a favor by putting its foot down sooner rather than later on an in-dustry that has channeled investors’ hard earned cash into bottomless pits.
ing demand for skilled accounting and
fi nancial personnel. Salaries at com-
mercial banks are jumping by 10-15%
as lenders race to open new branches.
Still, for all the money and op-
portunity, China has plenty to cause
pause for thought. Slow fi nancial re-
forms, cultural issues and pollution
can frustrate even the most eager of
expats.
Investment professionals dream
of making a killing in the fast-growing
Chinese capital market but regulators
currently can’t even offer the basics
to achieve that, such as a functioning
IPO system. Expats who don’t possess
strong local language skills are less
attractive to employers than bilingual
Chinese with international experience.
Ambitious professionals are un-
likely to be put off by the above if it
means getting ahead. Those who feel
under-employed or under-paid in the
West will also keep coming. “They
are prepared to accept compromises
on life, air quality and those sorts of
things,” said Simon Lance, the region-
al director for Hays in China.
As for the state of the Chinese
economy – so vital for the job mar-
ket – it’s hardly in dangerous territory
yet, Li-Gang Liu, Chief Economist for
Greater China at ANZ Bank, said at the
launch of the Hays report in Shanghai.
“GDP growth of even 6-7% is a very
good, sustainable number.”
THE HOUSE VIE W
China Economic Review | February 2014 09
NE WS ROUNDUP
MONTH IN REVIEW
ECONOMICSChina recorded fourth quarter GDP
growth of 7.7% as investment and demand weakened in the last few months of 2013. The fourth quarter growth rate compared with a 7.6% fore-cast by analysts in a Reuters poll but eased from 7.8% in the previous three months. That leaves growth in the Chi-nese economy at 7.7% for all of 2013, unchanged from revised levels in 2012. Analysts say growth could cool in 2014 as Beijing focuses on rebalancing the economy and other major reforms.
China’s National Development and Reform Commission said it plans to curb the “disorderly expansion” of local debt this year. The remarks from the central planning agency came after the National Audit Office said local governments had run up total debt of
US$2.95 trillion at the end of June. Leaders are looking for steady growth in the economy as they push through one of the country’s most ambitious reform agendas, aiming to transform the economy into one driven by con-sumers rather than the traditional investment and exports.
Chinese housing prices continued to soar in December but at a slower
pace than in previous months, Reu-ters reported, citing National Bureau of Statistics data. Prices in the capital Bei-jing rose 16% in December from a year ago, easing slightly from November’s year-on-year increase of 16.3%, and the second month of slowing gains after a record jump in October. In Guangzhou and Shenzhen, gains eased to 20.1% and 19.9% respectively from 20.7% and 20.6% in November, their first slow-down this year. Nationwide new home
prices rose 9.9% in December from a year ago, the same pace as November.
FINANCEChina Securities Regulatory Commis-sion (CSRC) has launched an inves-tigation into 13 underwriters and 44
institutions in its latest bid to curb highly valued initial public offerings, South China Morning Post reported. The CSRC insisted that the newly reformed offering mechanism would safeguard the interests of retail investors when the listing market was reopened. The new system required applicants to fully disclose information on earnings
and operations before the CSRC vet-ted the documents, while letting public investors decide their worth. Reforms haven’t been implemented yet and pric-ing power is still in the hands of the underwriters and institutional investors during the off-line subscription phase.
Data released by China’s central bank showed rapid growth in the country’s shadow banking sector in 2013, Finan-
cial Times reported. Funding from trust companies and other entities in the shadow sector rose to its highest level
on record and accounted for 30% of
the US$2.9 trillion (RMB17.3 trillion) in total credit issued last year, People’s Bank of China (PBOC) said, up from a 23% share of aggregate financing in 2012. “This shows that financial insti-tutions’ off-balance sheet business is developing relatively fast and providing strong capital support to the econo-my,” said Sheng Songcheng, head of PBOC’s statistical department.
London-based investment manager Ashmore has become the first foreign
group outside of Hong Kong to be allowed to directly invest in Chinese equities, Financial Times reported, cit-
SLOW DOWN: Economic growth in 2013 hit 7.7%,
the joint slowest pace since 1999
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China Economic Review | February 201410
ing the company. Permission has been granted as part of a recently agreed deal between London and Beijing giving British investors greater access to Chi-na’s US$3.4 trillion equity market and US$4.7 trillion bond market. Under a fixed investment quota for the UK of US$13.2 billion, Ashmore is expected to receive a small allocation, in the hundreds of millions of renminbi.
POLITICS & SOCIETYChinese authorities have pledged to improve the rural environment and
ensure food safety and security in 2014, Bloomberg reported, citing a statement on the State Council’s web-site. The statement, part of a policy document issued every January by the Central Committee of the Communist Party and the State Council, says the
government is committed to sustain-able agricultural development, safe food products and reduced pollution. Bei-jing is seeking to assuage public anger sparked by incidents such as chemical spills into supplies of drinking water and the sale of tainted baby formula.
The number of Chinese using microb-logs fell 9% in 2013 from 2012, accord-ing to a report by the government’s China Internet Network Information Center, The Wall Street Journal report-ed. The center attributed the drop in users – from 308.6 million in 2012 to 280.8 million in 2013 – to grow-ing competition from social networks and messaging applications on smart-phones, such as Tencent Holding’s
(0700.HKG) WeChat. A spokesman for Sina Corp (SINA.NASDAQ), which operates Sina Weibo, China’s most popular microblogging platform, said these numbers didn’t match the positive trend Sina reported as part of its most recent earnings filing. In 2013, the government launched a crackdown on content in microblogs.
BUSINESSFrench cosmetics and skincare giant L’Oreal (OR.EPA) plans to pull its Garnier business from the Chinese market, Financial Times reported. The group said it would halt sales of its Garnier beauty and hair products in China. L’Oreal said it would focus on its two other mass market brands in China: Maybelline, which is mainly make-up and L’Oreal Paris, cover-ing skincare, make-up and haircare. The announcement comes just a week after US rival Revlon (REV.NYSE), a much smaller player in the China beauty products market, said it would
withdraw from the country and cut 1,100 jobs.
China’s auto market will likely main-
tain its momentum this year, fueled by a round of new stimulus measures and demand for cars in smaller cities, Reu-ters reported, citing industry executives and analysts. The new year should mark a second year of double-digit growth for China after sales expansion rates slumped in 2011 and 2012 to 2.45% and 4.33%, respectively. But in 2013, sales in China rose 13.9% to 21.98 mil-lion vehicles, according to the China Association of Automobile Manufac-turers. In the previous 10 years, auto demand in China often surged 30 to 40% annually.
Apple’s (AAPL.NASDAQ) primary supplier Foxconn delivered about 1.4
million iPhone 5Ss to China Mobile (CHL.NYSE, 0941.HKG) for the state-run giant’s product launch, The
Wall Street Journal reported, citing an unamed source. While the initial ship-ment volume doesn’t represent the total sales at China Mobile for January, the figure helps gauge early demand for iPhones from China Mobile, the world’s biggest carrier by subscribers with more than 760 million customers. China Mobile began taking pre-orders for iPhones starting December 25.
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China Economic Review | February 2014 11
Q&A: EDUCATION
Th ought leaders
Education is the bedrock for a country’s growth. China has been investing big in its lead-
ing schools. Although it still lacks insti-tutions that are able to compete at the very top globally, China comfortably dominates its emerging market peer group. Chinese universities were the standout performers of the inaugural ranking of tertiary institutions in devel-oping economies published by Times Higher Education magazine.
Phil Baty, editor of Times High-er Education rankings, explains how Chinese universities have come this far, what it will take for them to break through into the leading pack and how they are struggling to overcome a block in creativity.
What were the notable attributes
of the top Chinese universities in
the ranking and why did Tsing-
hua and Peking come top?
You have to really perform well against all of our criteria. We have 13 separate performance indicators and they cover right across from teaching and research to knowledge transfer, to international outlook. But the one area where both Peking and Tsinghua were absolutely outstanding with the highest scores possible was for industry income, a sort of innovation indicator and third mission activities where universities are able to engage with businesses and companies and attract funding for their research through industries. That’s an incredible area of strength in China.
They have a very sound research performance compared to other uni-versities; they do pretty well on research impact where we look at how many times their research publications are cited by other scholars around the world. The two Chinese universities come out well on teaching. They are obviously very well regarded around the world as strong teaching institutions. We find that the Chinese universities are particularly well regarded in teach-ing and a good teacher-to-student ratio, healthy proportion of PhD to under-
graduate number, and also scored well in the reputation area.
Can you explain a bit
more about how gov-
ernment support and
funding has helped China to
build up its universities this way?
I think China is the outstanding exam-ple of a clear policy direction with a very strong recognition in the 1990s that China needed to develop to move from manufacturing to an innova-tion and knowledge economy. So they undertook a very strong series of moves and I think the key ones were the two in the 90s, but in particular the 985 project. [Project 985 is a state-direct-ed program aimed at building a select number of Chinese universities into world-class institutions.]
Now, obviously hard cash invest-ment is essential here. You do need money to pay the scholarships, to pay the high salaries, to attract the talent in, to build the research infrastructure and fund the research activities so there is a very clear sense of China’s commitment of funding.
But also reforms to improve and increase internationalization and the encouragement of international exchange programs, in particular some of the scholarship schemes which really encouraged Chinese scholars to come back to China to continue their higher study and start or continue their profes-sional careers back in China.
You say this new table highlights
how many more Chinese uni-
versities are potentially poised
to join Peking and Tsinghua in
the Global Top 50 but the oth-
ers are, at best, only ranked in
Chinese universities dominate emerging world rivals
China Economic Review | February 201412
They have a very sound rece compared to otheey do pretty well on reere we look at how
research publicatiother scholars aroun
e two Chinese univewell on teaching. Thery well regarded arourong teaching instituat the Chinese univearly well regarded in ood teacher-to-studenportion of PhD to ue number, and also in the reputation area
Can you explain
more about how
ernment support
performancversities; theimpact whetimes their cited by otworld. Thecome out wobviously veworld as strWe find thare particulaing and a gohealthy pro
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the top 200-225 worldwide at the
moment. Why is there such a big
gap with the best in the world?
A: I think they’re less visible in the world rankings - Fudan is just outside the top 200; there’s a few like Ren-min who are 226-250. So yes, you’re right, they’re all there or there abouts, just outside the global 200. But I think what this shows really that there is a large group of universities that are pret-ty close to that magical 200. The top 200 is roughly about 1% of the world’s higher educational institutions. What I am really trying to say is that given the trajectory of China; given that there’s continued economic growth; given that there’s continued commitment to investment in universities; given it’s not just Peking and Tsinghua who are get-
ting special funding and special support from the government, it would appear that the others are in a position to con-tinue to improve, to continue to march up these tables.
How can they close the gap?
I think there’s quite clearly a sense that there are some remaining barriers. Money is absolutely fundamental. But I think there are challenges around con-tinued reform and persistence – reforms to be more adaptable to the global mar-ket and trying to give maybe a bit more autonomy, a bit more freedom to be more dynamic, more entrepreneurial in the face of the changing global market.
I think there are still challenges around – Peking, there’s a concern, perhaps, that there’s a lack of creativ-
ity; the entrance exams are so rigorous in checking fact that maybe they are not encouraging students to do more free thinking, more creative in terms of answering questions that haven’t been asked yet and preparing for an uncer-tain future job market.
And of course there is a slight pres-sure on just churning out research publications as part of the work place incentives and maybe there needs to be a focus more on producing higher-quality research. There’s been an abso-lute explosion in the volume of research produced by China, which is very excit-ing but maybe the next step is to make sure that research is more carefully focused to make a real high impact with slightly less mediocre research and more focused on producing real quality.
Q&A: EDUCATION
China Economic Review | February 2014 13
Q&A: HOSPITALIT Y
China Economic Review | February 201414
Pillow talk
A d e c a d e a g o , s m a l l b u s i -ne s s owne r s
and middle class travel-ers faced a dilemma: Break the bank staying in a plush foreign hotel or take a risk and check into a cheap local room where you may or may
not receive hot water, a television or basic provisions. Today, they have more choices than ever before and soaring demand is driving industry innovation.
At the heart of this development has been 7 Days, one of the largest budget hotel chains in China and now a cor-nerstone brand of a hospitality group backed by the likes of Carlyle Group and Sequoia Capital. Its co-founder Chien Lee remains enthused by the prospects the market offers and sees huge opportunity in the largely unders-erved mid-tier market.
In the second part of an interview with CHINA ECONOMIC REVIEW, Mr. Lee talks about chasing the middle class, ponders the difficulties currently being faced by the big luxury hotel groups and gives his thoughts on why marketplace services like Airbnb will take time to take off in China.
What was the opportunity you
saw in the market when you
launched 7 Days in 2004, and
how has the market changed
since then?
Ten years ago, China was just open-
7 Days founder Chien Lee talks budget hotels in China and the rising mid-range market
aeBioiChien Lee
ing from manufacturing into domestic consumption. The market was growing. My partner and I saw the opportunity in the consumer sector. I lived in the US for 20 years from the 1980s and I saw that most of the businesses were run by individuals, just mom and pop owned stores. But in the 1980s, the big brands took over the small retail chain store. For example, you used to go to a mom and pop store to buy stationary but in the 1980s Staples and Office Depot opened up and all of those mom and pop stores closed. They took over the whole market.
So in 2004, we saw a lot of no-star hotels or zhaodaisuo (hostels), individ-ual owned or local government-owned. They didn’t have brand names or prop-er management because they were indi-vidual. So we saw the market there, we saw the Chinese economy was opening up, a lot of small businesses were start-ing and a growing middle class that liked to travel. People across the social spectrum liked to travel. So the budg-et hotel was a huge, huge market and that’s why we launched 7 Days.
There are now several budget
hotel brands in China. What are
your thoughts on that?
I think it’s really healthy. We only have four or five brand names in this space in China, like 7 Days, Home Inns, Hant-ing, Jinjiang. But China still has a lot of market space. You see, at the begin-ning, we only had the first or second tier cities, but now we are going into
the third tier city, fourth tier city and even the small town – we are going there and that is a huge market.
Another thing is urbanization – that will play a significant role in budget hotels. Because you are transforming this small town or village into a small city so you need budget hotels. I think budget hotel market still has a lot of potential going forward.
7 Days has around 2,000 hotels
in 230 cities. What is the geo-
graphical spread?
Many on the east coast. At the begin-ning, we focused on the first or second cities. But now we focus on third or fourth cities so we are more spread out now. We are moving out west slow-ly. We are spreading into small towns in the west. We are looking all over China, not just specific areas. If there is a market, we will go there. We are already in emerging centers like Wuhan and Chengdu, and probably, if there is the opportunity, we will open more.
What are the biggest challenges
7 Days has faced in establish-
ing its position in the Chinese
market?
The biggest challenge is the people. China has its market already, it is there, but it is the people who manage these hotels. There are 2,000 7 Days hotels, which require almost 4,000-5,000 man-agers for the hotels due to shift chang-es. People are really important; it is one of the challenges. The other is how to
Q&A: HOSPITALIT Y
China Economic Review | February 2014 15
maintain the quality of the hotel and the brand name.
Other companies have the same thing. The management team at 7 Days is more personal, it is people first in the company corporate culture, that is number one. On the business side it is always customer first, how to be dedi-cated to the customer.
Earlier this year 7 Days was
taken private and is launching
some new mid-market hotel
brands. Can you tell us more
about your plans?
Our founders, Carlyle Group and Sequoia Capital formed a concession to take the 7 Days private and now Plateno Hotels Group is a hotel opera-tor. Our brands include Lavande Hotel, James Joyce, Portofino, 7 Days, and the Zmax Hotel. We see the middle mar-ket is huge going forward, besides the budget hotel, and because China has a lot of medium and small business across the whole economy and we see a lot of business travelers need facilities. They travel a lot between city to city. Also, we see the room to create a couple of good brand names for the middle-level hotel in China, which is why we have got into this market.
By moving into the middle-mar-
ket, are you not risking getting
into competition with foreign
groups that have a strong pres-
ence in the mid-upper segment?
The Chinese market is so big that there is room for a few mid-end hotels in the market, easy. We are localized, we understand the market and we already have a platform through 7 Days, and we have 70 million club members, which provides a lot of data. And also
we don’t need a third-party registra-tion system. We have 70 million mem-bers and our own reservation system and that gives us a lot of advantage. We have the infrastructure to get into the middle market and we under-stand the market. I see a lot of foreign names, some have success, some they do not. Also, I haven’t seen any hotels dominating the middle market yet, no major hotel names and brands, unlike the budget hotel market. Even Holi-day Inn, they are here, but they do not have a dominating brand name and that is very important. I’m not saying only us, but you need to have three or four dominating names in the market.
China has seen a massive build
up of luxury hotels in recent
years, especially foreign brands,
but that market is currently
struggling with low occupancy
rates and falling room rates.
What is your view on all this?
I see a lot of foreign luxury groups coming to China and they are going
through some difficult times at this moment but my opinion is that this is a cycle and that the market will come back because the economy keeps grow-ing and the middle class keeps growing and urbanization is coming so the mar-ket will come back, but how long, that depends.
Marketplace services in the
US such as Airbnb that match
rooms in private homes with
travelers are challenging hotels.
Do you see something similar
happening in China?
There is something similar starting up in China. I see a couple of services rent-ing out condominiums and rooms as a private service. It has started but it is not fully there yet, it is way far away. It is not near to becoming competi-tion to hotels yet because of their size and their location. They are mostly in tourist areas; for example in the US it is mostly happening in places like Orlan-do, Florida, near Disneyland. So they do not pose competition in China yet.
COMFY BEDS: After establishing itself as one of the leading budget hotel chains in China, 7 Days is now
targeting the underserved mid-range market
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Q&A: BELL HELICOPTER
Hovering below
Crossing China, a vast and geographically challenging country, has never been an
easy task for its people, officials or res-cue workers. Listen to executives from the helicopter industry and they are convinced they have the answer. But while they are making some sales here, the Chinese market for whirlybirds remains small.
Laws, regulations and military restrictions have combined to limit growth in the country, concedes Chris Jaran, managing director of China for Texas-based Bell Helicopter. How-ever, he believes the next 10 years will see “significant growth.”
In an interview with China Eco-nomic Review, Jaran explains how Bell Helicopter is preparing to serve the market by training Chinese heli-copter pilots and maintenance crews, and how one day the company might assemble aircraft in China.
Helicopter ownership rates in
China are just a fraction of what
they are in the US, Europe and
even other big emerging mar-
kets. What are your growth pro-
jections for the market in the
next 10 years?
We see significant growth in China in the next 10 years, but it will depend on how fast the government opens up the airspace and how quickly pilots and mechanics can be trained.
What is your share of the China
helicopter market?
Bell Helicopter currently has approxi-mately 20% of the commercial turbine helicopter market in China and we expect to see additional growth in the years to come.
What are your goals, sales and
otherwise, in China for the next
decade?
Bell Helicopter is looking to provide better training and spares support for our customers as well as help build the general aviation infrastructure in China.
Which market segments do you
see as the fastest growing in
China and in what areas do you
specialise?
Due to the shortage of pilots in China, we see the helicopter training market has huge potential, especially with the SLS [short light single aircraft]. We also see potential with the Bell 525 as the energy industry grows in China.
Can you tell us about your top
selling models in China, and
let us know about your product
positioning in this market?
Currently the Bell 407 and Bell 429 are the top selling models in China. They are mainly used for corporate and utility purposes.
What are the challenges that
you face in selling to China from
global peers and how are you
addressing them?
In addition to adapting to the lan-guage and cultural differences, we are continually trying to streamline the sales process, and improve our spares supply, support, and training.Like with many sectors in China,
foreign companies have touted
helicopters as a potentially huge
market for years but progress has
been slow. To what extent have
your expectations been missed,
and how are you planning for
future growth considering your
past experiences?
While we would always prefer things to happen faster, we believe we are on the right path in China and predict a large opportunity ahead. As mentioned before, a lot of this will fall on train-ing for mechanics and pilots as well as government regulations, but we predict significant growth in the next 10 years and beyond.
Are you building or assembling
more helicopters within China or
are you mainly importing them?
What are the main difficulties
faced when importing helicop-
ters into China?
We have had success importing hel-icopters over the past few years and growing our international infrastructure and sales, but we do realize a localized approach is necessary for long term suc-cess in many international markets. Our strategy in emerging markets is to first build the training and infrastructure to
Companies are still waiting for the helicopter market to take off in China
China Economic Review | February 201416
support the market with qualified pilots and maintainers and learn the market, then progress to completions and ulti-mately to final assembly.
What are the biggest differences
you have noticed in buyer behav-
iour and requirements between
China and, for example, the US
or Brazil?
We are seeing customers that want multi-mission configurations that can be interchangeable, such as having cor-porate seating that can be removed to install a litter kit for rescue missions. This is compared to operators in North America that need dedicated configura-tions for HEMS [helicopter emergency medical service] and corporate missions.
A lack of helipads, air traffic con-
trol infrastructure and severe
restrictions on non-military and
non-commercial are often cited
as major obstacles to the devel-
opment of the China helicopter
market. What changes are you
seeing in these areas?
The recent changes by the CAAC [Civil Aviation Administration of China] to loosen airspace restrictions by the PLA [People’s Liberation Army] have certainly improved the outlook of the general aviation industry.
China has a shortage of qualified
air service personnel and mainte-
nance crews to deal with helicop-
ters. How can this be overcome?
We believe the best way to combat this issue is direct investment in the region. For example, Guangzhou Civil Aviation College is well on its way to becoming the first authorized Bell Hel-icopter Maintenance Training facil-
ity in China for the Bell 206L and Bell 407 product lines.
Guangzhou College’s instructors have made significant strides in process to become a Bell Helicopter certified training facility. The required classroom theory training and associated practical assessment were completed in July at the Bell Helicopter Training Academy (BTA) in Fort Worth, Texas. Under the supervision of BTA instructors, the college completed its first Bell 206 course in Anyang, China on August 23 and its first Bell 407 course in Beijing China on September 6. The college is procuring its first Bell model 206 train-ing aircraft and is expected to have it ready for training by early Q3 2014.
Plans are also moving forward with Suilian Helicopter General Aviation Co., Ltd. to open a Bell Helicopter authorized flight training school. Suil-ian began instructor pilot training on September 16 at the Bell Helicopter Training Academy in Fort Worth, Texas. Both pilots successfully com-pleted their Bell 206L flight instructor training. Additional training recently began for the Bell 407 model.
How much have aviation laws
and regulations in China
hindered the helicop-
ter market? What
impact do you see
in the easing of
new restrictions
that came into force on Decem-
ber 1 as having in the short to
medium term?
Easing of restrictions will accelerate the flight plan approval process, which will hopefully result in more general avia-tion aircraft being produced.
How do the laws, regulations
and military restrictions in China
compare with other big emerging
markets like Brazil, India and
Russia?
The government restrictions for general aviation have limited the growth for helicopters in China compared to other countries such as Brazil and Russia which already have strong infrastruc-ture in place for commercial helicop-ters. However we see China eventually catching up to these countries in the future.
“Restrictions have limited the growth for helicopters in China compared to other countries like Brazil.”
Q&A: BELL HELICOPTER
China Economic Review | February 2014 17
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BEIJING HAS RICE TO GO AROUND, BUT KEEPING EVERYONE IN CHINA FULL AT BEIJING HAS RICE TO GO AROUND, BUT KEEPING EVERYONE IN CHINA FULL AT
MEALTIMES IS MORE AND MORE OF A GLOBAL MATTERMEALTIMES IS MORE AND MORE OF A GLOBAL MATTER
Feeding ChinaFeeding China
Rice is serious business in China. The country ingest-ed 146 million tons in 2013,
making it by far the world’s largest con-sumer of the grain, a longstanding title.
What’s worrying the government isn’t how much rice China will eat this year. That figure is set to slow-ly decrease as the country urbanizes. Rather, leaders are closely monitor-ing how much rice China imports, as well as the factors that could make China dependent on foreign grain in the future.
During the past four years, rice shipments to China have climbed some 530%. In 2013, China bought 3.4 million tons of rice from abroad, surpassing Nigeria for the first time as the world’s biggest importer, according to Index Mundi, an edible commodi-ties tracker.
Beijing isn’t exactly celebrating the new title. In fact, this year agricultural policymakers will step up their guard on what they consider to be grain self-sufficiency. In early 2014, China’s State Council will issue an annual pol-icy report known as “Document No. 1.” The statement, compiled by a spe-cial team from the country’s cabinet, will likely call for 100% self-sufficiency in edible grain, clarifying one of Chi-na’s longest-running policies.
A less specific definition for self-sufficiency was originally set at 95% in a long-term plan running 12 years through 2020.
“[The government is] very, very worried about imports,” said Huang Guiheng, research director at BRIC Consultants in Beijing. “They have increased very rapidly in the past few years.”
The good earthFor a country that produced more than 200 million tons of rice in 2013, 3.4 million tons in imports seems like a trivial sum. As agricultural policymak-ers watch import levels rise, they’re also tracking the country’s long-term capac-ity to supply its own grain – often in the face of mounting environmental challenges.
In 2010, the director of China’s Rural Development Institute, Chen Xiwen, first sounded the alarm on the scarcity of water in the northeast, the country’s grain basket. Of the increas-ing shortfall, he wrote, “It’s inevita-ble that the rate of self-sufficiency will decline.”
China feeds 22% of the world’s population with just 7% of the earth’s arable land and the second figure is declining steadily as croplands desertify. This week, the State Forestry Adminis-tration said that 9% of China’s wetlands disappeared during the past 10 years.
Chen raised doubts again early last year when, as grain imports hit an all-time high, he announced that the coun-try would not impose curbs on imports in 2013. It’s unclear at present if limits will be introduced this year but Docu-ment No. 1 could clarify how the gov-ernment will act on this.
Pollution is another bombshell. In May, a government test in rice markets in the southern city of Guangzhou said that half of the tested grain was con-taminated with high levels of the heavy metal cadmium, although the scope of those tests was later shown to be quite limited.
In the final days of 2013, the Min-istry of Land and Resources said about 2.5% of China’s arable land was too
COVER STORY: FEEDING CHINA
China Economic Review | February 2014 19
contaminated by heavy metals to farm. It was a major admission from the government, which hadn’t made such data public since 1996. The ministry called the situation “grim.”
Legacy policyAnxiety over cadmium-laced rice or drying paddy fields isn’t misplaced. Given its history with famine, and its long-term struggle to be self-sufficient, a deteriorating environment gives China good reason to worry.
Self-sufficiency has been a guid-ing light for the country dating back to the early years of New China. In the 1950s, the age-old tradition of house-hold farming was broken apart by the central government and reorganized into collective farms that put hundreds of people working together in the fields.
Collective farming for the most part was disastrous. Tens of millions of peo-ple starved in the countryside due partly to poor productivity and low yields on farms in 1959 and 1960. Farmers con-tinued to till the fields in that man-
COVER STORY: FEEDING CHINA
ner until the late 1970s, when villages began spontaneously breaking away to resume household-based cultivation.
The opening up of China in the late 1970s and early 1980s was led by reformers striving to stabilize crop yields and keep bellies full.
“Grain self-sufficiency has been the most important challenge since the establishment of People’s Republic of China, and it was the main reason of starting the policy of reform and of opening doors,” said Chisa Ogura, a Tokyo-based senior consultant at agri-cultural-focused Promar Consulting, giving a sense of the weight put on agricultural policy in the country.
Ogura isn’t convinced of the potency of Document No. 1 this time around. The last major central policy state-ment on self-sufficiency was issued in 2008 after world grain prices surged the year before. Reaffirming and even strengthening the definition of self-suf-ficiency this year with Document No. 1 wouldn’t be terribly surprising, she said.
Fu Zhenzhen, an analyst at Beijing
Shennong Kexin Agribusiness Con-sulting, agreed with that. She said for decades the government has strived to incrementally raise the rate of self-suffi-ciency with one goal in mind: “The first thing it wants to do is protect the edible grain. Everything else is less impor-tant.”
Bushels after bushelsThe central government isn’t just wor-ried about rice. Imports of wheat, corn and soybeans have grown dramatically during the past few years. China is also the world’s largest consumer of wheat, putting down 126 million tons of noo-dles, fried gluten, as well as wheat-based animal feed, in 2013. Imports jumped by 187% last year alone.
Corn imports grew by 159% in 2013, after surging by 2,657% in 2009 and some 3,000% in 2005, according to Index Mundi.
Because the amount of rice, wheat and corn consumed in the country is so vast, a slight adjustment in Chi-na’s self-sufficiency rates can lead to upheavals in the amount it imports, Huang at BRIC said. That’s why even seemingly small changes in policy can have a great impact on the global mar-ket.
“[Consumption] is so huge that if one type of these three main grains’ self-sufficiency rate declines a little, it means that China will become the largest importer immediately,” he said.
This happened with rice during the past three years, but not for the most obvious reasons.
At the end of 2012, as China closed in on the No. 1 rice-importer title, some analysts questioned if the coun-try’s new hunger for imported grain would continue to grow and eventually
KEEP ’EM COMING: China’s growing food needs will create more business for farmers in agricultual
exporting regions such as the United States
China Economic Review | February 201420
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push the price of rice on the interna-tional market sky high.
Experts have come out to disprove that notion. Huang Jikun, director at the Center for Chinese Agricultural Policy at the Chinese Academy of Sci-ences in Beijing, told China Economic Review that China’s overall demand for rice is falling as the country urban-izes. Urban dwellers consume about half the amount of rice their counter-parts in the countryside eat. As more and more rural folk move to the cities they will slowly diversify their diet and China will eat fewer bowls of rice.
“It is not too difficult for China to achieve food grain self-sufficiency because per capita consumption for rice and wheat will fall in the coming decades,” Huang said.
Pricing is the dominant factor con-tributing to imported rice. Central planners set grain prices that, in terms of rice, have been higher than inter-national prices since countries such as India and Pakistan flooded the market with the grain in 2012. Many Chinese traders have opted for the cheaper stuff.
Global diet“What rate of self-sufficiency do we have to achieve before we are consid-ered safe?” a reporter at Chinese week-ly newspaper The Economic Observer
asked in December.By the accounts of many experts,
the country has long been self-suf-ficient despite rising imports. Envi-ronmentalists, on the other hand, might say that major challenges such as pollution and water shortage stand between China and a full basket of rice in the future.
In a possible indication that leaders doubt China’s agricultural capacity at
home, they have pushed state firms to buy up farms and companies abroad to help boost supply.
In September, state-owned Xin-jiang Construction and Produc-tion Corporation struck a deal with Ukraine for the rights to farm 3 mil-lion hectares of its land for 50 years. The deal more than doubled China’s overseas agricultural projects in what analysts said was a new era for Chinese farming abroad.
Recently, China’s state grain trader
Cofco put in a US$250 million bid for a stake in Dutch grain trader Nidera with the hope of securing new access to resources.
Whether agricultural resourc-es abroad, when brought under the control of government firms, will be added to China’s calculation on self-sufficiency is questionable. What does seem evident is that feeding China – with imports, buyouts or homegrown crops – is a global feat and will not be confined to the country’s borders.
Document No. 1: Th is rural policy has implications far beyond China’s farms
There is little consensus on the possible direction for the renminbi this year, although the bulls probably have the edge
All it takes is a quick phone call and a “yellow cow,” or an unauthorized money
changer, will appear on a motorcy-cle in a matter of minutes, ready to unload the rolls of notes he’s stuffed in a waist pack. That’s how many people in China, locals and expats alike, buy foreign currency to bypass controls.
The changers were busy punch-ing in numbers on their calculators in 2013. The value of the yuan hit the upward limit on the 1% trading band set by the central bank 41 times last year. It maxed out eight times in
December alone, demonstrating the high demand on the still-closely con-trolled currency.
People’s Bank of China (PBOC) allows the yuan to appreciate or depre-ciate daily by 1% in either direction of a marker it sets. The bank, not the market, sets the marker on a daily basis. During intraday trading on the last day of 2013, the yuan hit 6.0507 against the dollar, an all-time high. It appreciated 2.9% against the dollar last year compared to a 1.01% gain in 2012.
Bold statements coming out of
the central bank late last year helped push up demand for the yuan. PBOC Governor Zhou Xiaochuan said on November 19 that the bank would “basically” end normal intervention in the currency market, meaning it will stop massive purchases of US treasury bonds that keep the value of the yuan down.
The bank’s Deputy Governor Yi Gang went a bit further last week, say-ing that China’s currency was close to equilibrium and would not require more intervention.
If that’s true, and China intends to
Yuan versus dollarWHAT’S IT WORTH?: China’s increasing current account surplus is putting huge pressure on the yuan to appreciate. But as usual there is no clear guidance
from offi cials about where they want to take the currency, leading to continued speculation in 2014.
China Economic Review | February 201422
stop buying US treasuries on a regu-lar basis, the value of the yuan should appreciate considerably this year and in the years to come as China’s trade surplus is set to rise too. The IMF says the country’s current accounts surplus will double between 2013 and 2017.
China’s increasing current accounts surplus puts pressure on the yuan to appreciate. Since China earned the reputation of the “world’s factory” in the late 1980s and early 1990s, policy makers have bought up dollar-denom-inated assets such as US treasury bonds, ramping up demand for the dollar and pushing down on the value of the yuan. A weaker currency makes Chinese exports more competitive.
Adding to this upward pressure on the yuan more recently is the central bank’s policy on tightening liquidity in the interbank market. Since June, PBOC has refrained several times from pumping cash into money mar-kets, raising the cost of interbank lend-ing. That has no doubt attracted those looking to arbitrage on interest rates, ANZ Bank said in a note to investors.
In Hong Kong, traders can get loans for offshore yuan at low interest rates, bring that money onshore and deposit it at higher interest rates, turn-ing a risk-free profit on the hot money.
Under this mounting pressure, a halt to currency intervention should mean that growth in the value of the yuan this year. That is, if PBOC can stick to it. Mark Williams, chief Asia economist at London-based research firm Capital Economics, in a note to investors last week called into question China’s intention to stop buying US assets.
By Capital Economics’ count, China bought up about US$78 billion
in foreign exchange in October, and then a similar amount in November. The bank has said the purchases were necessary to counteract the hot money that has poured into the country this year.
Still, the recent moves indicate that PBOC is far from weaning itself off such buy-ups. Capital Economics pro-jected slowing appreciation of the yuan over the next two years: 5.9 yuan to the dollar at the end of this year, or 2.5% appreciation, and then just 1.7% in 2015 at 5.8 yuan to the dollar.
Other projections have varied greatly. In the face of the US Fed-eral Reserve tapering its bond buying program, which has released trillions of dollars of easy cash into emerging markets since 2008, PBOC will look to stabilize the yuan against the dollar, researchers at Bank of America Merrill Lynch said in a note in December.
The bank also pointed out that, while much money may have crossed the Hong Kong border into China this year, speculation over appreciation
of the currency onshore likely led to outflows into offshore accounts as well, something that would ease the central bank’s need to buy US treasuries.
ANZ expects “mild appreciation” in 2014.
Alex Fuste Mozo, chief economist at Andorra-based Andbank, said in an email that the yuan could appre-ciate by 3-3.5% annually for several years. Fuste Mozo looks to the market reforms for resource allocation as a signal that some state currency con-trols could be lifted. In November, the government pledged that the market would play a decisive role in the pric-ing of water, oil, power and transport.
“I interpret here, [market reforms] also in the FX arena,” he said in an email. The central bank seems to be on board with that. In an interview published in early December, PBOC deputy governor Yi Gang said many new reforms would extend to Chi-na’s currency. “Those who trust in the market,” he told a reporter, “will have great innovation.”
China Economic Review | February 2014 23
CHANGING VALUE: The yuan has strenghtened against the dollar in recent years and will continue to
do so, but how far it will go in 2014 is unclear
Growing painsIt increasingly looks like China’s economy is going to grow at a consistently lower rate and that could be a good thing
At 7.7% year-on-year GDP growth in 2013, it’s hard to tell just how much room lead-
ers in Beijing had to wield their rebal-ancing tools. Growth, which slowed in the last quarter of the year, also to 7.7% from 7.8% in the third quarter, may have given them some elbow room, but not quite enough.
Annual expansion matched that of both 2012 and 1999. During the 12 years in between, China grew by an average of 10.2% per year. So leveling out at well below 8% per year is a sig-nificant downshift from what were clearly China’s boom – and likely bub-ble – years.
Also, it was only thanks to the gov-ernment’s “targeted stimulus” in the third quarter that nudged GDP above the official 2013 goal of 7.5%. Without the quick stimulus money in July and August, which was reflected in higher-than-expected growth in the second half of the year, China may well have actually hit its target. That could have been a disaster.
Analysts have understood for months now that maintaining a rate of growth above this year’s target was cru-cial for China’s new administration, led by party boss Xi Jinping and Premier Li Keqiang. Gaining political consen-sus around strong economic growth in the hopes of pushing through painful reform in the future has been a corner-stone of Li and Xi’s first year in power. That model has even been dubbed
“Likonomics” or the “Li Keqiang Put,” after its primary designer.
What’s coming into focus now is the balance between appeasement – that is, powering the economy with cheap credit, maintaining employment and social stability and keeping state busi-nesses afloat – and rebalancing. The concept of rebalancing China has come to mean scaling back govern-ment investment, killing inefficient state firms and tightening their access to credit, all the while opening channels of credit to the real economy, namely small and medium enterprises.
This is a delicate balancing act because without strong economic growth, leaders will be wary of imple-menting reforms, many of which are
thought to be impediments to strong headline GDP.
For example, industrial produc-tion in December slowed to 9.7% from 10% a year before; fixed-asset invest-ment eased to 19.6% year-on-year from 19.9% during the first 11 months of the year. The slowing figures likely made the Xi and Li combo less confi-dent about pushing reform in the final month of the year.
“What that points to is the pace for reform was not as quick as people previ-ously expected,” said Zhang Fan, senior economist at UOB Kay Hian.
Economists at BBVA Research said in a note that the rate of growth in December was “strong enough to press ahead with reforms.” Glenn Levine, a senior economist at Moody’s Analytics, noted that, “Beneath the headline there is some economic rebalancing taking place, but not much.”
Leaders were longwinded on talk of reform last year. In several official communiques issued after high-level policy meets toward the end of the year, Xi rose a reformist flag. He called for major market reforms in areas such as state-owned enterprises, resource allocation, and even the social sphere, hitting the one-child policy and the household registration system.
For now, much of that reform-ist speak can be disregarded as far-off ambition. In 2013, the true reform-ers were at People’s Bank of China (PBOC). Centralbanking.com in Lon-
“The strategy seems to be to maintain a decent pace of overall credit growth, but to use higher rates to push banks to seek out more productive private-sector borrowers ... which will help keep GDP relatively stable as credit growth slows.”-Andrew Batson, GavKal Dragonomics
ECONOMICS & POLICY: 2013 GDP
China Economic Review | February 201424
Source: National Bureau of Statistics of China
10
8
6
4
2
0Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Quarterly GDP GrowthY-O-Y growth
2011 2012 2013
8.9%
8.1%
7.6% 7.4% 7.9% 7.7% 7.5% 7.8% 7.7%
Source: National Bureau of Statistics of China
14
12
10
8
Industrial Value Added Output
Y-O-Y growthDec 2012-Dec 2013
Dec MayMarch July Sept NovJan-Feb JuneApril Aug Oct Dec
2012 2013
10.3%9.9%
8.9% 9.3% 9.2% 8.9%
9.7%
10.4%10.2% 10.3%
10% 9.7%
0.3%9.9%
8.9% 9.3% 9.2% 8.9%
9.7%
0 %10.2% 10.3%
10% 9.7%
don didn’t give PBOC the “Central Bank of the Year” award for nothing. The PBOC drew a line in the sand between GDP growth and rebalancing and asked who was coming with it.
Not everyone was on board at first. When PBOC first tightened liquidity in the interbank market in late June, banks, analysts and investors yelped in pain. That attempt to slow credit growth in China’s shadow-banking sec-tor was so strong that it prompted the central government to launch its tar-geted stimulus a month later.
The resulting higher, short-term interbank rates have boosted the cost of financing loans, squeezing banks’ mar-gins. Therefore, they cannot continue lending to the same inefficient borrow-ers, such as well-connected firms that pay low interest rates. The banks must seek out higher-risk companies looking for longer-term loans. The hope is that the new target is small and medium firms, China’s true powerhouse for effi-ciency, innovation and employment.
“The strategy seems to be to main-tain a decent pace of overall credit growth, but to use higher rates to push banks to seek out more productive pri-vate-sector borrowers,” Andrew Batson, senior China economist at GavKal Dragonomics, said in a response to the GDP figures. “The key is to move cred-it from less to more productive uses, which will help keep GDP growth rela-tively stable as credit growth slows.”
The conditions put in place by the central bank made for a rough second half of 2013. But striking a better bal-ance between credit and GDP growth is still the No. 1 question for the new year. “The monetary policy will remain tight so it’s very likely they are think-ing about how to balance this tight
monetary policy with steady economic growth,” Zhang Fan at UOB said.
More efficient lending that powers robust economic expansion, coupled with slower credit growth, will be the
story to follow in 2014. If PBOC can dig in its heels long enough, it could give other leaders the stable footing they need to kickstart bigger financial reforms.
ECONOMICS & POLICY: 2013 GDP
Source: National Bureau of Statistics of China
45
40
35
30
25
20
15
10
5
0
30
20
10
0
Jan-Dec
2012 2013
Jan-Feb
Jan-May
Jan-Oct
Jan-March
Jan-Aug
Jan-June
Jan-Nov
Jan-April
Jan-Sept
Jan-July
Jan-Dec
Urban Fixed-asset Investment
DecFeb
MayOctrch
AugneNov
prilSept
uly Dec
20.6%
36.5
2.65.8
9.113.1
18.122.2
26.26
30.92
35.1739.1
43.65
21.2%
20.9%
20.6%
20.4%
20.1% 20.1% 20.3% 20.2%
20.1%
19.9% 19.6%
Investment (in trillion yuan) Y-O-Y growth
%20.622 2
26.26
3 230 92
35.1721.2%
20.9%
20.6%
20.4%
20.1% 20.1% 20.3% 20.2%
20.1%20.1%
19.9%9.9% 19. %9.6%
%
China Economic Review | February 2014 25
BUSINESS: RURAL LOGISTICS
Delivering the goods
Arriving in late January at their rural homes to celebrate Spring Festival, millions of
Chinese who work in the cities will sit at dinner tables surrounded by TVs, fridges and all manner of modern con-veniences. A decade ago this picture would have been very different.
Rising incomes have given farmers extra cash to pay for such goods, and it is the e-commerce revolution that has furnished many of these homes.
Between 2008 and early 2013 rural shoppers drove huge growth in the white goods market, supported by
three subsidy programs from the central government. Although those growth rates have tailed off since the schemes came to an end, the continued increase in rural earnings is creating genuine demand for such goods.
The per capita net income of rural residents grew by 10.7% to RMB7,917 (US$1,304) in 2012, according to offi-cial data. According to a survey of Chi-nese consumer confidence published by Nielsen, a research firm, residents in the lowest-tier cities and rural areas are most willing to raise their spending.
Rural consumption growth was
expected to outpace that of urban areas in 2013, said a report by a department of the Ministry of Commerce published last May.
More of this rural shopping is being done online. Farmers and their fami-lies make up almost 28% of all internet users in China, exceeding 165 million, and are the biggest source of new neti-zens. Recognizing this potential, large e-commerce firms are coming up with creative marketing strategies such as painting adverts on barnyard walls and promoting at rural wet markets.
Dispatching orders to farms can
Alibaba is on a long march to get consumer products into homes throughout rural China
WHERE THE CONSUMER IS: As rural wage growth continues to outpace that of urban areas and farmers demand access to a bigger range of consumer prod-
ucts, e-commerce companies are racing to push their delivery networks into China’s vast hinterland
China Economic Review | February 201426
BUSINESS: RURAL LOGISTICS
confound the biggest of e-retailers, however. China’s vast, geographically challenging interior cannot easily be weaved together to create the efficien-cies that are the hallmark of the most developed delivery networks.
Undeveloped infrastructure in rural areas, such as poor roads, insufficient information platforms, which increase logistical costs, and a lack of effective supervision and policy support contrib-ute to the difficulties, said Hong Tao, a professor at Beijing Technology and Business University. State management of rural logistics is also to some extent “chaotic,” Hong noted.
That’s where Alibaba Group and Haier Electronics come in.
In December, Alibaba said it would invest US$364 million to form a joint
venture with the logistics unit of Haier, the largest white goods maker in the world. Commentators have said the tie-up is targeted specifically at putting more major appliances into modest liv-ing rooms in towns and villages. Com-petition in this segment of the market is set to rise.
360Buy.com is investing billions of yuan in developing its own logistics network. Alibaba on the other hand is working with partners across the supply chain, including delivery networks and manufacturers. In addition to the Haier deal it has pledged to spend US$16 bil-lion by 2020 to develop logistics chan-nels that penetrate into China’s hinter-land.
The cost of the goods will remain important to the country’s rural people
but, when it comes to Chinese e-com-merce, winning the market is all in the delivery.
“Most online retailers in China are offering similar products with competi-tively low prices, so they have to com-pete on service such as fast and reliable delivery and returns,” said Shu Zhou, assistant professor at San Jose Univer-sity and an expert in logistics and sup-ply chains.
They can either build their own net-works or partner up, Shu wrote in a paper published last year.
If either or both options can make significant gains in delivering goods to rural markets, visitors returning home next year will likely see many more shiny products dotted around the farm.
China Economic Review | February 2014 27
On track
It seems like just yesterday that for-eign companies from Japan, Ger-many and France crammed into
Chinese boardrooms to bid on high-speed rail projects. Yet, today, it is Chi-nese state firms that are bidding on – and winning – similar projects abroad, such as the ones secured late last year in Central and Eastern Europe.
The development doesn’t just epito-mize the Chinese government’s vig-orous “going out” policy, which has pushed state-backed companies and private enterprises alike onto the inter-national stage. The quick turnaround
time demonstrates China’s vast exploits after more than 10 years of mandatory technology transfers for many foreign companies wishing to manufacture on the mainland.
At the time, companies scrambled to get into China, giving up decades worth of technological secrets for the promise of future access to the market. Now, the same companies are competing against their own technology and a rival that can greatly undercut prices for major international projects.
Nowhere is this more evident than in the global market for high-speed rail.
Siemens and ThyssenKrupp began building the Shanghai Maglev train in 2001. The line, which levitates on magnets and has always operated at a loss, was China’s first attempt to get its hands on high-speed rail technology. Both companies were required to trans-fer to a Chinese partner some of the techniques used on the line if they were to secure the contract.
In 2004, Japan’s Kawasaki, Germa-ny’s Bombardier Transportation and France’s Alstom bid on high-speed rail projects in China. The companies were required to partner with Chinese firms.
Chinese high-speed train builders are taking on multinationals in foreign markets
BUSINESS: TECHNOLOGY TRANSFER
CROSSING BORDERS: Big foreign fi rms came and signed lucrative high-speed rail deals in China as the country embarked on a rail boom but they are now going
to come face to face in international markets from assertive Chinese competitors, backed by Beijing, to whom they passed key technologies
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BUSINESS: TECHNOLOGY TRANSFER
Fast forward a decade and China has laid more than 12,000 kilometers of rail using the technology it’s learned from these partners. Lucrative deals are now kept inside the country. In December, China’s two biggest train makers, CSR and China CNR, won bids for 258 bullet trains, which could be worth as much as US$7.3 billion.
The ownership of the rail technol-ogy China has acquired and re-engi-neered during the past decade is cen-tralized squarely in the hands of China Railway Corporation, helping the country streamline projects at home and, more recently, abroad.
“In other countries it is difficult to export all the technologies since they are controlled by different companies,” Ji Jialun, a professor at the School of Traffic and Transportation at Beijing Jiaotong University, said. But in China, given the central nature of technology ownership, the state can act as a nego-tiator for projects such as these.
That’s exactly what Premier Li Keqiang did in November during a visit to Eastern Europe. China will partner with Serbia and Hungary to construct a high-speed rail line between the capitals of the two countries. During the same trip, Li also sold a Chinese partnership to construct rail lines in Romania.
China’s first international high-speed rail deal, a line in Saudi Arabia agreed to in 2009, is set to launch this year, state media has reported. Chinese rail engineers are at work in countries such as Thailand, Russia, Laos and the US. The deals are attractive to foreign countries because China not only builds them for a low price, it finances the projects too.
“They [European countries] can get more low-cost, competitive products
and their financial pressure is alleviat-ed,” said Li Hongchang, associate pro-fessor at the School of Economics and Management of Beijing Jiaotong Uni-versity. “For China, we get more shares in the international high-technology products market, which will help to drive national industrial development.”
Of course, high-speed rail is just one of several industries where China learned the ropes quickly from foreign firms and turned that technology back on the world. When Chinese govern-ment officials go abroad, they advertise nuclear power, telecommunications and satellite technology. And always at rock bottom prices.
Foreign companies are sure to reflect deeply on the past decade, where they gave up their secrets for market access, only to get out-priced on the same products just a few years later.
“They can get more low-cost, competitive products and their fi nancial pressure is alleviated ... For China, we get more shares in the international high-technology products market, which will help to drive national industrial development.” - Li Hongchang, associate professor at the School of Economics and Management of Beijing Jiaotong University
ALL ABOARD: China is building the largest high-speed rail network in the world at home but the com-
panies behind it harbor ambitions to lay tracks also in Europe and Asia
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China Economic Review | February 2014 29
Running the docks
Amid the horror stories of fail-ing Chinese shipyards and shipping lines, one area of
maritime success has largely been over-looked. Port operators, which man-age container ports and handle stor-age facilities, are doing well and are increasingly looking to expand over-seas.
In a report issued in January, ana-lysts at Barclays led by Jon Windham said they expect to see this trend con-tinuing in 2014, driven partly by Chi-na’s broader “going out” policy and a slowdown in activity at Chinese ports.
Should this pan out, then domi-nant players COSCO Pacific, a unit of a major Chinese shipping line, and China Merchants Holdings Inter-national could secure their transition from being large players with potential to sitting at the top table of global port operators.
Going global marks a significant shift from the original focus of these firms on domestic operations. As China opened up to the world and began exporting it needed the infra-structure to ship goods abroad. Vast facilities opened to connect manu-
facturing hubs on the east coast and across Guangdong province to the world.
Booming trade has provided brisk business at these ports. But China can no longer be counted on to generate huge cash flows for the firms. Global trade and manufacturing patterns are changing, meaning that international expansion is increasingly necessary if they are to maintain growth.
“China’s share of low-end manu-factured goods trade is starting to, at worst, decline and, at best, stagnate after rapidly increasing for 15 years.
Chinese managers will probably be coming soon to a port near you
BUSINESS: SHIPPING
RIDING OUT THE STORM: Chinese port operators have survived the volatiity in global shipbuilding and container shipping by tapping growing trade with emerg-
ing markets. This year will see them set sail for more foreign shores
China Economic Review | February 201430
BUSINESS: SHIPPING
Low value, but bulky goods are the life blood of container shipping and China is losing market share of US imports in apparel, shoes and furniture,” noted the Barclays report. This means fewer vessels docking at Chinese ports.
Executives at the firms are therefore looking for where the action is, or is increasingly going to be. They have racked up millions of air miles flying to South East Asia and Africa. “ASEAN and African ports will be major targets because of booming economies and growing inter-Asian trade,” said Law-rence Li, senior transport analyst at UOB Kay Hian in Shanghai.
Europe potentially offers good deals given lower asset prices in the tough economic climate there at the moment, coupled with tentative signs of a recovery in the world’s largest trading bloc. However, as Li noted, Chinese firms are mostly limited to minor stakes.
COSCO Pacific was one of the first Chinese firms to set sail for for-eign shores. Between 2003 and 2007, it snapped up minority stakes in ports in Belgium’s Antwerp, Egypt’s Suez and Singapore – all important regional shipping hubs. In 2009, it took control of half of Piraeus Port in Greece, and last year announced plans to invest around US$300 million to increase capacity.
China Merchants hasn’t been idle either, pumping in about US$2 billion into ports as far away as Nigeria, Sri Lanka and Djibouti, as well as invest-ing in French-owned Terminal Link in early 2013. It is also in talks to build a port Tanzania.
“They are trying to transform into global port operators,” said Li. Yet despite these deals, Chinese port oper-
ators are still not considered by experts to rank among the major hitters, such as APM Terminals and DP World. Drewry, a London-based maritime consultancy, says they can close this gap through international deals.
In a report published in 2013, Drewry noted the rise of COSCO Pacific and China Merchants. “Port authorities looking to tender container terminal management concessions now have two Chinese players with over-seas aspirations to assess.”
They certainly have the wind in their sales. Enviable ties to Chinese state banks and strong cash flow from domestic port operations have helped fuel their war chests. COSCO Pacific is currently packing an extra US$1.2 billion following an asset sale last year, and analysts say the company is likely to spend some of that on more terminal acquisitions in the coming years.
It could pick up some bargains. “China’s move to invest internation-ally coincides with deep distress in the container shipping industry,” said the Barclays report, noting that container liners are being forced to sell off non-core assets such as ports to pump cash
into their main business.Yet the challenges cannot be
ignored. Making foreign deals a suc-cess, as their Chinese counterparts in other sectors can attest, will require a big effort from the terminal operators.
Li noted that one of the big obsta-cles to doing deals in the US and Europe is that Chinese port operators will have to negotiate with powerful unions, in which they have little expe-rience. There are also foreign policy risks. China Merchants halted a port deal in Vietnam over territorial ten-sions with China in the South China Sea.
Protectionism is generally less of an issue. A question mark remains over whether the US would allow any large port deal, although smaller ones have been accepted. India, which is in need of big, modern-operated port facilities, remains off limits. Most other nations are welcoming.
Some initial overseas deals bode well for future. COSCO Pacific’s Piraeus port operations, analysts say, is a success. The firm has turned the port, the first to the west of the Suez Canal, into a trans-shipment hub, securing deals with the likes of Hewlett Packard.
The key driver behind the firms’ current expansion plans – a slowing Chinese economy and less container-heavy trade from China – is not going to change. This course has been set. Expect to see more Chinese managers at ports across much of the world.
What does remain to be seen is if COSCO Pacific and China Mer-chants will assume the power and reach of their biggest peers. Either way, they are keeping China’s mari-time ambitions afloat.
“ASEAN and African ports will be major targets because of booming economies and growing inter-Asian trade.”-Lawrence Li, senior transport analyst at UOB Kay Hian
China Economic Review | February 2014 31
Automated labor
China is aiming high on the industrial ladder. Getting there requires advanced equip-
ment such as robots that is still firmly in the hands of foreign enterprises.
Industrial robots are used to do things like bolt panels on cars or assemble motherboards. China is the world’s second-largest robotics mar-ket, growing on average by 25% per year between 2005 and 2012, accord-ing to the International Federation of Robotics. The country is projected to become the biggest market for indus-trial robots by 2016.
At the end of December, Kuka, a German firm, opened the doors to a new plant in Shanghai, seeking to cap-ture expanding opportunities. Kuka announced that it had won big orders for robots from the booming domestic auto industry, which produced a record number of cars in 2013.
There are few Chinese companies to compete for that business. Experts say China’s robotics industry has not developed like its other industrial machinery sectors due to a lack of gov-ernment support, insufficient demand and cultural prejudices.
However, as demand kicks up a gear on the back of further Chinese industrialization and as more small and medium firms decide to automate processes to reduce production costs, local companies may start to assemble.
The likes of Kuka, ABB of Swit-zerland, and Fanuc and Yaskawa Elec-tric of Japan have flocked to China, attracted by an explosion in auto pro-duction. More than 15 million pas-senger cars were produced in 2013, a record for China. New car plants are opening all the time; Volkswagen and General Motors are investing a com-
Foreign fi rms are expanding their efforts to play a role in Chinese robotics
BUSINESS: AUTOMATION
HUMAN COST: Once ignored by factory owners because of their hefty price tags and loathed by workers fearful for their jobs, robots that can automate production
processes are gaining acceptance in China. For now, foreign fi rms have a clear lead in the market
China Economic Review | February 201432
BUSINESS: AUTOMATION
bined US$36 billion in the country to raise capacity.
Robots are now also increasingly being sought in traditional sectors such as apparel.
The growth in the army of robots tracks rising wages. A shortage of workers in eastern China has squeezed margins and led to a double-digit jump in the cost of labor at factories. This is making automation all the more attractive. In 2011, Terry Gou, the boss of Foxconn, a Taiwanese elec-
tronics firm that makes phones and tablets for Apple, proclaimed that he wanted to introduce one million robots at his firm’s factories in China within three years – the kind that won’t pro-test working conditions or petition for higher wages.
And as more youngsters find work in shops and restaurants, previous cul-tural objections to robots as takers of once sought-after manufacturing jobs are waning, clearing the path for their adoption.
When the time comes, it is foreign firms that are set to cash in on that windfall in demand, not Chinese ones. “We [China] lack core robotics tech-nology… domestic robotics companies are still not able to make reliable and competitive products as foreign robot-ics companies,” Yueh-Hsuan Weng, Research Associate at Peking Univer-sity’s Law School, told China Eco-nomic Review.
Going on past precedents, when China starts to need certain equipment for its industrial development, it drafts policies to support domestic firms to invest and build their own capabilities. This has not yet been the case for this industry, noted Yueh-Hsuan.
At the same time, foreign invest-ment in the manufacture of the most commonly used industrial robots has been encouraged by the Ministry of Commerce. Once China feels that it has comfortably mastered a technol-ogy it starts to scale back incentives for overseas investors.
Industrial policymakers are slowly catching up. At the end of December, the Ministry of Industry and Informa-tion Technology published simple pol-icy guidelines for the robotics industry. This is the first step in encouraging domestic firms to plough cash into robotics. Further details and, crucially, incentives will need to follow at a later date.
The same trends that are attracting foreign investors into China’s robot-ics market are bound to stimulate the interest of their local counterparts. Still, Kuka has little to worry about in the immediate future, and should have plenty of time to enjoy the benefits of its expansion here.
NIMBLE FINGERS: As the Chinese labor force shrinks and fewer youngsters seek work in factories,
labor prices are going up rapidly, making robots more attractive even in industires such as textiles
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BUSINESS: MOBILE INTERNET
Coming to terms with change
There’s a lot of name calling in China’s telecommunica-tions industry. And it’s hard
to blame mobile operators when they label messaging apps or social media services freeloaders.
Over-the-top (OTT) applications such as Tencent Holdings’ messenger WeChat and Sina Corp’s micro-blog-ger Sina Weibo are largely dependent on mobile data networks to reach cus-tomers. China Mobile and the coun-try’s two other operators have spent the better part of a decade and tens
of billions of dollars putting those networks in place, only see the inter-net giants scrape off the top of their profits. When users use apps such as WeChat they don’t send texts or make calls that they have to pay for.
China Mobile, the world’s largest mobile operator with more than 760 million users, still generates nearly 70% of its revenue from traditional voice and texting services, the exact segment of the market that’s being hit as more smartphone users type and whisper messages into apps like
WeChat.The telecoms giant is lumbering
on this issue. If it considers Tencent and Sina to be taking a free ride, the internet firms likely think of China Mobile as rigid, uncreative and slow to respond to demand.
Up and over the topOperators in China have been slow to catch on to the OTT trend. Where once users made calls and sent text messages, earning fees for telecoms firms, they are increasingly commu-
China Mobile has done very well out of the growth of the digital world in the past decade, but it will now have to make nice with internet fi rms that piggyback on its platform
OVER THE TOP: Hugely popular messaging apps such as WeChat and Weibo are hurting China Mobile’s revenues as users send fewer text messages and make
fewer calls. The telecoms giant will have to fi nd ways to work with and make money from such services as it won’t be able to block them
China Economic Review | February 201434
BUSINESS: MOBILE INTERNET
nicating over the internet thanks to smartphones. That is biting hard into the telcos’ earnings.
China Mobile is the poster child for rigidity in the industry. Analysts note the behemoth’s inability to adapt to a changing technology environment or cash in on data services.
Mobile operators worldwide have experienced billions in losses to OTT services, yet many have made that money back with slick 3G and 4G networks, as they are able to charge users for data packages. China Mobile is widely scorned by Chinese users for its poor 3G network, which by most accounts has failed to bring the com-pany adequate returns. Its 4G net-work, while expected to drive the company forward, was only licensed in December and can’t be measured for success just yet.
The country’s OTT industry is one of the world’s most innovative and fastest growing, and as the industry leader in the country, China Mobile has lost the most to such services. It’s not surprising that the company has also led the way in competing directly with companies such as Tencent.
In March 2013 China Mobile said it would revamp its Fetion plat-form, an instant messaging service that launched in 2007. The service was originally intended to compete with internet-based messaging appli-cations such as Tencent’s QQ and MSN Instant Messenger, long before China’s smartphone era. The push to expand Fetion was an attempt to pull users off of WeChat and onto its homegrown service.
That effort hasn’t gained traction but China Mobile hasn’t given up. In November, the company launched a
voice-to-internet-protocol service called Jego, which functions similar to Skype.
Such a model is flawed, however. Despite herding users away from inde-pendent messaging apps, the serv-ices will not retrieve the voice and text messaging revenues that China Mobile has lost to internet firms. At best, it will “keep some users in its own garden,” Neha Dharia, a Bangalore-based telecoms analyst at research firm Ovum, said in an interview.
“It’s going to be hard to get mobile operators to compete with OTT giants because the nature of their business is so different,” Dharia said. “Mobile operators get money from voice, from text and from data. So for them to come up with an OTT service, it’s det-rimental to their own business.”
Internationally, other major mobile operators have tried to corral their users into using services that they co-developed – many to little avail. Tel-ephonica, a Spain-based global tel-ecoms firm, launched a free messaging app in May 2012 only to ditch the product little more than a year later.
Ganging up on the big guyIf building its own messaging services doesn’t work, China Mobile may have a few other tricks up its sleeve. Given that the company answers directly to the Ministry of Industry and Informa-tion Technology (MIIT), it may be able to convince the agency to tighten up regulation of the industry and even collect new fees from unfriendly busi-ness.
In March last year, it looked
EYES DOWN: Huge demand for mobile internet should provide an opportunity for profi t from lucrative
data subscriptions, if China Mobile can actually deliver a reliable service
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BUSINESS: MOBILE INTERNET
like that could happen. MIIT head Miao Wei said that OTT players, while accruing hundreds of millions of users on their services, made no con-tribution to the mobile networks on which they proliferated. He said that mobile operators might be allowed to collect fees from internet companies in the future.
Global companies have tried similar strategies to weed out pesky messag-ing apps. The Dutch telecoms firm KNP sought to add charges to the bills of users of WhatsApp, a global chat service similar to WeChat, after the company started losing revenues from text messaging. The Dutch parliament blocked the extra fee in 2012, leaving KNP at the mercy of innovative, dis-ruptive technologies.
Fears that MIIT will levy heavy fees on players like Tencent have subsided for now. That’s because China Unicom, the country’s No. 2 mobile operator, quietly announced a partnership with WeChat in August. The tie-up, a co-branded sim card that gives Unicom users exclusive emoticons, the smiley faces and animations that increasing-ly appear in messages, and a little free mobile data, demonstrated a tolerance among some mobile operators for OTT products and services developed by internet companies. But more impor-tantly, it’s a strategy to strike at the big-gest player in the market.
“China Unicom and [China] Tel-ecom are more open to the internet players. They want to cooperate with the players to compete with China Mobile,” said Vincent Fu, a principal analyst for technology and service pro-viders at research firm Gartner. “China Mobile is more concerned about them because they’re the market leader.”
China Telecom, the smallest of the three operators, has followed suit. In August, the firm formed a joint venture with Chinese internet firm Netease to launch a messaging service called Yixin. The more China Mobile pushes against new OTT services, the more China Unicom and China Tel-ecom will seek out tie-ups. By part-nering directly with Tencent, China Unicom may succeed in pulling some customers away from China Mobile. “One reason that they were cooper-ating was that China Mobile was so against WeChat. So it was their way of gaining market share,” Dharia said.
China’s two smaller mobile opera-tors are less sensitive to low text and voice revenues because they make more money from individual data users than China Mobile does. For them, more messaging and social media apps on their networks mean more revenue from data services.
Tough virtual realityIf that wasn’t enough, a new competi-
tor to mobile operators reared its head in December: Mobile virtual network operators, or MVNOs. Late last year, MIIT issued 10 licenses to companies to operate networks that can sidestep the major mobile players. A virtual network license will allow companies to rent network space from mobile operators in order to conduct their own mobile and data services.
This should be a wakeup call to China Mobile. Before long, OTT services will no longer need to use its mobile data to reach customers. If Tencent became a mobile virtual oper-ator, “it wouldn’t need to deal with China Mobile anymore,” Dharia said.
Only domestic private companies can apply for the licenses now, but Fu said there is word that the central government could open the industry to partnerships with foreign companies in the not-so-distant future, another potential shakeup to the market.
China Mobile should stop with the name calling and figure how to get in good with some of China’s most inno-vative companies before it’s too late. By partnering with companies that make popular apps, the operator can attract new customers to its network. But first it will need to generate better revenues with its 4G network than it did with its 3G blunder, which would make it less sensitive to decreasing text message income.
In the future, the operator and the internet firms should also be able to forge revenue-sharing deals that will help China Mobile get a little bit more of what it feels it deserves. “They both need each other and a lot of operators are realizing that,” Dharia said. “[Tie-ups] will happen more and more in a couple of years.”
“China Unicom and [China] Telecom are more open to the internet players. They want to cooperate with the players to compete with China Mobile ... China Mobile is more concerned about them as it is the market leader.” - Vincent Fu, a principal analyst at Gartner
China Economic Review | February 201436
MARKETS & F INANCE: CHINA IPO
False start
The re-opening of mainland securities markets to IPOs is off to a bad start.
After a 15-month pause, Jiangsu Aosaikang Pharmaceutical was one among several Chinese firms pricing for an offering in January. However, after pricing its shares at 67 times its net profit in 2012, Aosaikang said in an urgent statement that the scale of the sale was “relatively big” and that it would have to postpone the IPO.
Then five more firms said they would suspend their IPOs.
The announcements from the com-
panies smack of behind-the-scenes coercion from the China Securities Regulatory Commission (CSRC). Unnamed sources told Reuters as much. According to a report from the news agency, CSRC had pressured Aosaikang into delaying the IPO, although the regulator denies this.
But CSRC did say on its website that it would tighten its supervision over new IPOs. The regulator will do spot inspections on companies dur-ing the pricing process. Underwriters and issuers will be punished if they use information not available in pro-
spectuses. Companies will also have to warn investors if their price-to-earnings ratios are higher than the average, as Aosaikang was. Reuters said that the average for ChiNext, Shenzhen’s board for startups, was about 55.
The delayed IPOs are a bad sign for what is already one of the worst per-forming markets in the world.
On the regulation side, CSRC’s heavy hand at the onset of what was supposed to be a new era for IPOs is discomforting. Last year closed with a commitment from China’s top lead-ers to move the market away from
China is trying to reopen its IPO market, but it’s not going according to plan
WAIT A BIT LONGER: Regulators said at the beginning of the January that around 50 companies had been approved to list on various domestic stock markets
but the problems of state interference and overly high share pricing still plague the system
China Economic Review | February 2014 37
MARKETS & F INANCE: CHINA IPO
a rigid yet unpredictable regulation system run by the CSRC to something more akin to the registration systems used in developed markets.
In a registration system, instead of trying to hit moving regulation targets set by officials, which often shrink with the amount of liquidity in the market, companies would be required only to meet basic listing requirements before IPOs. The rest would be decided by the market.
Zhao Xijun, Vice Director of Peking University’s Finance and Secu-rities Institute, told China Economic Review in November it was likely that, when mainland markets re-opened to IPOs, CSRC would adopt such a system. There is still a chance that could happen at a meeting in March, the first opportunity the regulator will have to change the rules. However, the increased controls on IPOs are not promising.
China market watchers are hoping the move was a one-off from a jittery CSRC, worried that companies will be greatly overvalued and once again sap liquidity from an already dry market.
Another distressing sign from the Aosaikang affair is its PE ratio. At 67 times its net profit in 2012, investors are showing an eagerness to buy up shares on par with the mentality that led to boom and bust in the market in 2006 and 2007. The firm had priced at US$12.06 per share, rather high for a company that is testing the waters of a stagnant market.
If the true test of the value of com-panies will be left up to the market to decide, it will take much more savviness on the part of investors, not a free-for-all come IPO time.
In the statement, CSRC hinted at tougher punishments for companies and underwriters that conceal infor-mation from investors. That kind of talk is welcome. As Zhao pointed out in November, only increased culpa-bility for cheaters will make investors safe. Handing out prison sentences to
offenders will be difficult, given the close ties between company executives and the regulator itself.
It has few other choices, though, if China really wants to “play the stock exchange game,” as investors, many of whom are elderly citizens, call it today in China.
Chinese IPO stocks: Overpriced?In early January six companies said
they were suspending their IPOs. Of
those six companies, fi ve were due
to list on ChiNext, China’s NASDAQ-
style board of growth enterprises (see
table). The news triggered worries
among analysts and industry watch-
ers that regulators were still meddling
with the IPO system despite promises
late last year that investors and the
market would be left alone to price the
shares of companies going public. On
January 12, China Securities Regula-
tory Commission (CSRC) announced
that it would further tighten supervi-
sion of IPOs, a move which analysts
said was likely aimed at protecting
the interests of the millions of indi-
viduals who comprise the majority of
investors in mainland China stocks.
Many of those investors have lost
large sums of money in recent years
after buying into overpriced IPOs and
seeing the share prices of those fi rms
drop. In its announcement, CSRC said
that any company that priced its IPO
at a premium to its industrial peers in
the secondary market, measured by
the price-to-earnings ratios, would
need to hold back from opening sub-
scriptions to retail investors by three
weeks while at same time making any
risks known. The regular also said it
would conduct random spot checks
of book-building and roadshows in a
bid to keep companies in check.
* ChiNext, January 20, 2014
Source: China Securities Investor Protection Fund
Listing on ChiNextOffer price (RMB per share)
Average PE ratio*
70
60
50
40
30
20
10
0
80
70
60
50
40
30
20
10
0
Post-offering PE ratio
Jiangsu Aosaikang
Pharmaceutical
Netposa
Technologies
Hebei Huijin
Electromechanical
NSFocus Information
Technology
Beijing Forever
Technology
age PE ratio*
Jiangsu Aosaikangetposa Hebei Huijin NSFocus Information Beijing Forever
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