Country Report China March 2013

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Country Report

China

Generated on April 3rd 2013

Economist Intelligence Unit20 Cabot SquareLondon E14 4QWUnited Kingdom

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Symbols for tables

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China

ForecastHighlights

Outlook for 2013-17 Political stability

Election watch

International relations

Democracy index: China

Policy trends

Fiscal policy

Monetary policy

International assumptions

Economic growth

Inflation

Exchange rates

External sector

Forecast summary

Quarterly forecasts

Data and charts Annual data and forecast

Quarterly data

Monthly data

Annual trends charts

Quarterly trends charts

Monthly trends charts

Comparative economic indicators

Summary Basic data

Political structure

Recent analysisPolitics Forecast updates

Analysis

Economy Forecast updates

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China 1

Country Report March 2013 www.eiu.com © Economist Intelligence Unit Limited 2013

HighlightsEditor: Tom Rafferty

Forecast Closing Date: February 20, 2013

Outlook for 2013-17

The handover of power to a new generation of leaders, which began at the November 2012 congress of theruling Chinese Communist Party (CCP), will be completed at the March meeting of the National People'sCongress.Although the elevation of a younger set of leaders will lead to some shifts in government policy, the relativelyconservative line-up unveiled at the party congress suggests that prospects for political liberalisation in 2013-17 are low.Moves to raise incomes, and thus spending, among the less well-off will form part of the government's effortsto expand the role of consumption in driving economic growth in the forecast period.Monetary policy will return to a tightening stance in 2013 as inflation and economic growth accelerate. Theauthorities will gradually liberalise interest rates in 2013-17, and this will result in rates drifting higher.Economic expansion will average 7.6% a year in the forecast period. Private consumption, rather thaninvestment, will be the main driver of growth.The current account is forecast to move into deficit from 2016, from an estimated surplus equivalent to 2.6% ofGDP in 2012, as growth in imports of goods and services outpaces that of exports.

Review

The anti-graft drive launched by the new CCP leadership has showed few signs of being effective. A corruptformer deputy party secretary of Shanxi province, Hou Wujie, was released early from prison in February.China said that it was "firmly opposed" to a suspected nuclear test carried out on February 12th by NorthKorea. But it also called for a "calm response" to the incident, highlighting its unwillingness to abandon itslong-term ally.In a sign that it may be tightening monetary policy, in mid-February the People's Bank of China (the centralbank) withdrew liquidity from the economy through open-market operations for the first time since June 2012.On February 5th the State Council (the cabinet) published a list of guidelines aimed at reducing incomeinequality. Many of the policies put forward are vague or bear resemblance to existing plans.China's official manufacturing purchasing managers' index (PMI) slipped fractionally in January, to 50.4, from50.6 in the previous month. However, the PMI produced by HSBC strengthened to reach a two-year high.China's exports grew in value by 25% year on year in January, according to the country's customs bureau,while imports climbed by 28.8%. The trade figures were distorted by the timing of the Chinese New Year.

China 2


Outlook for 2013-17

Political stabilityThe political dominance of the Chinese Communist Party (CCP) is not expected to be challenged in 2013-17. Factionalstruggles within the party are more likely to be a source of political instability. However, with the battle for the mostsenior positions having been settled by the outcome of the CCP congress in November 2012, the risk of an outbreakof severe factional conflict will be low in the early part of the forecast period. The transition to a new generation ofpolitical leaders will be completed at the annual meeting of the National People's Congress (the legislature) in March2013.

The figures promoted to the CCP politburo standing committee (PSC, China's most powerful political body) at theparty congress were largely conservatives. Notable reformers failed to make the PSC. The one prominent reformer whodid, Wang Qishan, gained only a low-ranked placement and was moved out of his core area of policy expertise ineconomic affairs to a poisoned-chalice posting in the anti-corruption bureau. The new leadership has launched a freshcampaign against graft, but it is likely to be as ineffective as similar drives in the past. Corruption within the CCP is soentrenched that any bold moves to tackle it would risk destabilising the political system, suggesting that theauthorities will refrain from ramping up the powers of internal disciplinary organs (let alone steps granting the press orjudiciary greater oversight of the party). The failure to tackle corruption, or engage in substantive political reform,increases the potential for a severe bout of economically destabilising volatility. However, serious unrest is not theEconomist Intelligence Unit's core forecast in 2013-17.

The government will continue to face myriad sources of political tensions generated by social problems ranging fromenvironmental pollution to conspicuous levels of income inequality. Disputes in the countryside will remain localised,and there is little potential for such protests to develop into wider movements that might threaten national stability.Unrest in urban areas could pose a greater threat. It remains possible that in an economic or political crisis anti-government forces could coalesce in a way that would be hard to control without bloodshed. Notably, the nascentforce of labour activism, especially in high-skill industries, could prove troublesome.

Separatist movements will remain weak, but unrest will occasionally erupt in the ethnic-minority regions of Tibet andXinjiang, and related incidents of terrorist violence elsewhere are possible. Large-scale violence broke out in Tibet in2008 and in Xinjiang in 2009. There is a risk, albeit small, that separatism in Xinjiang will escalate into a full-blowninsurgency. The Tibetan separatist movement could also grow more violent when the exiled Tibetan spiritual leader,the Dalai Lama, dies. China's government shows no signs of adjusting the harsh approach it takes towards separatistand ethnic unrest. It will increase development expenditure in Xinjiang and Tibet in an attempt to pacify these regionsby improving economic opportunities, but this tactic has failed in the past.

Election watchSince China's outgoing administration, headed by the president, Hu Jintao, and the premier, Wen Jiabao, came topower a collective-style government has emerged. A reconfiguration of the political leadership began in November2012, when the CCP's 18th congress selected its new party leadership. Xi Jinping, who succeeded Mr Hu as CCPgeneral secretary at the conclave, will also replace him as China's president in March 2013, when the installation of anew state leadership takes place. The current executive vice-premier, Li Keqiang, who is ranked second on the PSC,will succeed Mr Wen as premier. The fact that Mr Xi and Mr Li are set to serve three terms each on the PSC, retiring in2022, will put them in an advantageous position over the other members of the committee, who will serve only oneterm because of CCP age limits. Mr Xi's authority has also been strengthened by Mr Hu's decision to hand to himcontrol of the CCP committee that oversees the military in November 2012.

China 3


International relationsChina will be a crucial participant in international negotiations on a range of economic and diplomatic issues, but it ishighly sensitive to perceived slights, interference in its internal affairs and what it characterises as attempts to curb itsrise. Its ability to deal effectively with other major powers is hampered by the weak influence within China of theMinistry of Foreign Affairs.

Since assuming power, the few comments made by Mr Xi on foreign policy indicate that the more forceful approachadopted by China on the global stage in recent years will continue under his leadership. The country is likely to beinvolved in a number of disputes with its neighbours in 2013-17, as concerns about its power-projection capabilitiesgrow. The territorial dispute between China and Japan over the Senkaku islands (known as the Diaoyu islands inChina) will linger dangerously, particularly since the election in December 2012 of a new government in Japan, whichhas promised to pursue a tougher line towards China.

China’s claim on Taiwan will remain a foreign policy priority, but the status quo looks set to endure. The suspectednuclear test carried out by North Korea in February 2013 angered the Chinese government, but it will continue toview engagement of its longterm ally as the best means to curb the North's belligerence. China’s expandinginternational interests have been highlighted by increased activity in fields such as peacekeeping and anti-piracypatrols. This trend will continue, but military intervention by China to defend its interests in territory that it does notclaim as its own looks unlikely in the short term. The greatest source of Chinese influence on the global stage will bethe desire of foreign governments and companies to tap China's vast market and also to attract Chinese investment.

Democracy index: ChinaThe Economist Intelligence Unit's 2012 democracy index ranks China 142nd out of 167 countries, putting it among theclass of governments considered "authoritarian" regimes. This puts it in the company of countries such as Angola,Belarus and Vietnam. China's failure to engage in any form of substantive electoral process involving its people is themain reason for its low overall score of 3 (out of 10). The government's mistrust of popular engagement in politicsalso results in a suppressed political participation score of 3.89, reflecting among other factors the absence of amultiparty system. The civil liberties category also receives a very low score, at 1.18, which highlights thesubordination of judicial, trade union and religious bodies to the all-dominating Chinese Communist Party (CCP). Thepoor score for this category is also the result of China's lack of freedoms in areas such as the Internet, newspapersand broadcast media.

Democracy indexRegime type Overall score Overall rank

2012 Authoritarian 3.00 out of 10 142 out of 167



Slower economic growth and political transition will impede reform

China’s low overall democracy index score obscures respectable performances in government functioning andpolitical culture for a country of China’s level of development. This in part reflects a compromise whereby the Chinesepeople have tacitly accepted minimal political freedoms in exchange for competent economic management by the CCP.However, China's transition to a slower rate of economic growth may challenge this bargain, as will growing politicalawareness among the population (aided by an explosion in social media). Official corruption remains a lightning-rodissue for those dissatisfied with the system, as it exposes the gulf between the political leadership and the mass of thepublic whom it is meant to represent. Against this background, the authorities are likely to introduce measures both toenhance bureaucratic transparency, as well as to develop more sophisticated forms of "social management" aimed atmaintaining stability and curbing dissent. This, in addition to the efficiency of the security forces, will allow theauthorities to keep a lid on discontent without having to engage in substantive political reform. The CCP will beparticularly sensitive to any perceived threat to its power in 2013, as it completes a process begun last year ofoverhauling its main party and government personnel, including those in senior leadership positions. On a morepositive note, underlying social development, including the emergence of civil-society groups and legal and mediaactivism, will still progress, especially at the local level, despite the heavy restraints imposed by the CCP leadership.

Democracy index, 2012, by category(on a scale of 0 to 10)

Electoral process Functioning of government Political participation Political culture Civil liberties

0.00 4.64 3.89 5.00 1.47

China 4


A free white paper containing the full index and detailed methodology can be downloaded fromwww.eiu.com/DemocracyIndex2012.

Note on methodology

There is no consensus on how to measure democracy and definitions of democracy are contested. Having free andfair competitive elections, and satisfying related aspects of political freedom, is the sine qua non of all definitions.However, our index is based on the view that measures of democracy that reflect the state of political freedom andcivil liberties are not "thick" enough: they do not encompass sufficiently some crucial features that determine thequality and substance of democracy. Thus, our index also includes measures of political participation, political cultureand functioning of government, which are, at best, marginalised by other measures.

Our index of democracy covers 167 countries and territories. The index, on a 0 to 10 scale, is based on the ratings for60 indicators grouped in five categories: electoral process and pluralism; civil liberties; the functioning of government;political participation; and political culture. The five categories are inter-related and form a coherent conceptual whole.Each category has a rating on a 0 to 10 scale, and the overall index of democracy is the simple average of the fivecategory indexes.

The category indexes are based on the sum of the indicator scores in the category, converted to a 0 to 10 scale.Adjustments to the category scores are made if countries fall short in the following critical areas for democracy:

whether national elections are free and fair;the security of voters;the influence of foreign powers on government; andthe capability of the civil service to implement policies.

The index values are used to place countries within one of four types of regimes:

full democracies—scores of 8 to 10;flawed democracies—score of 6 to 7.9;hybrid regimes—scores of 4 to 5.9;authoritarian regimes—scores below 4.

Thresholds for regime types depend on overall scores that are rounded to one decimal point.

Policy trendsRebalancing the economy further away from its dependence on investment will be a crucial goal over the next fewyears. The reluctance of the authorities to relax the tight policies governing the housing sector, or to launch a bigstimulus drive, in response to the economic slowdown in 2012 was a sign of its commitment to this aim. To boost therole of consumption in driving economic growth in 201317, the government will look to raise the incomes of the lesswell-off. Redistributive tax reforms could be enacted, and officials will support workers' efforts to secure substantialpay increases. The household registration (hukou) system, which prevents migrant workers from accessing statewelfare services in localities other than their place of birth, may also be relaxed in order to encourage urbanisation.Despite growth in spending on health, education, pensions and poverty alleviation in the forecast period, theseservices will remain underdeveloped.

A daunting array of reforms is needed in 2013-17 to sustain economic growth in the medium term. Wages are subjectto a number of upward pressures, reducing the advantages that China has enjoyed as a low-cost manufacturinglocation. Moving the economy up the value chain, through the cultivation of high-technology industries and acompetitive services sector, will therefore be a policy priority in 2013-17. The need to curb pollution generated byheavy industries will provide a further incentive for restructuring. However, the difficult changes that this transition islikely to require will be resisted by a variety of vested interests. The restructuring of state-owned enterprises andbanks looks set to be a key battleground, as efforts are likely to be made in the next five years to increase competitionin the sectors that they monopolise. The potential for substantive reforms in the state sector has been reduced by theconservative slant of the new PSC.

China 5


Fiscal policyThe budget deficit is estimated at the equivalent of 1.6% of GDP in 2012, and The shortfall is expected to average 1.8%of GDP in 2013-17. Higher spending will be concentrated on education, healthcare and other forms of social welfare.At central government level, revenue growth will remain strong as the economy continues to expand. But thegovernment's financial position is not as healthy as the headline figures suggest. The extent of off-budget fiscaltransactions, including much defence spending, is large (albeit hard to quantify), and the quality of data on localgovernment finances is poor. Local authorities' fiscal positions have worsened as borrowing by entities under theircontrol to fund economic development has risen dramatically. Many loans have apparently been rolled over ratherthan repaid. There is widespread agreement on the need to reform the fiscal system in order to address thedeficiencies of local government finances (including a dangerous dependence on land sales for revenue), but littleconsensus on the means of doing so. The mooted nationwide extension of a pilot property tax in 2013 will provideonly a modest new revenue stream for local governments, while proposals to allow local authorities to issue bondsdirectly remain at the exploratory stage.

Monetary policyIn 2013 the People's Bank of China (PBC, the central bank) is likely to shift from the accommodative policy stance ithas maintained since late 2011 as inflationary concerns re-emerge. In an indication that it has already begun to leantowards monetary tightening, in February the PBC auctioned its first forward bond repurchase agreements since June2012. We expect benchmark interest rates to be raised from the second half of the year. In the medium term, theauthorities are committed to a policy of moving away from artificially suppressing interest rates—two rate cuts in mid2012 were accompanied by measures that relaxed restrictions on banks' ability to set rates freely. The PBC will pushfor interest rate liberalisation in 2013-17 as part of a broader effort to move the economy towards consumption-ledgrowth, with the result that rates will drift higher. Low or negative returns on deposits have until now allowed cheaploans to be channelled to corporate investors, while depressing growth in household incomes.

International assumptions 2012 2013 2014 2015 2016 2017

Economic growth (%)

US GDP 2.2 2.1 2.4 2.3 2.3 2.4

OECD GDP 1.3 1.4 2.2 2.2 2.2 2.2

World GDP 2.1 2.3 2.9 2.9 2.9 3.0

World trade 2.9 4.2 5.2 5.4 5.5 5.6

Inflation indicators (% unless otherwise indicated)

US CPI 2.1 2.2 2.5 2.2 2.3 2.3

OECD CPI 2.2 2.1 2.3 2.2 2.2 2.2

Manufactures (measured in US$) -0.6 -1.0 1.2 0.6 1.1 1.8

Oil (Brent; US$/b) 112.0 104.5 104.8 107.3 110.0 115.0

Non-oil commodities (measured in US$) -10.8 -0.4 -1.5 1.4 1.9 1.9

Financial variables

US$ 3-month commercial paper rate (av; %) 0.2 0.2 0.2 0.3 1.2 2.2

¥ 3month money market rate (av; %) 0.2 0.2 0.2 0.4 1.1 1.4

¥:US$ (av) 80.0 92.8 94.5 96.3 97.5 96.5

Rmb:US$ (av) 6.31 6.26 6.23 6.16 6.10 6.04

China 6


Economic growthReal GDP growth slowed to 7.8% in 2012, from 9.3% in 2011. Weak demand for Chinese exports, and deceleratinggrowth in property investment (as well as activity in associated sectors), held back economic expansion in 2012, butstrong growth in income continued to support private consumption. Looser monetary policy and investment ingovernment-backed infrastructure projects drove an acceleration in real GDP growth in the fourth quarter of 2012. Asthis momentum carries over, economic expansion will accelerate to 8.5% in 2013. Investment will further benefit from amodest upturn in real-estate development, and external demand will pick up slightly, in line with marginally fasterglobal GDP growth.

Economic expansion will gradually decelerate in the remainder of the forecast period, slowing to 6.5% by 2017. Thiswill partly reflect slowing growth in investment as higher input costs make property and infrastructure developmentmore expensive. However, rapid job creation and rising wages should ensure strong private consumption growth. Aslocal demand increases rapidly, growth in imports will outpace export expansion, and the foreign balance willconsequently subtract from GDP growth. Export growth will nevertheless remain impressive, largely owing toemerging-market demand, despite the negative impact on overseas sales of an appreciating renminbi and rising costsin China.

We are not optimistic about the prospects for economic expansion in the long term under China's new leaders, as theylook unlikely to be committed to pursuing the types of policy needed to support productivity growth. The possibilityalso remains that China will suffer a sharp slowdown in GDP growth in 2013-17, with political unrest and problems inthe housing sector being the most likely sources of turbulence. The government’s capacity to counteract economiccrises is strong, but doing so might aggravate other economic imbalances.

Economic growth% 2012a 2013b 2014b 2015b 2016b 2017b

GDP 7.8c 8.5 7.8 7.7 7.3 6.5

Private consumption 9.9 9.7 9.6 9.3 9.0 8.8

Government consumption 11.0 8.9 9.1 8.9 8.6 8.8

Gross fixed investment 7.4 8.5 7.7 7.2 6.6 5.4

Exports of goods & services 6.1 8.3 7.6 7.3 6.6 6.1

Imports of goods & services 5.6 9.7 9.2 8.5 8.1 7.8

Domestic demand 7.7 9.0 8.5 8.2 8.0 7.2

Agriculture 4.5c 4.2 3.6 3.1 2.6 2.5

Industry 8.1c 8.5 7.9 7.7 7.4 6.0

Services 8.1c 9.5 8.6 8.5 8.1 7.9a Economist Intelligence Unit estimates. b Economist Intelligence Unit forecasts. c Actual.

InflationThe rate of consumer price inflation slowed to 2.6% on average in 2012, reflecting a deceleration in economic growthand moderating global commodity prices. However, in the forecast period strong liquidity growth and boomingdemand will generate upward inflationary pressures. We expect inflation to average 4.1% a year in 2013-17, but thereare upside risks to our forecast. Food and transport costs in China are exposed to volatility in global oil prices. Localagricultural costs, meanwhile, are dependent on the vagaries of the weather, and pork prices entered a new cyclicalupswing in early 2013.

Producer prices, which fell in 2012, will be subject to upward forces in 2013-17, partly as a result of policy-drivenincreases in utility costs. Producer prices are expected to rise by 3.9% a year on average in 2013-17, and soaring wageswill have a particularly strong impact on prices for labour-intensive agricultural products. There is a danger thatspeculative asset price bubbles could re-emerge in the forecast period. The risk of such bubbles would increaseshould progress towards interest rate liberalisation stall, as this would encourage savers to channel their money intowealth-management products and investment vehicles instead of tolerating low or negative real returns on deposits inthe formal banking system.

China 7


Exchange ratesChina's trade surplus as a proportion of GDP is forecast to fall to modest levels in the forecast period, while thecurrent account will move into deficit in 2016. The country will thus be in a strong position to resist external pressureto allow a faster rate of currency appreciation. The renminbi is now probably close to a market-determined level, withthe consequence that greater volatility in its value, including bouts of depreciation, is likely in the next five years. Therenminbi's daily trading band against the US dollar is likely to be widened further, thereby permitting market forces toplay a greater role in determining the currency's value.

We still believe that the renminbi will strengthen against the US dollar in 2013-17, by an annual average of 0.9%,owing to forecast higher productivity growth in China than in the US. The fact that the pace of appreciation will beonly modest will partly reflect the strength of the US currency in the period; the renminbi will rise more swiftly againstthe euro and the yen, with the strengthening trend particularly strong against the latter owing to forecast loosemonetary policy in Japan. However, the risk of renminbi depreciation in 2013-17 is significant.

External sectorChina's current-account balance is expected to move from an estimated surplus equivalent to 2.6% of GDP in 2012 to adeficit of 1.2% by 2017. Merchandise exports will grow by 9.4% a year on average in 2013-17, more slowly than inrecent years, owing to the erosion of the country's price competitiveness. A large proportion of China's importsconsist of components that are assembled locally before being shipped overseas, and imports and exports thereforetend to expand at similar rates. However, a growing proportion of imports are used to make goods for localconsumption. Partly as a result, merchandise import growth will outpace export expansion in the forecast period, withimports increasing by 12.5% a year on average.

The services deficit will widen considerably in the forecast period, largely owing to a surge in overseas travel byChinese tourists. Exports of services will also grow strongly, reflecting the rising earnings of Chinese companiesworking on infrastructure projects abroad. The current transfers account will move into deficit from 2013 as thenumber of foreigners remitting earnings from China increases significantly in 2013-17, particularly in low-skillprofessions. As the Chinese authorities try to make the renminbi an international currency, controls on capital flowsinto and out of the country will be relaxed significantly. Outward direct investment will increase rapidly as domesticcompanies look to access new markets and acquire foreign brands and technology. The government will also expandquotas under the qualified foreign institutional investor (QFII) scheme as it looks to deepen the local securities andbond markets.

Forecast summaryForecast summary(% unless otherwise indicated)

2012a 2013b 2014b 2015b 2016b 2017b

Real GDP growth 7.8 8.5 7.8 7.7 7.3 6.5

Industrial production growth 10.0 11.5 9.6 9.4 8.9 7.5

Gross agricultural production growth 4.5 4.2 3.6 3.1 2.6 2.5

Unemployment rate (av) 6.5c 6.4 6.1 5.8 5.5 5.0

Consumer price inflation (av) 2.6 4.3 4.1 3.9 4.2 4.0

Consumer price inflation (end-period) 2.5 5.1 4.5 3.9 4.2 4.0

Short-term interbank rate (end-period) 6.0c 6.8 7.5 7.5 7.8 7.8

Government balance (% of GDP) -1.6c -2.0 -1.9 -1.9 -1.8 -1.3

Exports of goods fob (US$ bn) 2,054.3c 2,265.8 2,483.8 2,717.4 2,959.1 3,213.0

Imports of goods fob (US$ bn) 1,733.7c 1,939.3 2,194.4 2,467.0 2,774.8 3,121.1

Current-account balance (US$ bn) 217.6c 169.4 83.0 19.5 -62.5 -178.0

Current-account balance (% of GDP) 2.6c 1.8 0.8 0.2 -0.5 -1.2

External debt (end-period; US$ bn) 726.8c 814.7 923.9 1,032.3 1,170.0 1,329.1

Exchange rate Rmb:US$ (av) 6.31 6.26 6.23 6.16 6.10 6.04

Exchange rate Rmb:US$ (end-period) 6.29 6.25 6.20 6.14 6.06 6.03

Exchange rate Rmb:¥100 (av) 7.89 6.75 6.59 6.40 6.25 6.26

Exchange rate Rmb:€ (endperiod) 8.26 8.25 8.09 7.70 7.64 7.59a Actual. b Economist Intelligence Unit forecasts. c Economist Intelligence Unit estimates.

China 8


Quarterly forecastsQuarterly forecasts 2012 2013 2014

1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

GDP

% change, quarter on quarter 1.9 1.4 2.1 2.3 2.2 1.9 1.9 1.8 1.8 1.9 2.1 2.2

% change, year on year 8.1 7.6 7.4 7.9 8.3 8.9 8.7 8.1 7.6 7.6 7.8 8.2

Consumer prices

% change, quarter on quarter 1.2 -0.4 0.1 0.6 2.2 1.1 1.1 0.7 1.6 0.0 1.4 1.2

% change, year on year 3.8 2.9 2.0 1.6 2.6 4.1 5.1 5.2 4.6 3.5 3.8 4.3

Producer prices

% change, quarter on quarter -0.7 1.4 -1.6 -0.3 0.3 1.4 2.7 1.8 0.7 0.7 0.6 0.6

% change, year on year 0.1 -1.4 -3.3 -1.2 -0.2 -0.2 4.2 6.4 6.8 6.0 3.8 2.6

Exchange rate Rmb:US$

Average 6.31 6.31 6.33 6.30 6.28 6.26 6.26 6.26 6.26 6.25 6.22 6.20

End-period 6.29 6.33 6.34 6.29 6.27 6.26 6.26 6.25 6.25 6.24 6.21 6.20

Interest rates (%; av)

Money market rate 5.3 5.0 4.0 4.2 4.3 4.4 4.7 5.3 5.7 5.8 5.9 5.9

China 9


Data and charts

Annual data and forecast 2008a 2009a 2010a 2011a 2012b 2013c 2014c

GDP

Nominal GDP (US$ bn) 4,547 5,105 5,950 7,212 8,223 9,403 10,643

Nominal GDP (Rmb bn) 31,598 34,877 40,282 46,600 51,904 58,912 66,321

Real GDP growth (%) 9.6 9.2 10.4 9.3 7.8a 8.5 7.8

Expenditure on GDP (% real change)

Private consumption 8.5b 9.8b 8.5b 10.2b 9.9 9.7 9.6

Government consumption 8.8b 8.5b 11.2b 12.1b 11.0 8.9 9.1

Gross fixed investment 9.8b 22.6b 11.5b 8.7b 7.4 8.5 7.7

Exports of goods & services 4.8b -4.1b 19.0b 7.3b 6.1 8.3 7.6

Imports of goods & services 3.9b 4.5b 20.7b 9.4b 5.6 9.7 9.2

Origin of GDP (% real change)

Agriculture 5.4 4.2 4.3 4.3 4.5a 4.2 3.6

Industry 9.9 9.9 12.3 10.3 8.1a 8.5 7.9

Services 10.4 9.3 9.8 9.4 8.1a 9.5 8.6

Population and income

Population (m) 1,297b 1,305b 1,313b 1,321b 1,329 1,336 1,343

GDP per head (US$ at PPP) 6,418b 7,028b 7,816b 8,672b 9,472 10,429 11,414

Fiscal indicators (% of GDP)

General government revenue 19.4 19.6 20.6 22.3 22.6 22.6 23.0

General government expenditure 19.8 21.9 22.2 23.4 24.2 24.6 24.9

General government balance -0.4 -2.2 -1.6 -1.1 -1.6 -2.0 -1.9

Net public debt 15.1b 16.4b 16.1b 15.3b 15.6 16.0 16.3

Prices and financial indicators

Exchange rate Rmb:US$ (end-period) 6.84 6.83 6.62 6.30 6.29a 6.25 6.20

Exchange rate ¥:Rmb (endperiod) 9.51 9.84 8.85 8.15 8.26a 8.25 8.09

Consumer prices (end-period; %) 1.2 1.9 4.6 4.1 2.5a 5.1 4.5

Producer prices (av; % change) 6.9 -5.4 5.5 6.0 -1.7a 2.6 4.7

Stock of money M1 (% change) 9.0 33.2 20.4 8.7 6.5 8.6 9.0

Stock of money M2 (% change) 17.8 28.4 18.9 17.3 13.3 13.9 14.1

Lending interest rate (end-period; %) 5.3 5.3 5.8 6.6 6.0 6.8 7.5

Current account (US$ bn)

Trade balance 360.6 249.5 254.2 243.5 320.6 326.5 289.5

Goods: exports fob 1,434.7 1,203.8 1,581.4 1,903.8 2,054.3 2,265.8 2,483.8

Goods: imports fob -1,074.1 -954.3 -1,327.2 -1,660.3 -1,733.7 -1,939.3 -2,194.4

Services balance -11.8 -29.4 -31.2 -55.2 -90.1 -121.0 -145.4

Income balance 28.6 7.3 -25.9 -11.9 -14.5 -33.3 -52.6

Current transfers balance 43.2 33.7 40.7 25.3 1.7 -2.8 -8.5

Current-account balance 420.6 261.1 237.8 201.7 217.6 169.4 83.0

External debt (US$ bn)

Debt stock 380.2 443.2 558.3 685.4 726.8 814.7 923.9

Debt service paid 33.3 39.8 63.6 78.0 41.5 50.7 60.7

Principal repayments 24.0 33.4 29.5 39.3 27.1 33.2 40.7

Interest 9.3 6.4 34.1 38.7b 14.4 17.5 20.0

International reserves (US$ bn)

Total international reserves 1,953.3 2,425.9 2,875.9 3,212.6 3,319.9 3,501.3 3,759.0a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.Source: IMF, International Financial Statistics.

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Quarterly data 2011 2012

1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Output

Real GDP (% change, year on year) 9.8 9.5 9.1 8.9 8.1 7.6 7.4 7.9

Industrial production, gross value added (1990 prices; % change, year on year) 14.9 13.9 13.8 12.8 11.9 9.5 9.1 10.0

Electricity production (% change, year on year) 12.1 12.4 10.8 8.9 6.1 1.2 2.1 7.4

Prices

Consumer prices (2000=100) 120.9 121.5 122.7 124.0 125.5 125.0 125.2 126.0

Consumer prices (% change, year on year) 5.1 5.7 6.3 4.6 3.8 2.9 2.0 1.6

Financial indicators

Exchange rate Rmb:US$ (av) 6.58 6.50 6.42 6.34 6.31 6.31 6.33 6.30

Exchange rate Rmb:US$ (end-period) 6.56 6.47 6.36 6.30 6.29 6.33 6.34 6.29

Deposit rate (end-period; %) 3.0 3.3 3.5 3.5 3.5 3.3 3.0 3.0

Prime lending rate (end-period; %) 6.1 6.3 6.6 6.6 6.6 6.3 6.0 6.0

3-month interbank rate (av; %) 4.6 5.0 5.8 5.7 5.3 5.0 4.0 4.16

Total loans 16.0 15.3 14.5 14.3 15.5 15.9 16.4 15.6

Short-term loans 21.6 24.2 25.4 27.0 22.6 22.1 22.9 23.3

Medium- & long-term loans 17.7 14.2 10.9 9.4 9.9 9.3 9.7 9.0

Urban & rural savings deposits 17.9 17.2 14.2 16.3 16.3 17.4 18.0 16.6

M1 (end-period; Rmb bn) 26,626 27,466 26,719 28,985 27,800 28,753 28,679 n/a

M1 (% change, year on year) 16.1 14.2 9.6 8.7 4.4 4.7 7.3 n/a

M2 (end-period; Rmb bn) 75,813 78,082 78,741 85,159 89,557 92,499 94,369 n/a

M2 (% change, year on year) 16.6 15.9 13.1 17.3 18.1 18.5 19.8 n/a

Shanghai “A” share price index (endperiod; Feb 21st 1992=100) 3,066 2,894 2,471 2,304 2,370 2,331 2,185 2,376

Shanghai “A” share price index (% change, year on year) -6.0 15.1 -11.2 -20.3 -22.7 -19.5 -11.6 3.1

Sectoral trends (% change, year on year)

Retail sales, consumer goods 17.1 18.2 17.3 15.8 n/a 14.0 13.8 14.5

Foreign trade (US$ bn)

Exports fob 399.6 474.6 518.0 506.3 430.1 524.6 541.3 554.1

Imports cif -401.5 -428.1 -455.3 -458.1 -429.0 -456.1 -461.8 -470.8

Trade balance -2.0 46.5 62.8 48.2 1.0 68.5 79.4 83.3

Capital flows (US$ bn)

Foreign direct investment 30.4 30.6 25.8 29.3 29.5 29.6 24.3 28.3

Foreign direct investment (% change, year on year) 29.5 9.1 12.7 -6.6 -2.8 -3.1 -5.7 -3.5

Reserves excl gold (end-period) 3,067 3,220 3,223 3,203 3,327 3,261 3,305 n/aSources: IMF, International Financial Statistics; China Statistical Information Centre; National Bureau of Statistics, China Monthly Economic Indicators; People's Bank of

China, Quarterly Statistics Bulletin.

Monthly data Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Exchange rate Rmb:US$ (av)

2011 6.60 6.58 6.57 6.53 6.50 6.48 6.46 6.41 6.38 6.36 6.34 6.33

2012 6.32 6.30 6.31 6.30 6.31 6.32 6.32 6.34 6.34 6.31 6.30 6.29

2013 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a

Exchange rate Rmb:US$ (end-period)

2011 6.59 6.58 6.56 6.50 6.49 6.47 6.44 6.39 6.36 6.32 6.35 6.30

2012 6.31 6.29 6.29 6.28 6.34 6.33 6.33 6.35 6.34 6.30 6.29 6.29


Real effective exchange rate (2000=100; CPI basis)

2011 110.20 109.83 109.47 109.02 109.43 110.42 110.48 111.10 114.21 115.58 115.99 117.07

2012 117.93 115.73 117.55 117.92 118.98 119.89 119.70 118.71 117.01 117.95 119.52 n/a


Money supply M1 (% change, year on year)

2011 14.0 15.6 16.1 14.0 13.9 14.2 12.4 11.9 9.6 9.2 8.5 8.7

2012 3.2 4.3 4.4 3.1 3.5 4.7 4.6 4.5 7.3 6.1 5.5 6.5

2013 15.3 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a

Money supply M2 (% change, year on year)

2011 17.3 15.7 16.6 15.4 15.1 15.9 14.7 13.6 13.1 12.9 12.7 13.6

2012 12.4 13.0 13.4 12.8 13.2 13.6 13.9 13.5 14.8 14.1 13.9 13.8


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Deposit rate (end-period; %)

2011 2.8 3.0 3.0 3.3 3.3 3.3 3.5 3.5 3.5 3.5 3.5 3.5

2012 3.5 3.5 3.5 3.5 3.5 3.3 3.0 3.0 3.0 3.0 3.0 3.0


Prime lending rate (end-period; %)

2011 5.8 6.1 6.1 6.3 6.3 6.3 6.6 6.6 6.6 6.6 6.6 6.6

2012 6.6 6.6 6.6 6.6 6.6 6.3 6.0 6.0 6.0 6.0 6.0 6.0


Industrial production (% change, year on year)

2011 n/a 14.9 14.8 13.4 13.3 15.1 14.0 13.5 13.8 13.2 12.4 12.8

2012 n/a n/a 11.9 9.3 9.6 9.5 9.2 8.9 9.2 9.6 10.1 10.3


Retail sales of consumer goods (% change, year on year)

2011 19.9 11.6 20.0 18.6 18.0 18.1 17.6 17.0 17.2 15.8 15.9 15.7

2012 n/a n/a 15.2 14.3 13.7 13.9 13.2 13.3 14.9 14.4 14.6 14.6


Shanghai “A” share price index (endperiod; Feb 21st 1992=100)2011 2,922 3,042 3,066 3,049 2,873 2,894 2,829 2,689 2,471 2,585 2,444 2,304

2012 2,402 2,544 2,370 2,510 2,485 2,331 2,204 2,144 2,185 2,166 2,073 2,376

2013 2,497 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a

Consumer prices (av; % change, year on year)

2011 4.9 4.9 5.4 5.3 5.5 6.4 6.5 6.2 6.1 5.5 4.2 4.1

2012 4.5 3.2 3.6 3.4 3.0 2.2 1.8 2.0 1.9 1.7 2.0 2.5


Producer prices (av; % change, year on year)

2011 6.6 7.2 7.3 6.8 6.8 7.1 7.5 7.3 6.5 5.0 2.7 1.7

2012 0.7 0.0 -0.3 -0.7 -1.4 -2.1 -2.9 -3.5 -3.6 -2.8 -2.2 -1.9

2013 -1.6 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a

Total exports fob (US$ bn)

2011 150.7 96.7 152.2 155.6 157.1 161.9 175.2 173.3 169.6 157.3 174.3 174.6

2012 149.8 114.5 165.7 163.3 181.1 180.2 176.9 178.0 186.4 175.5 179.3 199.2


Total imports cif (US$ bn)

2011 144.8 104.6 152.2 144.4 144.0 139.7 145.0 155.4 155.0 140.2 159.7 158.1

2012 122.7 146.0 160.4 144.8 163.0 148.4 151.8 151.4 158.7 143.4 159.8 167.6


Trade balance fob-cif (US$ bn)

2011 5.9 -7.9 0.0 11.2 13.1 22.2 30.2 17.9 14.6 17.1 14.6 16.5

2012 27.2 -31.5 5.4 18.6 18.1 31.8 25.1 26.6 27.7 32.1 19.5 31.6


Foreign-exchange reserves excl gold (US$ bn)

2011 2,952 3,012 3,067 3,168 3,188 3,220 3,267 3,284 3,223 3,295 3,242 3,203

2012 3,276 3,331 3,327 3,321 3,227 3,261 3,260 3,293 3,305 3,307 3,317 3,331

2013 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/aSources: IMF, International Financial Statistics; Haver Analytics.

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Annual trends charts

China 13


Quarterly trends charts

China 14


Monthly trends charts

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Comparative economic indicators

Basic data

Land area

9,561,000 sq km

Population

1.35bn (end-2012; official estimate)

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Main towns

Population (millions) of metropolitan areas. (Economist Intelligence Unit Access China estimates, 2011):

Shanghai: 16.4

Beijing (capital): 14.4

Shenzhen: 11.5

Tianjin: 9.5

Chongqing: 9.5

Guangzhou: 9.4

Chengdu: 8.8

Wuhan: 8.5

Xi'an: 7.1

Zhengzhou: 7.1

Nanjing: 6.4

Changsha: 5.6

Climate

Continental, with extremes of temperature; subtropical in the south-east

Weather in Shanghai (altitude 4 metres)

Hottest months, July and August, 2333°C (average daily minimum and maximum); coldest month, January, 1 to 9°C;driest month, September, less than 5 mm average rainfall; wettest month, June, 160-165 mm average rainfall

Language

Mainly putonghua, or Standard Chinese, based on northern Chinese (the Beijing dialect known as Mandarin); localdialects and languages are also used

Measures

The metric system is used alongside certain standard Chinese weights and measures, of which the most common are:

1 jin = 0.5 kg 2,000 jin = 1 tonne

1 dan = 50 kg 20 dan = 1 tonne

1 mu = 0.0667 ha 15 mu = 1 shang = 1 ha

Currency

Renminbi (Rmb), or yuan. Rmb1 = 10 jiao = 100 fen. Average exchange rate in 2012: Rmb6.31:US$1

Fiscal year

January-December

Time

8 hours ahead of GMT

Public holidays

New Year, January 1st-3rd; Chinese New Year, February 9th-15th; Qingming Festival, April 4th-6th; Labour Day, April29th-May 1st; Dragon Boat Festival, June 10th-12th; Mid-Autumn Day, September 19th-21st; National Day, October1st-7th. All public holidays are technically one day long except for Chinese New Year and National Day, which arethree days long. When the holiday covers weekdays in excess of this figure, they are compensated for by workingweekends around the holiday

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Political structure

Official name

People's Republic of China

Form of government

One-party rule by the Chinese Communist Party (CCP)

The executive

The State Council, whose membership is approved by the legislature. State Council members, including the premier,may serve no more than two consecutive five-year terms

Head of state

A president and a vice-president are approved by the legislature for a maximum of two consecutive five-year terms

National legislature

The unicameral National People's Congress (NPC), whose 2,989 delegates are selected by provinces, municipalities,autonomous regions and the armed forces. The NPC approves the president and members of the State Council, as wellas the membership of the standing committee of the NPC, which meets when the NPC is not in session. All arms of thelegislature and the executive sit for five-year terms

Regional assemblies and administrations

There are 22 provinces, four municipalities directly under central government control and five autonomous regions.These elect local people's congresses and are administered by people's governments

China 18


National elections

The current government line-up was approved at the NPC meeting in 2008. A new party leadership was unveiled atthe 18th national congress of the CCP in November 2012. The new government line-up will be announced in March2013 at the NPC, when Xi Jinping and Li Keqiang are expected to take over from Hu Jintao and Wen Jiabao aspresident and premier respectively

National government

The politburo (political bureau) of the CCP decides on policy and controls all administrative, legal and executiveappointments; the seven-member politburo standing committee is the focus of power

Main political organisation

The CCP, of which Mr Xi is the general secretary

Politburo standing committee members

Xi Jinping

Li Keqiang

Zhang Dejiang

Yu Zhengsheng

Liu Yunshan

Wang Qishan

Zhang Gaoli

Heads of selected state ministries and commissions

President: Hu Jintao

Vice-president: Xi Jinping

Premier: Wen Jiabao

Vice-premiers:

Li Keqiang

Hui Liangyu

Zhang Dejiang

Wang Qishan

Commerce: Chen Deming

Finance: Xie Xuren

Foreign affairs: Yang Jiechi

National Development & Reform Commission: Zhang Ping

Central bank governor

Zhou Xiaochuan

The following articles have been written in response to events occurring since our most recent forecastwas released, and indicate how we expect these events to affect our next forecast.

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Recent analysis

Politics

Forecast updates

March 5, 2013: Election watch

China awaits the formation of a new government

Event

The National People's Congress (NPC, China's largely rubber-stamp legislature) was convened on March 5th for atwo-week session that will see the election of a new government and the passage of key laws.

Analysis

The annual session of the legislature signals the end of the administration of the current premier, Wen Jiabao, whodelivered his last major address at the start of the meeting. Mr Wen glossed over the lack of political reform over thepast ten years, highlighting instead China's rapid economic growth under his stewardship. Yet his call for economicrestructuring—perennially reiterated at these sessions—underlined the fact that serious problems have beenbequeathed to his successors.

The modest annual GDP growth target of 7.5% for 2013 that was outlined by Mr Wen, unchanged from 2012,represents a symbolic figure that is likely to be overshot. However, it sends a signal that the government is notexpecting a return to double-digit growth and that official efforts to reduce the economy's over-reliance on investmentwill be maintained. The premier proposed a 10% increase in overall government spending for 2013 and a 50%expansion in the fiscal deficit, to Rmb1.2trn (US$191.7bn), which he said would be equivalent to around 2% of GDP.The annual inflation target for 2013 has meanwhile been set at 3.5%, up from the actual figure of 2.6% in 2012.

Over the coming two weeks a reorganisation of central government ministries is likely to be approved by the NPC,with the powerful but scandal-tainted Ministry of Railways being broken up. Regulatory bodies overseeing food anddrugs safety may also be beefed up. Modest reforms to local government financing could also be put forward, and theChinese public will be looking to the NPC to advance new proposals to address environmental pollution. The sessionwill conclude with the election of Xi Jinping, chairman of the ruling Chinese Communist Party, as the country'spresident. Mr Wen's successor, Li Keqiang, will also be installed, along with a new State Council (the cabinet).

Impact on the forecast

Beyond the measures cited above, we do not currently expect big reforms to be passed at the NPC; our outlook maychange if any major new legislation is unveiled. The economic targets are in line with our expectations, and so we willnot be lowering our GDP or inflation forecasts immediately—although downside risks to the inflation outlook arebuilding.

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March 7, 2013: Political stability

Beijing grumbles about "subversives" in Hong Kong

Event

On March 7th Hong Kong media reported that Yu Zhengsheng, a member of China's politburo standing committee,had warned delegates from the Special Administrative Region against the danger posed by subversives in its territory.

Analysis

The comments from such a senior political figure raise further concerns about China's attitude towards politicalfreedoms in the territory. He warned that the mainland authorities would not allow the territory to become abridgehead for subverting the central authorities, and took particular umbrage against activists who waved theterritory's colonial-era flag during protests. On a more sympathetic note, Mr Yu declared that he understood thedisgruntlement some Hong Kong residents felt over the strains created by the competition for resources asmainlanders visited the territory, for example to give birth in Hong Kong hospitals and buy baby formula. However, hesuggested that such issues should be dealt with by increasing supply.

Mr Yu's conservative comments indicate that it is highly unlikely that the mainland has any intention of allowing thelocal electorate a completely free rein in choosing the chief executive in 2017. While talk of introducing full universalsuffrage in time for the 2017 chief executive poll continues, it seems increasingly probable that the central authoritieswill demand a right to screen candidates before allowing them to run. Nevertheless, despite the comments aboutsubversion, it remains unlikely that the centre will force the territory's government to make another push for an anti-subversion law, which would further undermine public support for the current Hong Kong administration andprobably fail again, as have past attempts.

The retrograde approach displayed by the mainland authorities and the lack of new thinking concerning Hong Kongare key reasons for the growing political tension in the territory. The chief executive tends to lack a mandate from thepublic, undermining his public authority relative to the Legislative Council, which is now majority-directly elected.Pro-democracy forces suspect that the mainland has no intention of allowing the local government to be freelyelected, which encourages them to take direct action and adopt symbols (such as the colonial flags) that aredeliberately provocative to the Beijing-based regime.


We will adjust our forecast to reflect the increased likelihood of mainland interference in the 2017 chief executivepoll, which will increase tensions between the Hong Kong government and pro-democracy forces in 2013-17.

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March 14, 2013: Election watch

Xi Jinping confirmed as president

Event

On March 14th the general-secretary of the Chinese Communist Party (CCP), Xi Jinping, was confirmed as China'spresident at a meeting of the National People's Congress (NPC, the rubber-stamp legislature).

Analysis

Mr Xi's appointment as president, replacing Hu Jintao, was a formality following his elevation in November last yearto the top position in the CCP. He was "elected" to the presidency by nearly 3,000 delegates at the NPC, with only onevoting against him. Although the president is China's head of state, the position is largely ceremonial. Mr Xi willinstead exercise power through his leading rank on the CCP politburo standing committee and as chairman of theCentral Military Commission (CMC). His position as head of state, the CCP and the military gives him a strong base ofauthority from which to rule. Mr Hu had to wait two years to assume leadership of the CMC following his appointmentas general-secretary.

Mr Xi has signalled that he wants cleaner and more effective governance, but without enacting substantive politicalreforms that may compromise the CCP's dominance. In the past four months he has cultivated a relaxed leadershipstyle, launched an anti-corruption campaign and staked out his support for deeper economic liberalisation. None ofthis marks out Mr Xi as being from a radically different mould than his predecessors; anti-graft drives, for instance, aretools commonly used by incoming leaders in China to boost their authority. Mr Xi has pledged to uphold theconstitution and to place political power within a "cage of regulations", to the encouragement of some liberals, but hehas also been careful to mix this with messages appealing to conservatives. In a little-publicised speech to cadres inDecember he bemoaned the Soviet Union's collapse, arguing that it stemmed from the then ruling Communist Party'sfailure to control the military.

The careful crafting of his statements suggests that Mr Xi's greatest strength lies in his ability to balance internalfactions within the CCP. The appointment to the vice-presidency of Li Yuanchao, a reformist-leaning politburomember, is likely to have been a further example of this faction-balancing approach. Mr Xi's brokering skills will help topreserve stability at the top of the party, but alone they are unlikely to be sufficient to manage the challenges posedto the CCP by slower economic growth and rising demands for political reform.


Mr Xi's appointment as president was already factored into our political forecasts, which will therefore remainunchanged.

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March 25, 2013: International relations

China's president makes an inaugural trip to Russia

Event

China's leader, Xi Jinping, completed his first overseas visit as president, to Russia, on March 24th. He subsequentlyflew to Tanzania in a circuit that will also take in Congo-Brazzaville and the BRICS summit in South Africa.

Analysis

The fact that Russia was chosen for Mr Xi's inaugural presidential trip shows that bilateral relations are being givenhigh priority. Meetings between the two sides were remarkably productive. Mr Xi became the first foreign leaderpermitted to visit the operational command centre of the Russian military, and the Chinese signed an agreement to buyadvanced fighter jets from Russia. The two countries are also jointly to build diesel-electric super-quiet submarines.Meanwhile, several long-discussed energy deals were signed. After more than a decade of disagreement on pricing,Russia's Gazprom has agreed to supply 38bn cu metres of natural gas a year to China from 2018, a figure that couldrise further. The Russian oil company, Rosneft, is also to double oil supplies to China after receiving a US$2bn loanfrom the Chinese, and agreements for joint exploration and development of energy reserves between Chinese andRussian firms were signed.

Yet the decision to visit Russia first also reflects a lack of new thinking in China's foreign policy. China is beingpushed to firm up ties with Russia, partly because it is feeling under pressure on other fronts. Relations withneighbours to its east are being frayed by China's more aggressive pursuit of its maritime territorial claims, even as theUS "pivot" towards Asia has provided more support to those concerned by its rising power. China lacks reliablediplomatic partners, and Russia is unlikely to fulfil this role. While Russia, like China, is prone to adopting reflexivelyanti-US positions when it comes to international affairs, its interests in many areas are at odds with China's. Notably,Russian leaders regard China's rise as a threat to their influence in Central Asia, and, in the longer term, clashes overthe region are set to increase.


We will remain dubious about the sustainability of the recent improvements in Sino-Russian political ties, but theeconomic relationship between the two nations is still likely to deepen in the next few years, particularly with regard totrade in armaments and energy products.

Analysis

March 21, 2013

Dithering in the face of catastrophe

The recently concluded National People's Congress (NPC, China's rubber-stamp legislature) would have been agood moment for the country's new political leadership to signal a more vigorous approach to dealing with thepotential environmental catastrophe that confronts the country. Environmental issues have risen sharply up thepolitical agenda as public tolerance of urban smog, polluted water and contaminated soil nears its limits. In theevent, the NPC was a disappointment in this regard, with plenty of rhetoric but little to suggest that the governmentis about to get serious about enforcing stricter environmental standards. But a combination of social and economicpressures means that it cannot afford to remain so complacent in the long term.

China's new president, Xi Jinping, has called for the creation of a "beautiful China" as part of the realisation of a"Chinese dream". This is meant to denote the government's determination to address the manifold environmentalproblems that have emerged as a consequence of the country's rapid industrialisation. The authorities are also carefulto parade their achievements in this area, and the annual work report submitted at the NPC pointed out that last yearthe reductions in both energy consumption and carbon dioxide emissions per unit of GDP were greater than targeted.However, such statistics count for little in the face of wide evidence of continued environmental degradation. Whilethe NPC was in session, a water-contamination scandal hit the headlines as nearly 15,000 dead pigs were found in theHuangpu river, which delivers drinking water to China's largest city, Shanghai.

Controversial minister reappointed

Amid a mounting public outcry over pollution, the government could have used the NPC to send a strong message to

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local governments and vested interests that oppose environmental reform. The new premier, Li Keqiang, used hisinaugural press conference to express his unhappiness with current levels of air pollution, and promised that theauthorities would wield an "iron fist" when dealing with polluters. However, the concrete measures actually taken atthe NPC would suggest otherwise. Activists have expressed dismay at the decision to reappoint Zhou Shengxian ashead of the Ministry of Environmental Protection. Mr Zhou is widely perceived to have performed unimpressively inthe post despite its elevation to ministerial-level status in 2008. There had been speculation that Pan Yue, a vice-minister at the ministry with a reputation for taking a courageous stance on green issues, would be promoted. Thefailure of the incoming government to push through this key personnel change bodes ill for determined policyimplementation over the next few years.

The wider administrative shake-up approved by the NPC also suggested that the new government has only limitedreformist ambitions. A certain amount of progress on bureaucratic streamlining was achieved through the absorptionof the state electricity regulator by the National Energy Administration, thereby addressing the problem ofoverlapping functions between regulators in the energy sector. However, the move is unlikely to presage a widerliberalisation of power prices, which (like petrol prices) will continue to set by the National Development and ReformCommission—a body that continues to prioritise rapid industrial expansion. The failure to establish an independentenergy ministry, despite repeated speculation in recent years about such a move, has in effect left policy subservientto the interests of China's giant state-owned energy companies.

Enforcement, not policy

Bureaucratic concerns are important, because China's failure to address its environmental problems largely reflectsineffective enforcement. Certainly there are weaknesses in the country's environmental policy—the government'sinsistence on using measures of energy intensity, rather than total consumption, when devising targets is a majorshortcoming. However, legislation is in much better shape than it was a few years ago, and is progressive bydeveloping-country standards. The government's five-year economic plan includes targets for hundreds ofenvironmental standards to be revised over the period to end-2015. New air-quality standards were recentlyintroduced for six highly polluting industries in 47 cities. Carbon-trading pilot schemes are being set up in sevenmunicipalities and provinces this year. In addition, a more demanding sulphur-content standard for automotive petrol,equivalent to the EU's Euro 5 vehicle-emission requirements, is scheduled to be enacted nationwide by 2017.

Implementing such measures will be difficult while enforcement mechanisms remain so weak. The environmentministry struggles to make its voice heard within central government, where other departments and the major energycompanies wield greater clout. This has led in the past to backsliding over policy commitments (notably over vehicle-emission standards and a much-delayed "carbon tax"). At the local level, the environment ministry has only a smallbureaucratic presence, giving it little influence over decision-making. Provincial- and city-level officials are reluctant toclose energy-intensive industrial capacity because of the implications of such moves for economic growth and localemployment. In the absence of public accountability, they recognise that their performance will ultimately still bemeasured against those benchmarks, rather than on the basis of their success in furthering environmental protection.

Reasons for hope?

Outcomes from the recent NPC were disappointing, but public disquiet may still eventually mean that China's leadersfeel compelled to grasp the nettle of environmental reform. Environmental issues now rival the requisition of rural landas a cause of popular protest. In a sign that this anxiety may gradually be filtering through into the politicalmainstream, Mr Zhou's reappointment was opposed by 171 of the NPC's 3,000-odd delegates, marking the largestrebellion in the legislature since a vote on whether to proceed with the construction of the Three Gorges Dam in 1992.Public pressure has also yielded some concessions on transparency issues. In early 2012, following a campaign byonline activists, the municipal government of China's capital, Beijing, began publishing data on airborne particulatematter with a diameter of more than 2.5 microns (PM2.5). A further 116 cities will establish PM2.5 monitoring stationsbefore the end of this year. Forcing the authorities to reveal levels of soil contamination is the next issue incampaigners' sights.

In addition to its potential adverse impact on social stability, the government may also come to recognise the threatthat environmental degradation poses to economic growth. Policy currently remains guided by the default assumptionthat measures aimed at curbing pollution have the effect of crimping economic output. There has been scant officialrecognition of the dangers posed by environmental pollution to the economy, and particularly the damaging impact ofpollution-related health problems on worker productivity. This subject may receive greater attention in future owing tothe fact that the growth of the Chinese economy, long driven by an expanding labour force, will instead relyincreasingly on enhancing the quality of the country's human capital in the coming years.

China 24


March 27, 2013

Hong Kong's dream of democracy remains elusive

The promise of "gradual and orderly" progress towards full and free democracy in Hong Kong appears to bereceding, as hopes for political reform ultimately stumble on the lack of democracy in mainland China. Recentstatements by Chinese officials indicate that candidates who might challenge the central government will not bepermitted to run in Hong Kong's next chief executive election in 2017.

China has always been vague on the shape of the electoral reforms that would be introduced before 2017, but itincreasingly looks like the mainland authorities will demand a veto over the list of potential candidates. There has notyet been a popular consultation in the territory on the reforms, making it unclear whether the current chief executive,Leung Chun-ying, will be able to assemble enough support to pass changes in time for the 2017 vote. At least two-thirds of the local Legislative Council (Legco) would have to back the proposals for them to be implemented.

Loving China, loving Hong Kong?

A number of statements on Hong Kong's constitutional arrangements were made in March by Chinese leadersmeeting in the capital, Beijing, for the annual convening of the National People's Congress (NPC, China's legislature)and a related advisory body. A politburo member, Yu Zhengsheng, expressed his concern over "subversives" inHong Kong and warned of "dire consequences" if a candidate who opposed the central government became chiefexecutive of Hong Kong after 2017. The newly promoted chairman of the NPC law committee, Qiao Xiaoyang, clarifiedon March 24th that only candidates who "love China and love Hong Kong" and do not confront the central Chinesegovernment would be allowed to contest the 2017 election. The director of China's Hong Kong and Macau AffairsOffice, Wang Guangya, appeared to hint that pro-democratic parties may be deemed insufficiently patriotic to run inthe election.

Such comments come amid signs that many people in Hong Kong are becoming increasingly alienated from mainlandChina. Tensions have been generated by the large volume of mainland tourists visiting the territory, and over issuessuch as mainland mothers giving birth in Hong Kong hospitals and local shortages of milk formula after mass buyingby people seeking to take the product over the border into the mainland. Seeking to capitalise on this disgruntlement,some pro-democracy activists have provocatively taken to waving British-era colonial flags, which incorporate theBritish flag, at demonstrations.

The long road to universal suffrage

Hong Kong's chief executive is currently chosen by an election committee of around 1,200 people, drawn from anumber of business and social constituencies. Mr Qiao's comments indicate that China envisages using a similarcommittee to screen nominations for the chief executive election in 2017, before allowing the public to vote through"universal suffrage" on the candidates deemed eligible. It had long been suspected that this would be the case, butthe fresh stipulation that candidates must be "patriotic", an ill-defined concept, could actually lead to a narrowerelection than has been the case in the past. In the 2012 chief executive election, the democratic camp were permitted toput up a candidate, the Democratic Party's Albert Ho. Yet Mr Qiao has been quoted referring to Mr Ho specifically asan example of the type of candidate who would be screened out in 2017, because Mr Ho once wrote an articledescribing China's Communist Party as a foe of democrats in Hong Kong. Consequently, it seems likely that HongKong people would, if reforms are passed, be permitted to vote only for a selection of pro-government candidates.

An increase in tensions between the Hong Kong government and the pro-democratic political parties is thereforelikely, particularly if it is confirmed that candidates from the pro-democracy camp will not be permitted to run in theelection. This would complicate efforts to implement the reforms needed to move towards a new electoral arrangement,as any reforms would need to be passed by a two-thirds majority in Legco. Pro-democracy legislators hold 27 of the 70seats in the body and, therefore, have sufficient numbers to block proposed changes. Consultations on politicalreform will need to begin over the next year, if the reform timetable is not to be blown off course, but as things standthere is little incentive for the democracy camp to co-operate. A new Legco is due to be elected in 2016 (according tothe existing formula, where only 40 of the body's 70 seats are elected under universal suffrage), but it is unlikely tolead to substantial changes in the legislature's composition.

Mr Leung does not have much room for manoeuvre, given China's effective veto over political reform. It may be thatsome kind of deal can be done whereby there is no blanket definition of democrats as insufficiently patriotic, allowingelements of the pro-democracy camp to support the changes and the reforms to be approved by Legco. However, it isequally possible that no acceptable solution will be found. The Democracy Party's decision to support the lastelectoral reforms in 2010 caused splits within the pro-democracy camp. The party is unlikely to support another dealunless it can confirm that it represents genuine liberalisation of the local political environment—which the recent

China 25


comments from mainland officials appear to rule out.

China faces a tough choice

While the pro-democracy camp looks to be in the most difficult position at present, in the long run it is likely to be thecentral government that ends up losing in this clash. If it opts to permit only a set of candidates that are unacceptableto Hong Kong's democrats, it risks provoking an electoral boycott that would probably mark the biggest political face-off between the local population and the central authorities since Hong Kong's return to Chinese rule. Alternatively, itwill have to include at least one candidate of whom it disapproves—and who might win. In practice, the governmentin Beijing might find the latter option less politically risky. It has many ways to apply pressure on a chief executive,whichever camp he or she comes from. Ironically, the democrats also have a poor record when it comes to electoralsuccess in Hong Kong. If a pro-establishment candidate were able to win a mandate in a genuinely competitive race, itmight represent the best of all worlds from China's perspective.

Economy

Forecast updates

March 1, 2013: Economic growth

PMIs point to downside risks to growth

Event

Although two purchasing managers' indices (PMIs) point to continued expansion in the manufacturing sector inFebruary, both have retreated from their month-earlier readings.

Analysis

The falls in the PMI readings suggest that China's economy has lost some of the momentum that it built up in the finalquarter of 2012. Both indices are published on a seasonally adjusted basis, and this ought to have minimised anydistortions caused by the Chinese New Year holiday in February. However, doubts about their reliability over thisperiod remain. The official PMI issued by the China Federation of Logistics and Purchasing, which tends to offer abetter snapshot of trends in the state sector, slipped to 50.1 in February, from 50.4 in the previous month. The indexcompiled by HSBC, which is more strongly oriented towards private companies, fell to 50.4, representing a sharpdecline from its two-year high of 52.3 in January. Although a reading above 50 indicates expansion, the latest figureshighlight the mild nature of the recent economic upswing.

Uneven external demand curtailed factory output in February. The export orders subindex of the official PMI felldeeper into contractionary territory, reaching a six-month low. In the HSBC survey, the component for export ordersremained unchanged, pointing to only marginal growth. Such weakness is likely to reflect not only the depressed stateof demand in traditional markets, but also China's diminishing export competitiveness. The support provided by

China 26


domestic demand, the main factor driving increased manufacturing activity in recent months, also appears to beebbing. Orders from local clients recorded a reading above 50 in both indices in February, but this still represented afall from their levels in the previous month.

The downward trend in the PMI figures places the authorities in a difficult position. They have signalled theirintention of managing emerging upside risks to consumer price inflation and adopting measures to curb the recentacceleration in house price increases. They have also moved to address concerns about expanding credit supply bydraining liquidity through open-market operations. However, the softness evident in the latest data complicates theprocess of tightening. There will be pressure to maintain a loose monetary policy stance as long as the economicrecovery continues to appear fragile.


We will maintain unchanged our forecast of 8.5% real GDP growth in 2013 until more data for January-Februarybecome available. However, the PMI data suggest that downside risks to our forecast are mounting.


New property curbs raise economic risks

Event

On March 1st China's government announced a rash of new measures designed to rein in overheated propertymarkets.

Analysis

The latest moves highlight the government's continued determination to keep a lid on the rise in property prices. Realestate prices in a number of cities have been accelerating recently, giving rise to concerns that already frothyvaluations could be stoked by speculative buyers. Given the important role that property plays in many differentspheres of the economy, from investment to bank lending, there have been fears that real estate asset-price bubblescould jeopardise the country's economic stability. Surging prices also aggravate tensions associated with socialinequality, as many of the less-well-off are priced out of the housing market.

Nevertheless, the country's property market is not unitary, and, while prices in first-tier cities currently appear to beballooning, those in some other parts of China are actually falling. The measures announced on March 1st recognisethis, and build in flexibility at the local level. Cities are asked to set targets for house-price growth and banks will beable to vary downpayments and mortgage interest rates, depending on local conditions. Other restrictions designedto limit multiple home ownership were also strengthened, and an existing 20% capital gains tax on housing sales is tobe more strictly enforced.

The announcement has dampened sentiment, but the complexity and multi-stranded nature of the latest policy movessuggest that there will be ample room for local governments to fudge their implementation. Moreover, the changeshave been closely linked to the outgoing premier, Wen Jiabao, and once he is replaced at the imminent NationalPeople's Congress (the annual session of the legislature), there is no guarantee that the government's tough approachwill be maintained. Nevertheless, the restrictions confirm that the government is unwilling to allow the momentumgathering in the property market to get out of hand. This, in turn, indicates that the economy's growth potential—which is closely tied to trends in real estate investment—will remain capped in 2013.


For now, we will maintain our current GDP growth forecast for 2013 of 8.5%, but downside risks to our investmentforecast have increased.

China 27


March 8, 2013: External sector

Strong February exports raise concerns over data quality

Event

China's merchandise exports surged by 21.8% year on year in February, according to a report published on March 8thby the country's customs bureau, while imports fell by 15.2%. The trade surplus for the month totalled US$15.3bn.

Analysis

The strong annual export growth seen in February was surprising given that many factories were shuttered for part ofthe month owing to the Chinese New Year, which fell in January in 2012. Looking at the trading sector's performanceacross the first two months of 2013 should provide a picture that is less distorted by the holiday. Total merchandiseimports rose by 5% year on year in January–February, not far behind the 7.9% expansion recorded a year earlier. Bycontrast, exports were up by a much stronger 23.6% in the two-month period.

In theory, the strong export growth points to a tangible recovery in export demand that should lift the local economy,but there are significant doubts about the data. Chinese figures show very rapid growth in exports to the US and theEU in January–February, but there has been little other evidence of a recovery in those markets. Figures from Taiwan,another major exporter, showed tepid growth in exports to both markets in January and sharp contractions inFebruary. Data from South Korea, another big trading country that releases data early, similarly show a year-on-yearcontraction in total exports in February.

This has given rise to suggestions that much of the surge in Chinese exports may be a statistical mirage, reflectingtransfer pricing by traders designed to switch funds into renminbi. This could be driven by receding expectations thatthe Chinese currency is set to weaken—last year concerns about the renminbi's prospects are thought to havecontributed to a rise in flows of liquidity out of the country. Confirming the true factors behind China's trade trendswill take time, but as data on US, EU and Hong Kong trade become available discrepancies should become moreobvious. If the distortions are occurring, the export sector may be less healthy than it seems at face value, but it wouldalso suggest that imports—and the strength of domestic demand—may be understated.


For now, we are unlikely to revise our forecasts that export and import growth in balance-of-payments terms will standat 10.3% and 11.9% respectively in 2013.

China 28


March 11, 2013: Policy trends

Government proposes shake-up of ministries

Event

On March 10th the State Council (China's cabinet) submitted plans to restructure government ministries to theNational People's Congress (the legislature) for rubber-stamping. It said that the proposals would reduce red tape andimprove efficiency.

Analysis

The most keenly anticipated move was a proposal to break up the Ministry of Railways into separate administrativeand commercial arms, with the former to fall under the purview of the Ministry of Transport and the latter to bemanaged by a new state-owned enterprise. The position of the railway ministry had become untenable, followingrevelations about high-level corruption and the 2011 Wenzhou high-speed train crash. But although the dismantlingof the ministry is likely to be welcomed by the public, it may lead to rises in ticket prices. Rail travel has long beensubsidised by the ministry, and the government will have to accede to price rises if, as it plans, it is to attract privateinvestment into the sector.

Meanwhile, the proposed establishment of a maritime law enforcement agency within the State OceanicAdministration (an arm of the Ministry of Land and Resources) may help China to improve co-ordination of itsapproach towards various disputes in its claimed territorial waters. The large number of government actors with astake in maritime affairs is widely perceived to have complicated the management of such issues. The creation of aunified coast guard should limit the risk of a single agency taking measures that are out of step with national policy,and ought to improve communication with other countries. However, it may also allow China to strengthenenforcement of its various maritime claims.

Other streamlining measures outlined by the State Council include integrating the Family Planning Commission (whichoversees China's one-child policy) with the Ministry of Health. The cabinet also proposed upgrading the status of theState Food and Drug Administration, merging the two main media-regulating bodies, and giving the National EnergyAdministration responsibility for electricity-market regulation.

The reforms represent modest adjustments to administrative structures that remain shaped by the legacy of the state-planned economy. The number of ministries has been reduced only slightly, to 25, from 27 previously, and there islittle in the measures to suggest that they will boost transparency or reduce bureaucracy. Merging departments into"super-ministries" may improve policy co-ordination, but it also serves to cement the position of vested intereststhat oppose structural reform and deregulation.


We do not see anything in the plans that will cause us to change our core policy forecasts.

China 29


March 11, 2013: Inflation

Food prices drive inflation higher

Event

China's consumer price index (CPI) rose by 3.2% year on year in February, according to a National Bureau of Statisticsreport published on March 9th. The producer price index, released on the same day, fell by 1.6%.

Analysis

China's consumer prices grew at their fastest pace in ten months in February, with inflation up by 1.2 percentagepoints from the 2% year-on-year expansion posted in January. Rising food prices, which were up by 6%, were themain contributor to the upward momentum. Within this category, meat and poultry prices grew by 5.3%, while theprice of fresh vegetables climbed by 10%. The increasing cost of animal feed has put upward pressure on meat prices,while vegetable supplies were reduced by cold weather, pushing up their cost. Oil prices were also 4.7% higher inFebruary, after the government raised state-mandated petrol and diesel prices by 3.2% and 3.4% respectively in themonth.

The shifting date of the Chinese New Year exaggerated the jump in inflation: averaged across the first two months of2013, the CPI rose by a more modest 2.6% year on year, only slightly faster than the 2.5% recorded for December.Nonetheless, Chinese officials are bracing themselves for faster inflation: the government recently announced a targetinflation rate of 3.5% in 2013. Given the upward pressure on food prices, and especially for pork, we expect inflation tocome in above this level.

For producers, although prices were lower compared with February 2012 levels, they continue to rise on a month-on-month basis, climbing by 0.2% in February. The HSBC purchasing managers' index, released on March 1st 2013,showed that producer inventories of finished goods declined for the fifth consecutive month in February. The highlevel of inventories continues to depress prices, but the erosion of these stockpiles suggests that the upward trend inproducer prices will be sustained in the coming months.


Our forecast that consumer price inflation will average 4.3% in 2013 remains unchanged in the light of the latest data.Likewise, the recent figures support our expectation that producer prices will rise in 2013, returning to strong annualgrowth in the second half of the year.

China 30



February figures prompt concern for economy

Event

The latest National Bureau of Statistics (NBS) figures, released on March 9th, have stoked concerns about the healthof the Chinese economy.

Analysis

The most worrying aspect of the NBS data was the slump in retail sales growth, which slipped to 12.3% year on yearin January–February, from 15.2% in December. One likely explanation for the decline is the government's crackdownon corruption and official extravagance. This has led to a marked drop in both gift-giving (which has particularlyaffected sales of luxury goods) and spending at restaurants and hotels. The Chinese New Year is traditionallyassociated with a peak in these two types of expenditure, and the weak retail sales figure may be a sign that thecrackdown is having its intended effect. It remains unclear how long the campaign will be sustained, but there are fewsigns of it drawing to a close in the near future.

Other elements of the January–February figures provided a more confusing picture. Industrial production growthedged down to 9.9% year on year, from 10.3% in December. This pace of growth is slow relative to historic levels, butremains faster than during the depth of the slowdown in mid–2012. Industrial output is being held back by strugglingsectors such as power generation and the manufacture of non-automotive transport equipment (includingshipbuilding and aerospace). By contrast, urban fixed asset investment growth accelerated in January–February, to21.2% year on year, from 20.6% in December. This was driven partly by a jump in investment in the primary sector,notably agriculture, and partly by a surge in realestate investment, which was up by 22.8% in January–February,compared with average growth of 16.2% in 2012 as a whole.

The upturn in real-estate activity nevertheless appears regionally skewed, with first-tier cities booming and third andfourthtier markets suffering. This was evident in the fact that land sales by area continued to decline in January–February, by 18.6% year on year, despite reports of strong demand for new plots in the top-tier locations. A pick-up inproperty investment remains key to our assumption that economic growth will be stronger this year than last, but theoutlook remains far from certain.


The latest data have increased the downside risks to our GDP assumptions, and we will make a modest downwardrevision to our current forecast of 8.5% growth in 2013.

China 31



Hiring expectations improve

Event

A survey of 4,203 employers in China showed that 21% of the firms plan to increase their workforces in the secondquarter of 2013, up from 18% three months earlier, according to a report released by ManpowerGroup on March 13th.

Analysis

The optimism shown about hiring prospects for the coming quarter is the strongest since the second quarter of 2012,suggesting that firms are becoming slightly more confident about future demand again after the economic slowdownthat affected the country last year. ManpowerGroup's quarterly survey also noted that just 3% of Chinese employerspredict a decrease in staff numbers, while 41% plan to make no change.

China's seasonally adjusted, quarteronquarter gain of 3 percentage points in the net employment outlook—thepercentage of employers planning to increase staff minus the percentage expecting a decrease—was the secondstrongest increase among Asian countries covered in the survey. It was behind only Singapore's 5-percentage-pointrise. According to the survey results, all nine Chinese regions tracked by ManpowerGroup showed strong intentionsto increase staff, with employers in Chengdu the most bullish on the prospects for payroll expansion. Adjusted forseasonality, 22% of respondents from the city said that they planned to add jobs in the second quarter.

By industry category, China's services sector demonstrated the strongest inclination to add workers, with 21% ofsurveyed employers reporting plans to hire in the coming quarter (22% in seasonally adjusted terms). China's leadershave placed special emphasis on expanding the services sector, with the 12th fiveyear plan (2011–15) setting a goalof increasing its share of GDP by 4 percentage points, to 47%, by 2015. The survey showed that new-job prospects inthe manufacturing industry improved by 2 percentage points from the previous quarter, with 18% of manufacturingrespondents planning to hire (or 17% after seasonal adjustment).


We believe that quarteronquarter economic growth will decelerate slightly in January–March 2013. The latest hiringsurvey data confirm that, although the economy continues to grow, there is little momentum behind the expansion.Our forecast for GDP growth in 2013 is set to be marginally lowered from the current level of 8.5% in our next monthlyoutlook.

China 32


March 15, 2013: Policy trends

New chief justice may spell a shift in approach

Event

Although the appointment of the premier, Li Keqiang, was the most high-profile development at China's legislativesession on March 14th, the appointment of Zhou Qiang as chief justice may signal a more significant break with pastpolicy.

Analysis

The elevation of Mr Li to the premiership has long been expected, and its significance for government policy willprobably be limited in the short term. Mr Li has already been a member of the politburo standing committee (China'stop political body) since 2007, exercising strong influence over existing policies, especially in fields such as health andsocial housing. His assumption of the premiership is thus unlikely to lead to dramatic shifts in policy, although it ispossible that certain causes that he is believed to favour—including restructuring the state sector's role in theeconomy—may receive renewed attention in the years ahead.

More significant breaks with past policy may come as a result of the elevation of Mr Zhou, previously the ChineseCommunist Party (CCP) secretary of Hunan province, to the post of chief justice of the Supreme Court. Mr Zhou has astrong background in law, both in terms of academic study and in administrative handling of legal issues, a markedcontrast to recent appointees to the position who have tended to lack such expertise.

Although some critics have been able to find much to bemoan in his record, it is nevertheless positive that the newchief justice comes from such a background. Legal reform stalled (and arguably retreated) over the past decade, partlyowing to the CCP leadership's preference for mediated outcomes in disputes. This approach hampered thedevelopment of the rule of law, including in business disputes—the system has encouraged aggrieved employees andbusiness partners to adopt extreme positions in the knowledge that a mediated result would offer them at least somerecompense. It also undermined the emergence of an effective system of checks and balances in China's politicalsystem.

Mr Zhou's authority will be limited by the fact that he is not a member of the CCP politburo. However, the chiefjustice's senior position outside the party structure will nevertheless offer him some flexibility to exercise influenceover the government's agenda.


For the time being our policy forecast remains unchanged, but Mr Zhou's appointment increases the likelihood ofbolder reform in the legal sphere over our current forecast period (2013–17).

China 33



Russian-Chinese energy talks

Event

Chinese-Russian talks to deepen energy relations continued on March 21st, with the main focus on gas.

Analysis

The two sides agreed in principle several years ago for Russia to supply China with 68bn cu metres per year of gas(equal to almost half of Russia's total gas exports to Europe) to be delivered by two yet-to-be-built pipelines.However, strong disagreements over pricing precluded progress. This year, a breakthrough has been made onvolumes and routes: the so-called Altai pipeline, which was to deliver 30bn cu metres per year to western China, hasbeen shelved. Instead, Gazprom and CNPC are focusing on deliveries of up to 38bn cu metres per year by a pipeline toeastern China, supplemented by deliveries of Russian liquefied natural gas (LNG) from Vladivostok. The principalsource of gas will be the Chayanda field in eastern Siberia, which Gazprom decided to commission in late 2012.Apparently, the two sides have narrowed their differences on price, from a gap of US$100 per 1,000 cu metres, toaround US$50. It was reported on March 15th that the Chinese were offering US$250 whereas Gazprom insisted on aprice of US$300. Gazprom's concessions on volume and price may reflect concern that it could lose out to Australia,Indonesia and Turkmenistan on the Chinese market by the end of this decade. Turkmenistan aspires to increasedeliveries to China from 20bn cu metres per year currently, to 65bn cu metres by 2020.

More headway has been made in the oil sector, building on the landmark loan of US$25bn to state-run oil giantRosneft and state-owned pipeline monopoly Transneft by Chinese entities in 2009. In return, Transneft speeded upconstruction of the East Siberia Pacific Ocean (ESPO) pipeline, which has a spur running to China, and Rosneftpledged to export 30m tonnes of crude oil to China each year. Rosneft now has to raise in excess of US$55bn tofinance its acquisition of TNK-BP and has been in negotiations with Chinese companies for loans, perhaps linked toincreased oil supplies. Reportedly, the financing package could reach US$30bn, in return for a doubling of oil suppliesvia an expanded ESPO pipeline, Russia's Pacific oil terminal and perhaps Kazakhstan's pipeline network. If such a dealis finalised, it would mark another step in the reorientation of Russia's oil exports, away from western markets and infavour of Asia in general and China in particular. Another Chinese loan for Rosneft might also open the door to jointexploration and production on Russian territory, which Chinese companies have long sought but so far have notrealised.


The latest Chinese-Russian talks on energy are in line with our forecast that the two countries will strengthen theireconomic ties.

China 34


Analysis

March 8, 2013

Micro-credit poses macro risks

In order to improve access to financing for small- and medium-sized enterprises (SMEs), the Chinese governmenthas encouraged the development of small and privately owned lenders in the Yangtze River Delta. However, a recentboom in unofficial lending carries serious risks for the economies of China's most prosperous region, including ahigh level of non-performing loans and a possible brake on financial sector liberalisation.

Being a Chinese SME is not easy. Fierce competition keeps margins low, and obtaining credit from China's state-owned banks is notoriously difficult. The latter prefer to lend to other state-owned firms or large private companies,which are able to post sufficient collateral and present minimal credit risk.

As of January 2013 there were more than 800,000 and 1.3m SMEs in the provinces of Zhejiang and Jiangsurespectively. These economic powerhouses, together with Shanghai, make up the Yangtze River Delta, one of theworld's most productive manufacturing regions. However, only 10% of these are able to obtain traditional bank loans,according to local industry officials. That leaves an estimated financing shortfall of around Rmb2.5trn (US$400bn) forthe two provinces.

After unsuccessful efforts to persuade state banks to lend more to SMEs, the government recently took steps tolegalise the region's large informal network of small and privately owned financial institutions, which includebusinesses ranging from pawn shops to private equity firms and micro-banks. Given that these firms' lending activitiesgo largely unrecorded, they have been dubbed China's shadow banking sector.

Micro-surge

The expansion of the shadow banking sector has been phenomenal. In 2011 there were 170 registered "small loancompanies" in Zhejiang. By the end of 2012 the figure had grown to 250. The numbers of small loan companies inJiangsu rose from 327 to 485 over the same period. At the end of 2012 these companies reported outstanding loansworth Rmb103.7bn and Rmb73.2bn in Jiangsu and Zhejiang respectively.

While the emergence of small-scale lenders is generally encouraged, the boom in shadow lending has begun to worryregulators. A large number of loans are turning sour, with the non-performing loan ratio for many small loancompanies in Zhejiang and Jiangsu rising to 10% by the end of 2012—three times higher than the nationwide ratio.Since many small lenders obtain funds from the traditional banks, a rise in SME defaults would have a knock-onimpact on the official banking system.

The problem is exacerbated by what are perceived by borrowers as extortionate lending rates, which often exceed 20%and sometimes even 30%—several times higher than the official benchmark lending rate of 6%. However, lendersclaim the high rates are necessary to offset the high credit risk associated with lending to small firms, which tend to gobust more easily. A survey in 2012 by Roadoor, a matchmaking website for venture capitalists and start-ups, revealedthat 85% of SMEs were experiencing loan repayment issues.

An alarming rate

While it is unlikely that an SME banking bust in the Yangtze River Delta would derail the national economy, it isentirely possible that defaults on a wide scale in the shadow banking sector will upset the authorities' appetite forbadly needed liberalisation of China's financial sector. Wenzhou city, located in Zhejiang province, has beendesignated a pilot city for financial sector reforms in China. If things turn out badly, private-sector participation in thecountry's financial system is likely to receive a setback.

Part of the problem for SMEs in China is that banks are unable to price loans at market rates. The traditional bankingsystem is subject to state-imposed interest rate ceilings, meaning that capital is generally under-priced. It also meansthat, given the trade-off between returns and risk, banks are only willing to lend to the safest borrowers.

China's shadow banking sector owes its existence in part to its ability to exploit arbitrage opportunities in borrowingat artificially low official lending rates and lending at market-determined ones. Liberalising official interest rates wouldgo some way towards obviating the need for an informal financial sector, which can be difficult to regulate. Until suchreforms are instituted, authorities will continue to chase their own tails.

March 15, 2013

China 35


Shifting trade winds

Trade growth is slowing in China, but that does not necessarily mean that tensions with its trading partners willease. Foreign trade by value rose by a mere 6.2% in 2012, well below the 10% target set for the year. However,the trade surplus surged by nearly 50% at the same time. Given Europe's continuing economic problems and theslow rate of US economic expansion, coupled with the increasing cost of Chinese land and labour, it is unlikely thatannual trade growth will ever again match the rates seen before the global financial crisis of 2008. Nonetheless,existing trade tensions will persist, and new ones may still emerge.

In 2012 trade with China's largest partners, most notably the EU, suffered the most. After many years of steady annualgrowth in exports to the EU, shipments to the 27-nation grouping dipped by 6.2% to US$334bn. Chinese imports fromthe EU increased by just 0.4%, to US$212.1bn. Trade with Japan also slipped. Sales of Japanese goods to China fell by8.6%, in part because of boycotts by Chinese consumers and companies as the countries' dispute over theSenkaku/Diaoyu islands escalated.

Major commodity exporters, who had seen their exports to China surge in recent years, found growth much harder tocome by in 2012 as investment and construction slowed, hitting prices hard as well as volumes. Australia, which sawits exports—largely of iron ore and other metallic and mineral resources—grow by more than 50% in 2010, and then35.9% in 2011, recorded growth of just 2% in 2012. Russia had a similar experience: after a 56.2% rise in its exports toChina in 2011, sales rose by only 9.3% in 2012.

Bright spots emerge

In contrast, trade with emerging regions was a bright spot. Trade between China and the Association of South-EastAsian Nations (ASEAN) has soared since the ASEAN-China Free-Trade Area (ACFTA) came into being onJanuary 1st 2010. Exports to ASEAN rose by 20.1% last year; they now account for 10% of China's total exports.ACFTA is one of the world's most populous free-trade regions and third only to the EU and the North American FreeTrade Agreement in terms of economic size.

Trade with Africa and Latin America also rose quickly, but the share of both continents in total trade remains small.Exports to Africa grew by 16.7% and imports by 21.4%, but their shares of the total remain at 4.2% and 6.2%respectively.

Trade tensions to rise

After narrowing over 2009-11, China's trade surplus surged by 49% last year to US$231bn, close to its previous peak.With import growth likely to be depressed in 2013 by high inventory levels, the Economist Intelligence Unit expectsthe trade surplus to edge higher this year. More Chinese companies are looking to export as added capacity in thecountry's favoured sectors, such as green energy, cars and steel, comes on stream.

As the trade surplus rises, political tensions—particularly with the US—are likely to increase. Overcapacity inChinese solar panels, for example, led to a glut of cheap panels in the global market. The US slapped tariffs on Chinesepanels at the end of 2012 and the EU is mulling similar measures. Indeed, trade tensions with China's major partnersworsened in 2012, with a notable increase in complaints about the country lodged with the World Trade Organisation(WTO). The last annual report from the US Trade Representative on China's compliance with the terms of its WTOaccession showed a distinct hardening of tone.

Other complaints by the US—and, to a lesser extent, the EU—centre on exchange rates, with the two Westerneconomic blocs alleging that China maintains a weak currency in order to boost its exports. These arguments nolonger carry the weight they once did; after seven years of more-or-less steady appreciation in the renminbi againstthe dollar, the former is now closer than it ever has been to market-determined levels.

As trade continues to grow with newer markets, more tiffs are sure to follow. China's exports to Mexico surged byaround 34.2% in 2011 and another 14.8% in 2012, to reach US$27.5bn. At the same time, its imports from Mexicoshrunk by 2.4% to a relatively modest US$9.2bn.

Partly spurred by the growing imbalance, in October 2012 Mexico lodged a complaint against China with the WTOconcerning measures that favoured Chinese textile and apparel exporters. The country currently has four disputeswith China at the WTO. As Chinese exports make further inroads into newer markets, new frictions are likely todevelop.

(More details on China's merchandise trade are available in the February chapter of China Hand. China Hand isthe Economist Intelligence Unit's comprehensive reference guide on the political, economic and businessenvironment of the People's Republic of China.)

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March 19, 2013

Softly, softly goes the NPC

The annual session of the National People's Congress (NPC, China's largely rubber-stamp legislature) drew to aclose on March 17th, and with it the transition of power to a new generation of political leaders was smoothlyconcluded. The incoming administration has already differentiated itself from its predecessor in terms of its tone.However, Xi Jinping and Li Keqiang have not yet provided much evidence that they have the stomach for boldreforms.

Behind the scenes, NPC sessions and the run-up to them can see intense clashes within the ranks of the rulingChinese Communist Party (CCP), with issues such as property rights, corruption and the Three Gorges Dam stokingcontroversy in the past. In public, however, they are becoming increasingly choreographed. With the transition to anew leadership taking place this year, sensitivity was especially high, choking off significant debate. In the event, theappointments went off without a hitch, with Mr Xi assuming the presidency from Hu Jintao and Mr Li taking overWen Jiabao's post as premier. Beneath them, a whole tier of lesser appointments were also confirmed.

No surprises, please

Most of the developments at the NPC were anticipated, including a restructuring of government departments that sawthe abolition of the Ministry of Railways—long a satrapy of special privileges and graft. Appointments were, for themost part, uncontroversial, although some saw the fact that Li Yuanchao was appointed to the vice-presidency as asign that Mr Xi was showing his independence from a former president, Jiang Zemin. (Li Yuanchao was passed overfor a much more powerful spot on the CCP politburo standing committee (PSC) last year, supposedly because he hadangered party elders.)

The budget, which was unveiled at the annual legislative session, was also unremarkable, except in so much that itseemed to envision a wider fiscal deficit in years to come. At a targeted 2% of GDP, however, the fiscal shortfall willnot be causing many worries.

Much of the core agenda laid out at the conference remains similar to that pursued under the administration led byMr Hu and Mr Wen, particularly when it comes to issues such as urbanisation and the development of state welfareprovision. This is not especially surprising, given that the new premier, Mr Li, was a driving force behind many ofthose policies.

Laying the groundwork

For those hoping that the incoming government will be more open-minded when it comes to reform than itspredecessor, there were some intriguing signs—but if this is the case, the new leadership is playing a long game. Theappointment of Zhou Qiang, previously the CCP chief in Hunan, as head of the Supreme People's Court could mark asignificant shift in approach towards legal reforms. Mr Zhou comes with a strong academic and administrativebackground in law, in marked contrast to his predecessor, Wang Shengjun, who had no formal legal training. UnderMr Wang there was a notable backsliding on judicial reform, as well as an unfortunate emphasis on mediatedoutcomes (sometimes with little regard to the merit of cases). Nevertheless, it remains doubtful that the CCP willsurrender its tight control over the courts.

Another interesting development was the merging of the family-planning bureaucracy into the Ministry of Health.This should undermine the power of the family-planning agency, and thus make it easier to implement an overdueretooling of China's one-child policy in the coming years. This sort of approach, in which subtle administrativerealignments were implemented that may ease the path of future reforms, was characteristic of this year's NPC.

Where is the meat?

Nonetheless, on certain key issues that are likely to define this government, there was very little news. Take the issueof the restructuring of the role of the state sector, which is thought to be one of Mr Li's main ambitions. Although therailways ministry was dismantled, the premier was not able to provide any further clarity on what the governmenthopes to do to improve the state sector's productivity. Appointments like that of Jiang Jiemin, the chairman of thestate-owned China National Petroleum Corporation, to the head of the state-owned Assets Supervision andAdministration Commission do not give confidence that a major shake-up in thinking is in the offing.

On financial sector reform, the fact that the respected head of the China Securities Regulatory Commission, GuoShuqing, is being tipped to become governor of Shandong province has sent mixed signals. Although this is not ademotion, investors are concerned that it might indicate that the government thinks that Mr Guo moved too quickly in

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liberalising capital markets. The core financial policies of the outgoing administration, such as interest rate andexchange-rate liberalisation, look set to remain in place. The continued presence of Zhou Xiaochuan at the helm of thePeople's Bank of China (the central bank), confirmed at the NPC, should help to ensure this. However, even if theextension of his term is only temporary, it is a depressing thought that the government was unable to bring in freshblood for fear of risking the success of these reforms.

The new president's rhetoric is also frustratingly vague. At the NPC Mr Xi talked again of a "China dream" andnational renaissance. These themes are clearly emerging as important ones for the government, but it is not clear whatthey will mean in policy terms. China's neighbours—especially those engaged in maritime territorial disputes with thecountry—fear that they will presage a tougher approach on international disputes. Mr Xi has also emphasised thefight against corruption, and there is an ongoing crackdown on official extravagance and graft. But such campaignsare traditional for incoming administrations, and their impact tends to be fleeting. So far, there are few signs ofinstitutional changes that would put the fight against corruption on a better long-term footing.

Outside the tent

The new government has not staked out an aggressive reform agenda thus far. That is understandable in somerespects: Mr Wen frequently talked about the need for political reform, but oversaw a decade that in many ways saw aretreat on political liberalisation. Mr Li, by contrast, said little about political reform at the NPC. The new leadershipseems to be shying away from presenting an agenda that it cannot deliver. However, a pragmatic, gradualist approachrisks running into the sand as it encounters opposition from vested interests and bureaucratic inertia. In China, it hasoften required aggressive figures who are willing to court controversy—like a former premier, Zhu Rongji—toimplement difficult changes.

In the end, much may rely on the influence of more reformist leaders who are currently outside the top leadership.Figures like Li Yuanchao and Wang Yang, one of the new vice-premiers, occupy positions that are traditionally seenas relatively weak. However, if the leadership on the PSC proves too cautious, events may allow those on theperiphery of the CCP leadership to exert greater sway over policy.

March 20, 2013

EIU global forecast – Weaker outlook despite US progress(Forecast closing date: March 18th 2013)

Political headwinds are again buffeting the world economy. Tensions in the euro zone have risen amid post-electionlimbo in Italy and bail-out controversy in Cyprus. In the US sweeping budget cuts could, if allowed to continue intheir current form, slow an otherwise promising recovery. For now, the Economist Intelligence Unit believes thatsuch tensions can be contained. Led by the US, economic growth in most parts of the world should accelerate as2013 continues. Nonetheless, we have slightly lowered our global GDP forecast this month, reflecting adjustmentsto our growth projections for the euro zone and China.

We now expect world GDP at purchasing power parity exchange rates to grow by 3.3% in 2013. This is down by 0.1percentage points from our previous forecast of 3.4%, and reflects our view that the recovery from the slowdown in2012 will take a bit longer than expected to get going. Much of the euro zone, in particular, is off to a slow start to2013, notwithstanding continued resilience in Germany. While we still expect trading conditions in the 17-countrycurrency bloc to improve in the second half of the year, a weak first quarter will drag down full-year GDP. We havealso fractionally downgraded our China growth forecast. Data in the first two months of this year were a bit softerthan we had expected, and the government is moving sooner than anticipated to cool the housing market. That said,the Chinese economy has strengthened from what—by its lofty standards—was a year of slow growth in 2012, andwe still forecast growth well in excess of 8% in 2013.

The most promising major economy is perhaps the US. Although growth has been uneven, the US has shrugged off aseries of potential and actual policy shocks—think of the "fiscal cliff" that loomed like a miniature millennium bug atend2012—without undue trouble. There are still a couple more fiscal obstacles to overcome this year, and a rise inpayroll taxes at the start of 2013 will in any event cut into consumers' disposable income and weigh on growth. Butthere are encouraging signs on multiple fronts. Job creation has picked up, the housing market continues to recoverand retail sales have surged. US growth should strengthen in the second half of this year. Along with improvedmomentum elsewhere, this should create the platform for stronger global growth in 2014.

Despite these positives, major weaknesses in the global economy persist. The most significant of these is the never-ending debt crisis in the euro zone, of which the flaring-up of tensions over a bail-out for Cyprus is but the latestmanifestation. The proposed part-financing of the bail-out by a one-off levy on bank deposits will prove particularly

China 38


contentious and lead to a continuation of the difficult negotiations between Cyprus and its future creditors. Thisraises doubts about Cyprus's future in the euro, and may also weaken confidence in depositors' protection in largereuro member countries. Nonetheless, we expect this latest flare-up to be contained. We continue to believe that animminent break-up of the euro zone is no longer a threat. Intervention in 2012 by the European Central Bank (ECB) hashad a decisive impact, easing funding pressures greatly.

Developed world

The US economy continues to show resilience to the fiscal tightening that began at the start of this year andintensified in March. Although GDP growth slowed to a virtual standstill in the fourth quarter of 2012, this reflectedspecial factors such as movements in inventories and defence spending. Consumer spending and businessinvestment, key drivers of the recovery, both grew strongly in that quarter despite the overall GDP weakness. Weforecast real GDP growth of 2.1% in 2013, supported by the Federal Reserve's monetary stimulus. Annual growthshould peak at 2.4% next year, before a monetary tightening cycle begins in 2015.

Notwithstanding Italy's ongoing struggles to form a stable government and the latest furore over Cyprus, the eurozone has been enjoying an extended period of financial calm (thanks largely to the ECB's policies). But conditions inthe real economy remain dire. Austerity is hitting growth, which in turn is limiting the effectiveness of the very fiscaladjustments that such programmes aim to achieve. Unemployment remains very high, with youth unemploymentabove 50% in some regions of southern Europe. The recession deepened in the fourth quarter of 2012, and economicweakness has continued in the first quarter. We have therefore lowered our GDP forecast for the euro zone, and nowexpect a contraction of 0.4% in 2013 (previously we were forecasting a 0.2% decline). External demand will pick upduring 2013, supporting annual growth of 1% in 2014.

Japan's immediate growth outlook is positive, even though base effects that contributed to strong growth of nearly2% last year mean that the economy will grow at only about half that rate in 2013. The new government of Shinzo Abe,back as prime minister for a second time, is focused on large-scale monetary and fiscal stimulus. Such "Abenomics"will help the economy to grow by 0.9% this year (although there is some upside risk to this forecast) and by 1.9% in2014. The yen has weakened sharply in the past four months as a result of aggressive monetary loosening; this willhelp Japanese exporters.

Emerging markets

Following a slowdown in 2012, emerging markets are poised for stronger growth in the next two years. Weakness inthe advanced economies, and slower growth in China, has been curbing exports. But as the US and Chineseeconomies improve and Europe stabilises demand for emerging-market exports should start to rise again. We expectChina to record substantially better growth of 8.4% this year. This number is fractionally down from our last forecastof 8.5%, reflecting the hawkish tone of recent policy and some softness in the latest data. Retail sales have slowed(this may reflect a government anti-corruption drive that has dented luxury-goods consumption). Growth will ease to7.8% in 2014. In India, the economy is struggling from the effects of weak farm and services output. However, webelieve that the worst is over and expect GDP growth on an expenditure basis to pick up from a dismal 3.3% in fiscal2012/13 to 6.4% in the coming financial year.

Eastern Europe's transition economies continue to struggle, reflecting their close links with the troubled euro zone andthe lingering effects of the bursting of the credit bubble in 2008-09. This month we have made slight downwardrevisions to our 2013 GDP forecasts for eastern Europe, in keeping with the weaker prospects in the euro zone (a keytrading partner and source of investment and financing). We now expect the transition economies to grow by 2.3% in2013, before accelerating to 3.4% in 2014.

Growth in Latin America weakened last year, as a result of recession in the euro zone, a slowdown in China andsluggishness in the US economy. But we maintain the view that the Latin American slowdown is cyclical rather thanstructural. We expect growth to pick up to 3.6% this year, supported by Chinese demand for commodities as well asby the general improvement in global conditions. Regional GDP growth will accelerate further to 4% in 2014.

Economic growth in the Middle East and North Africa will weaken slightly to 3.3% in 2013, in part because the impactof a host of earlier fiscal stimulus measures will ease. Yet this headline figure masks a considerable divergencebetween positive prospects for oil-producing countries (except for Iran) and mostly negative prospects for non-oil-producing states. A number of major non-oil exporters, notably Egypt, are still suffering from the political andeconomic fall-out of the Arab Spring. Regional growth will strengthen next year, in keeping with the global trend.

Sub-Saharan Africa, meanwhile, will see growth pick up slightly to 4.4% in 2013 and to almost 5% next year. Several ofthe oil-exporting countries in the region (including Angola, Cameroon, Chad, Equatorial Guinea and Ghana) willbenefit from rising hydrocarbons output. New mining production in several countries will also be a positive factor for

China 39


growth.

Exchange rates

The US dollar has been ticking higher against other major currencies in the past two months, the result of what nowappears to be a sustained recovery in the US economy. The dollar got off to something of a ragged start in 2013,especially against the euro, which climbed as European banks repaid ECB loans (in effect, tightening the moneysupply and boosting demand for the euro). But economic fundamentals have taken hold since then, pushing the USdollar higher as equity, housing and labour-market indicators in the US have surpassed expectations. Our dollar/euroexchangerate forecast is unchanged this month at US$1.33:€1 on average in 2013 and US$1.31:€1 in 2014. However,we expect the Japanese yen to be slightly weaker than we were previously forecasting. We have also lowered oursterling forecast on the assumption that the British pound will be weaker against the dollar and euro in 2013-14.

Commodities

After a relatively strong start to 2013, commodity prices fell sharply in February and have so far remained weak orfalling in March. As an asset class, commodities have significantly underperformed relative to equities, which havesurged in recent months. The strength of the US dollar was a key factor depressing investor sentiment towardscommodities in February, while in March concerns about China's economic growth prospects resurfaced. In our view,barring an unforeseen weather or geopolitical event that would undermine supply prospects, the relatively subdueddemand picture suggests that commodity prices will struggle to make significant gains this year.

We still expect the oil market to be pulled in different directions in 2013. Economic concerns and uncertainty will tendto subdue prices, compounding the effect of a fundamentally oversupplied market. But political risk premiums relatedto tensions in the Middle East will add upside volatility to prices at times throughout the year. The price of a barrel ofoil (dated Brent Blend) will average US$106.6 in 2013 and US$104.8 in 2014.

World economy: Forecast summary

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Real GDP growth (%)

World (PPP exchange rates) a 2.4 -0.8 5.0 3.8 2.9 3.3 3.9 4.1 4.0 4.1

World (market exchange rates) 1.3 -2.3 3.9 2.6 2.1 2.2 2.9 2.9 2.9 2.9

US -0.3 -3.1 2.4 1.8 2.2 2.1 2.4 2.3 2.3 2.4

Japan -1.1 -5.5 4.7 -0.5 1.9 0.9 1.9 1.5 1.0 1.1

Euro area 0.2 -4.3 2.0 1.5 -0.5 -0.4 1.0 1.3 1.4 1.4

China 9.6 9.2 10.4 9.3 7.8 8.4 7.8 7.7 7.3 6.5

Eastern Europe 4.5 -5.6 3.5 3.8 2.1 2.3 3.4 3.7 3.9 4.1

Asia & Australasia (excl Japan) 5.6 5.0 8.4 6.6 5.3 6.1 6.3 6.3 6.2 6.2

Latin America 3.9 -1.9 5.9 4.3 3.0 3.6 4.0 3.8 3.9 3.9

Middle East & North Africa 4.6 1.5 5.3 2.5 3.6 3.3 4.3 4.6 4.9 4.9

Sub-Saharan Africab 4.8 1.2 4.5 4.6 4.2 4.4 4.9 5.0 5.3 5.7

World inflation (%; av) 4.5 1.5 3.0 4.1 3.4 3.4 3.4 3.4 3.3 3.3

World trade growth (%) 2.5 -11.5 14.1 6.3 2.7 4.0 5.2 5.4 5.5 5.6

Commodity prices

Oil (US$/barrel; Brent) 97.7 61.9 79.6 110.9 112.0 106.6 104.8 107.3 110.0 115.0

Industrial raw materials (US$; % change) -5.3 -25.7 45.4 21.1 -20.0 3.8 5.4 1.0 4.0 2.3

Food, feedstuffs & beverages (US$; % change) 28.0 -20.3 10.7 30.1 -3.7 -4.9 -3.9 -2.2 3.1 2.4

Exchange rates (annual av)

¥:US$ 103.4 93.6 87.8 79.8 79.8 94.0 95.3 96.3 97.5 96.5

US$:€ 1.47 1.39 1.33 1.39 1.29 1.33 1.31 1.27 1.26 1.26

a PPP = purchasing power parity. b Refers to Angola, Kenya, Nigeria and South Africa only.

Source: Economist Intelligence Unit.

March 22, 2013March 22, 2013

Cultural evolution

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In an effort to boost the role of the services sector in the economy, local governments are channelling resources intocultural sectors. Investment has soared. However, building cultural industries is more than just a question ofmoney. Without looser regulation, these efforts will not amount to much.

Over the past several years, the amount of attention paid to the cultural industries has grown as the centralgovernment has looked for ways to compensate for slowing construction and manufacturing activity. As part of widerefforts to strengthen the tertiary sector, cultural industry—a fuzzy term—was given its own section in the most recentfive-year plan (2011-15). This is a first. The longer-term aim is to have cultural industries contribute 5% of GDPby 2015, up from around 2.75% in 2010.

For the most part, local governments have embraced the idea and have issued schemes with varying degrees ofambition. Tourism, cinema, television and print media form the traditional core, but creative design, animation anddigital production also fall under the umbrella of cultural industry. Access to libraries, performances and museums areincluded too. Establishing cultural enterprises and boosting innovation are common themes, and cultural industrialparks are being set up to encourage these.

As a consequence, investment has boomed. Fixed-asset investment in the category of "culture and the arts" rocketedby 65% to Rmb200.2bn (US$32bn) in 2012—nearly on a par with investment in the healthcare sector that year. This isset to grow further as more regions increase investment in cultural industries. For example, the State Council (China'scabinet) has just approved a "Chinese Civilisation Inheritance and Innovation Zone" in Gansu, a poor westernprovince. Gansu's aims include setting up industrial bases and building an export-oriented and higher-technologystructure for the cultural industry.

Invest here

Cultural development plans often centre on local historical attractions. Gansu's plan focuses on its Silk Roadattractions, while Henan's includes tourism focused on its temples. However, the fuzzy definition of a "culturalinvestment" has allowed for liberal interpretation. For example, in 2012 Shandong held a cultural industry promotiontargeted at Hong Kong investors that included projects such as "culture shopping malls", "culture-themed hotels"and a dinosaur park. Other provincial plans tout "cultural high-tech exports", which can take advantage of preferentialpolicies for cultural enterprises. In addition to cultural tourism, Henan's plan, which was released in February 2013,includes digital media, creative design, animation and trade in the arts.

Heavy tax incentives are being offered, especially for favoured segments such as animation; 56 national animationbases were established during the short timeframe of 2004-11. According to a local publication, China Daily,more than 1,300 cultural parks are registered with the Ministry of Culture, although the real number may be as much as10,000. Many of these involve expensive infrastructure; Tianjin's shiny new cultural centre, which opened last year,includes a new museum, art gallery and library, as well as a new grand theatre and a shopping centre. The localgovernment spent Rmb6bn (US$960m) on the project.

At the same time, government-funded cultural companies are starting to proliferate. Shaanxi's Cultural IndustryInvestment Holding Company, a state-owned holding enterprise, has been tasked with the financing of cultural parksand projects, including those in Xi'an. Hunan TV, which is owned by the Hunan provincial government, is now thesecond largest channel in terms of ratings, behind only the national CCTV. A joint venture between a tourismcompany owned by the Dengfeng city government (in Henan) and a Hong Kong travel company has been set up tomanage the mountainous area near China's famed Shaolin temple. Some of these firms have already gone public;in November 2012 a cultural industry index was launched on the domestic stockmarket to track their performance.

Meddling in all the wrong places

Industrial planning in the cultural sector is proving more complicated than officials may have anticipated, however.Incentives to boost tourism revenue and traffic may clash with some of the institutions that they are meant topromote. The Shaolin temple has come under fire for what critics say is crass commercialism; its aggressive businessoperations now include film production and kung fu performances. Shi Yongxin, Shaolin's "CEO abbot", was forced toclarify that the temple would not go public on the stock exchange after a public uproar over its blatant divergencefrom spiritual activities. The management of another temple in Zhejiang came under fire for embracing commercialismafter rumours spread that a branch of Starbucks, the ubiquitous US coffee chain, had opened on the premises.

Applying the same principles of economic planning used in, say, steel production may be doing the cultural industriesmore harm than good. The animation industry's five-year plan includes building the capacity to produce 5,000 hoursof animation series and 30 animated films a year. Whether any of this is used, however, will be another matter entirely.The output has been criticised for being of a poor standard, as studios are rewarded for quantity rather than quality.Much of it is never screened.

China 41


On the other hand, tight regulation surrounding entertainment output limits the pay-off for projects that aresuccessful. Hunan TV, for example, has seen its audience tumble since the State Administration of Radio Film andTelevision (which has since merged with the General Administration of Press and Publications) restricted the numberof variety shows that each satellite channel could show during prime-time hours. An editorial in another statenewspaper, Global Times, lamented that owing to a regulation regarding Taiwan stars on mainland television,a popular host had to be cut from two reality shows produced by Shanghai's Dragon TV, disappointing viewers.The regulator has also introduced new restrictions on advertisements, cutting into the revenue of regional satellitebroadcasters further.

The Chinese box office just overtook that of Japan to become the world's second-largest, but the country's artisticelite regularly bemoan the fact that that other economies appear better than China at turning aspects of its own cultureinto commercial hits, such as Hollywood's Kung Fu Panda. If authorities want to replicate that success, they might dowell to do less. Cultural firms should be encouraged to make money from their intended audience, not fromgovernment subsidies. Otherwise, local officials may find themselves saddled with a glut of empty cultural parks.


The first BRICS summit in Africa makes concrete progress

Brazil, Russia, India, China and South Africa—collectively known as the BRICS nations—held a first summit onAfrican soil (and the group's fifth in total) in Durban on March 26-27th, thereby signalling the growing importanceof the continent. South Africa's economy is dwarfed by those of its fellow BRICS members (which together accountfor around 25% of global GDP), but the country warrants inclusion because of its role as a gateway to the rest ofAfrica, one of the world's fastest-growing regions. South-South links will continue to deepen regardless of theexistence of the BRICS grouping, although the institution is playing a role in facilitating the process. Highlightingthis, the South African summit led to several concrete plans, including the establishment of a BRICS bank, aBRICS business council and a joint foreign currency pool, all geared towards closer integration and reducedreliance on Western financial institutions.

The decision to establish a BRICS bank, to focus in particular on raising funds for infrastructure investment,could help to boost investment in the longer-term. However, it will take several years to establish and its impact will belimited by the relatively small size of its capital base. Current proposals call for each member to contribute US$10bn,making US$50bn in total; however, for example, combined lending to Africa by the World Bank and China's Exim bankexceeds this sum every year. As with other parts of the BRICS agenda, the proposed bank is as much symbolic as it ispractical. In addition, South Africa already has a well-developed financial system, and a lack of capital is just oneconstraint among many affecting investment projects in Africa (the others being skills shortages, corruption, politicalinstability and policy uncertainty).

The summit also approved the creation of a BRICS business council, comprising five members from each country,which will meet twice a year in order to promote business ties. In addition, the BRICS leaders sanctioned a US$100bnforeign-currency contingency reserve pool to help to avoid liquidity problems that could arise from global imbalances(although full details, as with the BRICS bank, have still to be negotiated). Nonetheless, South Africa, as the chair ofBRICS for the next 12 months, will be empowered to advance an African agenda.

Several bilateral agreements were signed during the summit

Apart from the agreements on new BRICS institutions, the summit also provided a framework for the signing ofnumerous bilateral deals between South Africa and other member states (especially China), which may have a moreimmediate impact than the bank and business council. In particular, the new Chinese president, Xi Jinping, used thesummit to reiterate his country's commitment to Africa, in both rhetorical and practical terms. Notable deals agreedinclude a two-year partnership between China's Sinopec and the South African state-run fuel firm, PetroSA, to assessthe feasibility of a proposed new oil refinery at Coega, costing US$10bn-11bn. In addition, the Chinese DevelopmentBank will provisionally lend US$5bn to help to fund Transnet's infrastructure investment programme, and Nedbankand the Bank of China agreed to finance jointly a cement factory in Limpopo costing US$90m. In a further key deal,the People's Bank of China agreed to let the South African Reserve Bank (SARB, the central bank) invest US$1.5bn inChina's bond market, thereby added renminbi-denominated assets into South Africa's hard-currency holdings for thefirst time.

China 42


Brazil and Russia also boost their African presence

Not to be outdone by China, India's Action Group may invest up to US$220m in the proposed US$2.2bn DubeTradePort development at Durban's King Shaka airport. Whereas India and China have both been focusing on Africafor several years, Brazil and Russia have had a much smaller African presence. However, in a sign of change,South Africa's Industrial Development Corporation signed financing deals with Brazilian and Russian developmentfinance institutions, with a view to securing capital for a range of projects valued at up to R50bn (US$5.5bn),in sectors including mineral processing, health and biofuels. Russia's Renova Group and two other Russiancompanies also agreed deals for mineral exploration and telecommunications in the southern Africa region.

South Africa has the best business climate among the BRICScountries

Facilitating South Africa's role in the partnerships, the country is best placed amongst all of the BRICS members in theWorld Bank's Doing Business index, ranking 39th out of 185 countries in 2013, ahead of China (91st), Russia (112th),Brazil (130th) and India (132nd). South Africa also ranked comparatively well on the World Economic Forum's GlobalCompetitiveness Index for 2012/13 at 52nd (out of 144 countries)—ahead of India and Russia, but behind China andBrazil. These factors partly compensate for the comparatively small size of South Africa's economy in comparison withthose of the other BRICS countries.

The outcome of the BRICS summit was broadly positive, but despite a vague commitment to address trade imbalancesthat have seen China run up large surpluses, there was very little to assuage the concerns of South African industryabout unfair competition. Moreover, not all of the proposals for new institutions and projects will materialise.Nonetheless, the summit played a role in deepening South-South co-operation. The potential benefits for South Africa—and whether or not its inclusion in BRICS is judged to be a success—will at least partly depend on how well thecountry performs in its assigned role as a gateway to the rest of Africa, which was the main reason for its inclusion.This, in turn, will depend in part on the adoption of accommodating policies. We expect ties to continue to strengthenin the run-up to the next BRICS summit in Brazil in 2014.

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Country Report China March 2013

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