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Chapter 3 Trends in the Chinese economy Section 1 Macroeconomic trends in China

In this section, we will provide an overview of the Chinese economy in 2016, mainly the trends in major economic indicators. In the next section, we will look at structural problems, such as excess production capacity, non-performing loans, and the real estate problem.

(1) GDP The real GDP growth rate in 2016 declined from the previous year to 6.7% (Figure I-3-1-1). A

comparison of contribution to GDP growth by item shows that net exports made a greater negative contribution than in the previous year, suggesting that the growth was led mainly by domestic demand. Among domestic demand components, investment made a smaller contribution than in the previous year, while consumption made a greater contribution, indicating a shift of the growth engine from investment to consumption. On a quarterly basis, the real GDP growth rate in the first quarter of 2017 rose for the second consecutive quarter.

Figure I-3-1-1 Changes in real GDP growth rates in China

Notes: This figure shows growth rates alone since no item-based breakdown of the quarterly demand by has been released. Source: National Bureau of Statistics of the People’s Republic of China and CEIC database.

In 2016, the nominal GDP growth rate accelerated from the previous year, and in the first quarter

of 2017, the growth rate was high at 11.8% (Figure I-3-1-2). A significant factor behind the high growth is that the deflator shifted to positive growth, causing the nominal growth rate to continue rising, as a result of an improvement in the secondary industry, in which prices had been sluggish because of the excess overcapacity problem, which will be discussed in Section 2.89 In addition, the 89 Prices (deflator) show volatile movements in the primary industry as well, and this is presumably

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tertiary industry continued to record high growth in both nominal and real terms.

Figure I-3-1-2 Changes in real GDP growth rates and deflator in China

Note: Deflator is counted backward as shown in the following formula as the Chinese government has not

reported it:

Deflator (price volatility) ＝ nominal volatility / real volatility

Source: National Bureau of Statistics of the People’s Republic of China and CEIC database.

On the other hand, there were regional disparities. The growth rate remained low in the Northeast and North China regions, including Liaoning Province, where negative growth was recorded in 2016, and Shanxi Province, where the economy was affected by the excess production capacity problem (Figure I-3-1-3).

because the prices of agricultural products are prone to be affected by weather conditions.

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Figure I-3-1-3 Real GDP growth rates by region in China (2016)

Note: The map is an approximate map. Source: National Bureau of Statistics of the People’s Republic of China and CEIC database.

(2) Consumption Looking at changes in retail sales of social consumer goods as a consumption indicator, we see that

the sales recorded strong growth of 10.4% in the whole of 2016 despite month-to-month fluctuations. In particular, internet sales, which account for around 10% of overall retail sales, recorded steep growth of 26.2% compared with the previous year (Figure I-3-1-4).

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Figure I-3-1-4 Changes in growth rates of retail sales in China (year-on-year rates)

Notes: The growth rate of internet sales includes those for sales of service. Source: National Bureau of Statistics of the People’s Republic of China and CEIC database.

Regarding retail sales by product item, foods, clothing and home electric appliances recorded low growth, but automobiles, which account for around 30% of overall retail sales, made a significant contribution by growing as much as 10% compared with the previous year because of a tax reduction for small cars90，91(Figures I-3-1-5 and I-3-1-6). In early 2017, the growth rate of automobile sales slowed down compared with 2016, as the margin of the tax reduction for cars was halved.

90 The automobile acquisition tax rate for small cars, or cars with engine displacement of 1,600 c.c. or less,

was lowered from 10% to 5%.The tax relief was implemented in October 2015 and was scheduled to expire in December 2016. However, in consideration of the risk of sales falling back in reaction, the tax relief was extended until December 2017, although the margin of the tax reduction was reduced from 5% to 2.5% (the tax rate was 7.5%, down from the original rate of 10%). There is also the view that the decline in the growth rate of automobile sales in early 2017 represented relative firmness given the initially-feared sales fall.

91 On the other hand, sales of sport utility vehicles (SUVs) grew more than sales of small cars, to which the tax reduction was applied, in terms of volume, and this may be evidence of a shift in consumers’ preference toward more luxurious products. For example, in 2016, the sales growth rate for SUVs was around 44% in terms of volume compared with around 21% for small cars (with engine displacement of 1,600 cc or less).

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Figure I-3-1-5 Composition of retail sales by major product item in China (2016)

Note: Major items are indicated. Source: National Bureau of Statistics of the People’s Republic of China and CEIC database.

Figure I-3-1-6 Growth rates of retail sales by product item in China

Notes: Growth rates of all items show the aggregated results targeting companies with large sales subject to the item-based statistics. These rates do not always correspond to the growth of overall retail sales that covers smaller companies. Source: National Bureau of Statistics of the People’s Republic of China and CEIC database.

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(3) Investment Although the growth in fixed asset investments continued to slow down for a long period of time,

the growth rate stopped declining around the middle of 2016 and has remained almost flat against the backdrop of governmental infrastructure investment and other measures (Figure I-3-1-7). Since the beginning of 2017, the growth rate has been rising again, led by infrastructure investment and other factors.

Figure I-3-1-7 Growth rates of fixed asset investments in China (year-to-date total/year-on-year

rates)

Note: Fixed asset investments are published as the accumulated amount from January.

Source: National Bureau of Statistics of the People’s Republic of China and CEIC database.

The growth in investments by the private sector declined steeply in 2016 (Figure I-3-1-8). On the

other hand, as infrastructure building continued to record high growth due to policy support (Table I-3-1-9), investments by state-owned enterprises, which are said to be at an advantage in receiving orders for public works, underpinned the overall fixed asset investments. In the second half of 2016, infrastructure and real estate investments by the private sector began to increase, so the growth in investments by the private sector also stopped declining and showed signs of recovery.

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Figure I-3-1-8 Growth rates of fixed asset investments and private investments in China (year-to-date total/year-on-year rates)

Note: Fixed asset investments are published as the accumulated amount from January. Source: National Bureau of Statistics of the People’s Republic of China and CEIC database.

Table I-3-1-9 Fixed asset investments by major industry in China (year-to-date total/year-on-year rates）

(Unit：%)

Mining Manufacturing Infrastructure

2015 ▲ 8.8 8.1 17.2 2016 ▲ 20.4 4.2 17.4

Source: National Bureau of Statistics of the People’s Republic of China and CEIC database.

(4) Trade Concerning trade in 2016, the value of both exports and imports declined from the previous year.

While exports recorded a larger decrease than in the previous year, imports registered a smaller decline, and as a result, the trade surplus shrank. On the other hand, on a monthly basis, in 2016 through early 2017, the negative growth rate of exports and imports turned positive in line with the global economic recovery (Figure I-3-1-10).

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Figure I-3-1-10 Growth rates of imports and exports in China (year-on-year rates)

Notes: This figure shows the total value from January to February to exclude the impact caused by the annual shift of the Lunar New Year period. Source: General Administration of Customs, CEIC database.

By product item, the growth in exports of electrical machinery turned negative in 2016 while the growth in exports of general machinery remained negative. Concerning imports, mineral fuels and ore recorded smaller negative growth due to a recovery in resource prices (Figure I-3-1-11).

Figure I-3-1-11 Changes in contribution levels of imports and exports by product item in

China

Source: Global Trade Atlas.

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(5) Stock prices and economic sentiment In 2016, trading was suspended on the Shanghai stock exchange at the beginning of the year as a

stock price plunge triggered a circuit breaker. Stock prices continued to decline for a while but have been on a moderate uptrend since around March (Figure I-3-1-12).

Figure I-3-1-12 Changes in the Shanghai Composite Index

Source: CEIC database. Shanghai Stock Exchange.

In 2016, economic sentiment, as measured by the manufacturing Purchasing Managers’ Index (PMI), surpassed the boom or bust line of 50 in the second half of the year. As for changes in the indicators for major items, in the second half of 2016, the indicators for production and new orders grew and the indicator for new export orders also improved. By company size, the PMI rose mainly for large companies, but economic sentiment remained weak at small and medium-sized companies (Figure I-3-1-13).

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Figure I-3-1-13 Changes in Purchasing Managers’ Index (PMI) in China

Notes: 1. The business conditions DI in a survey targeting purchasing managers of companies shows 50 as an economic outlook branch point. 2. PMI is calculated based on five indices, e.g., new orders received and production, but in this survey, respondents answered additional questionnaires, such as new orders for export received. Source: National Bureau of Statistics of the People’s Republic of China and CEIC database.

(6) Policy targets for 2016 and 2017 and achievements In 2016, the targets for the real GDP growth rate and other items were achieved due to the effects

of economic support measures (Table I-3-1-14). However, although the retail sales growth was almost in line with the target, fixed asset investments fell short of the target. In 2017, whereas the targets for such items as real GDP, fixed asset investments and retail sales were set at lower levels than in 2016, the target for the number of newly employed people was raised, indicating the emphasis placed on employment. While China maintained a “prudent and neutral” monetary policy, it slightly lowered the money supply target due to cautiousness about financial risk and an asset bubble. The targets for the budget deficit and infrastructure investments were set at levels similar to the previous year’s targets, indicating that China plans to continue economic support measures. In 2017, China is showing the stance of seeking to stabilize economic growth while continuing economic support measures ahead of the once-in-five-years Communist Party Congress scheduled for autumn.

China has announced a policy of resolving structural problems such as excess production capacity, excess debts and excess real estate inventories and promoting the sophistication of the economy through deepening of reform, expansion of domestic demand, and innovation (Table I-3-1-15).

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Table I-3-1-14 Major economic targets in China

2016 2017

Target Result Target GDP growth rate 6.7% 6.7% Around 6.5% Consumer price 2.0% 2.0% Around 3% Fixed assets investment (nominal) 7.9% 7.9% Around 9%

Total amount of retail sales of social consumer goods (nominal)

10.4% 10.4% Around 10%

Imports and exports (nominal) ▲0.9% ▲0.9% Level of fiscal deficit (ratio to GDP)

Ratio to GDP 3% (2.1800 trillion yuan)

Ratio to GDP 3% (2.1800 trillion yuan)

Ratio to GDP (2.3800 trillion yuan)

Money supply (ratio to the previous year) 11.3% 11.3% Around 12%

Social loan amount (year-on-year) - - Around 12%

Number of newly employed persons in urban areas 13.14 million 13.14 million Over 11 million

Registered unemployment rate in urban areas 4.02% 4.02% Within 4.5%

Infrastructure investment Railway: 774.8 bl.

yuan Road: 3.2937 trillion

yuan

Railway: 774.8 bl. yuan

Road: 3.2937 trillion yuan

Railway: over 800 bl. yuan

Roads and water channels: over 1.8000

trillion yuan Central budget frame:

507.6 bl. yuan Source: Government Activity Report and the Report on Action Plan for People’s Living and Social

Development (National People's Congress of China), the National Bureau of Statistics of China, and the CEIC database.

Table I-3-1-15 Fields on which China placed emphasis in 2017

1. Promote a policy “three resolutions, one reduction, and one reinforcement”

Remove excess production capacity, real-estate inventories, and excess debts; reduce company

costs; reinforce vulnerable elements in society, such as the issue of poverty.

2. Enrich reforms

Simplify administrative procedures and the value added tax system; watch out for financial risks;

advance the reform of state-own companies; relax conditions for the non-public ownership

economy to enter markets

3. Further bring out the potential of domestic demand

Develop service and quality products; act against counterfeit products; launch investment projects; enrich preferential treatment measures under the Public-Private Partnershi p (PPP) policy

4. Shift and enhance economic patterns through innovations

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Construct science and technology infrastructures; support emerging industries by reducing communication charges and other measures; support the existing industries by IoT and other means; support start-ups

5. Develop agricultural fields and encourage farmers to gain more income

Steadily develop agricultural fields and encourage farmers to sustainably gain more income 6. Expand the open-to-the world policy

Promote the One Belt, One Road initiatives through holding high-level forums; further relax the

conditions for inward foreign direct investment; promote free trade and investments 7. Promote ecology and environmental protection

Shift heating sources from coal to electricity or gas; take thorough actions to encourage factories

to meet environmental standards; and take thorough actions to encourage car companies to meet

emission standards

8. Improve the securement of people’s life quality

Enhance medical and insurance services to meet the two-child policy; secure the safe

management of food and medical products; provide support measures for pensioners and people

facing life difficulties

9. Enhance the government

Take actions to encourage staff to execute duty under laws; enrich actions against corruption Source: Government Activity Report (National People's Congress of China).

(7) China’s development strategy (industrial sophistication, innovation and overseas expansion) (A) Change in the industrial structure

As exemplified by the slowdown of the growth of the manufacturing industry due to such factors as excess production capacity, the economic center of gravity in China is shifting from the primary and secondary industries (e.g. manufacturing) to the tertiary industry (services industry) in terms of the share of GDP and the number of workers) (Figure I-3-1-16).

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Figure I-3-1-16 Changes in the industrial structure in China

Source: National Bureau of Statistics of the People’s Republic of China, Ministry of Human Resources and Social Security of the People’s Republic of China and CEIC database.

Source: National Bureau of Statistics of the People’s Republic of China, Ministry of Human Resources and Social Security of the People’s Republic of China and CEIC database.

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(B) Research and development, and innovation In addition, China aims to achieve industrial sophistication within the manufacturing industry

through innovation and research and development. For example, the ratio of research and development expenditure to GDP is rising to a level close to the ratios in major advanced countries (Figure Ⅰ-3-1-17).

Figure I-3-1-17 Ratio of R&D expenditures to GDP in major countries

Notes: According to the materials submitted by the National People's Congress, the ratio of R&D expenditures to GDP in 2016 in China was reported to be 2.08%. Source: OECD "Main Science and Technology Indicators".

An international comparison of the level of innovation activity in China based on an indicator

published by the World Intellectual Property Organization shows that the country has already reached a level close to the levels in G-7 and other advanced countries (Table I-3-1-18).

Looking at the patent trend as an indicator of the achievements of research and development activities, we see that the number of patent applications filed by China based on the Patent Cooperation Treaty has been increasing rapidly, and in 2016, the country was No. 3 in the rankings of countries (Figure I-3-1-19). Furthermore, Chinese IT equipment makers were ranked first and second in terms of patent applications in the rankings of companies.

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Table I-3-1-18 International comparison of innovation ability

Rank Country Rank in the previous year Rank Country Rank in the

previous year 1 Switzerland 1 14 Hong Kong 11 2 Sweden 3 15 Canada 16 3 UK 2 16 Japan 19 4 US 5 17 New Zealand 15 5 Finland 6 18 France 21 6 Singapore 7 19 Australia 17 7 Ireland 8 20 Austria 18 8 Denmark 10 21 Israel 22 9 Netherlands 4 22 Norway 20

10 Germany 12 23 Belgium 25 11 ROK 14 24 Estonia 23 12 Luxembourg 9 25 China 29 13 Iceland 13 (29) Italy

Notes: This table shows the top 25 countries among 128 according to the Global Innovation Index. The columns in green show G7 countries and China.

Source: Global Innovation Index 2016 (WIPO, etc.).

Figure I-3-1-19 Number of filed international patent applications

Notes: These figures show the number of international applications filed under the Patent Cooperation Treaty. Source: Press releases of the World Intellectual Property Organization (WIPO).

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Notes: These figures show the number of international applications filed under the Patent Cooperation

Treaty.2016.

Source: Press releases of the World Intellectual Property Organization (WIPO).

(C) Made in China 2025 “Made in China 2025” was announced in 2015 as a strategy aiming to strengthen the

manufacturing industry through such measures as promoting innovation and integrating information technology into the manufacturing industry. This strategy is intended to make China a manufacturing powerhouse by 2025, raise the level of the Chinese manufacturing industry to a medium level among manufacturing powerhouses across the world by 2035, and ultimately make China the global leader in the manufacturing industry by 2049, the centenary of China’s national foundation (Table I-3-1-20). The strategy proclaims policy measures including not only promoting innovation and integrating information technology into the manufacturing industry but also improving quality, branding and giving consideration to the environment.

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Table I-3-1-20 Made in China 2025 strategy - Three-step strategy

First step - strive to turn China into a major manufacturing power by 2025; second step - reach an intermediate level among world manufacturing powers by 2035; third step - become the leader among the world’s manufacturing powers by 2049, the centennial of the founding of New China

- Nine strategic tasks Improve innovation capability in the manufacturing industry; sophisticated integration of

informatization and industrialization; enhance fundamental industrial capabilities; enhance quality and

branding; promote green production (environmental conservation-oriented production); develop

breakthroughs in major areas (mentioned below); conduct structure adjustment in manufacturing;

promote service-oriented manufacturing industry; promote internationalization of manufacturing

- Ten prioritized fields Next generation IT; high-end digital control machine tools and robots; aerospace and aeronautic equipment; oceanographic engineering equipment and high-technology shipping; advanced rail transportation equipment; energy efficient and new energy automobiles; electric power equipment; agricultural machinery equipment; new materials; bio-pharmaceuticals and high-performance medical equipment

Source: Reports issued by think tanks. (D) New Silk Road (One Belt, One Road) initiative

China is advocating the New Silk Road (One Belt, One Road) initiative, which draws inspiration from the ancient Silk Road. This initiative aims to expand flows of people, goods, funds and information by developing infrastructure, including roads, railways, ports and communication networks, and create a vast economic area stretching from China to Europe (Table I-3-1-21 and Figure I-3-1-22).92 No definition has been set for countries which may participate in the initiative, and since it proposed the initiative, China has been calling for various countries to join it. In May 2017, a high-level forum was held in Beijing, with relevant countries invited to attend it.

92 During his visit to Kazakhstan in September 2013, Chinese President Xi Jinping proposed the New Silk

Road Economic Belt initiative (land route), and in his speech at Indonesia’s parliament in October of the same year, he proposed the 21st Century Maritime Silk Road initiative (maritime route). China collectively calls the two silk road plans the New Silk Road (One Belt, One Road) initiative.

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Table I-3-1-21 Target countries of the One Belt, One Road initiative Northeast Asia Russia, Mongolia

South-East Asia Singapore, Indonesia, Malaysia, Thailand, Vietnam, Philippines, Cambodia, Myanmar, Laos, East Timor

South Asia India, Pakistan, Sri Lanka, Bangladesh, Nepal, Malvern, Bhutan

West Asia North Africa

United Arab Emirates, Kuwait, Turkey, Qatar, Oman, Lebanon, Saudi Arabia, Bahrain, Israel, Yemen, Egypt, Iran, Jordan, Syria, Iraq, Afghanistan, Pakistan, Azerbaijan, Georgia (former Georgia), Armenia

Central and Eastern Europe

Poland, Albania, Estonia, Lithuania, Slovenia, Bulgaria, Czech Republic, Hungary, Macedonia, Serbia, Romania, Slovakia, Croatia, Latvia, Bosnia-Herzegovina, Montenegro, Ukraine, Belarus, Moldova

Central Asia Kazakhstan, Kyrgyzstan, Turkmenistan, Tajikistan, Uzbekistan Source: State Information Center, China.

Figure I-3-1-22 Map of the One Belt, One Road initiative

Source: China Central Television (CCTV; March 8, 2015). In the area covered by the One Belt, One Road initiative, infrastructure projects are ongoing with

the participation of Chinese companies, so in addition to improving infrastructure in partner countries, exporting steel and other products being produced in excessive amounts in China is presumed to be an economic significance of the initiative. Some people have pointed out that the initiative is effective in promoting economic development not only in countries in the area but also in China’s inland region. Moreover, over the long term, the initiative aims to achieve development in regions located along the developed infrastructure and strengthen the regions’ relationship with China.

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The promotion of the project is financially supported by existing financial institutions such as the Export-Import Bank of China and China Development Bank and the newly established Silk Road Fund. China also played the leading role in establishing the Asian Infrastructure Investment Bank (AIIB) in order to promote infrastructure investments in Asia.