China Market Forecast 2011- prepared for the Australia- China Business Council Victorian Division

10 February 2011

Dr He-ling ShiDepartment of Economics

Monash University

Three overarching themes

• Potential downturn for Chinese resource demands?

• Expanding opportunities in the high-end manufacturing and services sectors?

• Emerging China market entry challenges for foreign firms

China’s contributions to the mining boom in Australia

• 2009 – China became the largest trading partner of Australia with two-way trading of goods and services valued at $85.1 billion (47.9b(e):37.2b(i) )

• Export of iron ore was 260 million tonnes and valued at $21.7b (43.8% of total exports)

Historical perspective – iron ore exports to China

• Since 1999, – Export value has increased by

41.8% per annum, and – Export volumes have

increased by 25.7% per annum

• During 2004 – 2009, 140% per annum (2.7b, 5.5b, 7.6b, 9.0b, 17.9b, 21.7b)

• In 2009, 72.4% of iron ore was exported to China

At the States level – exports overview

• Western Australia:– Iron ore & con: 21.4b– Crude petroleum: 468m– Nickel ores & con: 345m– Copper ores & con: 306m

• Queensland:– Coal: 1.96b– Copper: 443m– Copper ores & con: 360m– Other ores & con: 265m

• New South Wales– Coal: 525m– Copper ores & con: 421m– Wool & other: 240m– Aluminium: 180m

The driving forces and trend forecasting of demands for Australia’s resources?

Consumers of steel products

• Capital goods industries (construction, machinery, heavy transport, etc.)

• Consumer goods industries (automotive, home appliance, etc.)

China’s steel production 2000-2009• Production of raw steel

– Component growth rate: 18%– Share of world production from

15% to 46%– 40% of iron ore is imported from

Australia

• Consumption of steel – Component growth rate: 16.7%– Share of world production from

16.8% to 47%

• Self-sufficient

Breakdown of steel consumption in China in 2009

• Construction: 70%(USA, 29.5%)• Machinery: 22%• Automobile: 7%(USA, 14%)• Household appliances: 3%• Other manufacturing: 2%• Shipbuilding: 1%TOTAL: 100%

• Housing: 69%• Infrastructure: 25%• Commercial: 6%

Very high density of steel use

• China produced 12.6% of GDP (PPP in 2009), but consumed 46.4% of steel (2008, in volume).

• In China, to produce 1 USD of GDP, steel consumption was 120g on average from 2005 - 2009

• USA produced 20.2% of GDP (PPP in 2009), but consumed 7.7% of steel (in 2008, in volume)

• In the USA, to produce 1 USD of GDP, steel consumption was 11g on average from 2005 - 2009

Common explanation

• Urbanisation, for example• In 2009, 50% of 1.3b population lived in urban

areas; by 2030, 70% will be in urban areas –another 200-300 million migrants

• Urbanisation demands housing, infrastructure, and etc. which drive up steel demand

Urbanisation

0

10

20

30

40

50

60

70

80

1950 1960 1970 1980 1990 2000 2009 2015(p)

100

1,000

10,000

100,000

Urbanisation rate (LHS)

GDP per capita (RHS)

Since 1979

Per cent US$ ppp (log scale)

However …• South Korea and

Malaysia had similar patterns of urbanisation

• South Korea consumed 58g (48.3% of the Chinese level) for 1 USD GDP

• Malaysia consumed 46g (38.3% of the Chinese level) for 1 USD GDP

Two key industries

• Housing construction (using 49% of total steel consumption)

• Infrastructure investment (using 17.5% of total steel consumption)

• Weird stories of these two industries

Housing

• May 2010, it was estimated that there were 65.4 million apartments with no use of electricity for consecutive 6 months – it may indicate these apartments have not be sold or rented out.

• Meanwhile, the housing price continue to climb – the housing price in 4 central districts in Beijing is comparable to 5 districts in the New York city

Infrastructure

• China has constructed 7,500 km of high speed rail (with average speed is 350km/h)

• A sample survey indicated that the there were only 40% of passengers from Wuhan – Guangzhou line – the best of the current 7 lines.

Common features of these two industries in China

• Drive up GDP in a visible and significant way• Public sector participation (leading role)• Supply driven – mismatch in demand and

supply• GPS - GDP centric, Public sector led, and

Supply driven

Unique political contracting system in China

• Top-down 5 layers public administrative hierarchy - Central, provincial, municipal, county, and village (gradually towards a 3 layer system)

• Since 1978, the dominant task of each level of public administration is economic growth - which is normally measured by GDP growth

• Implicit political contract with leaders (party secretary + governor) at each level of government - that “if you’re doing well in economic growth, get promoted; if not, step down” (Deng Xiaoping, 1980)

Incentives

• GDP has become the only measurable indicator for economic performance – which could affect the promotion of demotion of government officials – GDP centric

• Public sector dominates the economic growth through (a) public investment – infrastructure; and (b) regulating the private sector via excessive regulations

• Supply driven – excess capacity in almost every industry in which the public sector has influence

Consequences

• Expansionary lust - Regional GDP competition has generated outstanding GDP growth in the last 32 years

• Infrastructure is world-class, but not necessary economical (fails cost-benefit analysis – but accidently capture the spill over effects)

• A good system to weather GFC but may not be sustainable – environment, allocative inefficiency, inflation)

Implications for the Australian resources sector

• China’s demands for Australia’s resources have an element of irrationality (in economic terms) – which has so far caused environment degradation, and the supply-side inflation

• If China becomes more rational, demand for steel and iron ore will inevitably slow down

• The overarching objective of the 12th Five Year Plan (2011- 2015) is to adopt a more “scientific” modality in economic development – resources saving, environment friendly, income equality, higher value-added production, and etc.

Economic rationality?

• I do not think so – why?• China will continue to import minerals as long

as the desire for GDP growth continues – which could last another 10 – 15 years (2 years for the current administration (H&W) + 10 years for the next administration (X&L)

Political & Economic profiles in China after 2008

• Why 2008?– 2008 Beijing Olympic Games– Start of the GFC

• Public perceptions: CCP-led China survived the GFC and saved the world

• Since 2008, China has gradually shifted back to a partial planning economy - which is featured by– NDRC regains the power of economic planning and price

control– 4 trillion yuan fiscal stimulus revives SOEs

Some anecdote evidences

• Public servant has become the most attractive position for fresh university graduates (on average: 112 applicants for one position, and 10,000 applicants for an overseas post at the Ministry of Science and Technology)

• 跑步（部）前（钱）进 – run forward, means “bribe the ministries and get monetary favour”

国进民退（ the state advances as the private sector retreats ）

• That implies:– GPS will continue to dominate the political and

economic landscape in China in the coming years – economic rationality is far from reality

– GDP will continue to be higher than the 8% target set by the central government

– Good news for the Australia resources sector– Mixed news for other sectors (for example, high-

end manufacturing and services sector) in Australia

Housing & infrastructure industry

• Despite a series of policies to “suppress the housing sector” by the State Council, housing price continues to increase (14% in Beijing in 2010) – why? Because a lower land and house price violates the interests of all levels of governments

• For infrastructure, China will continue to build High Speed Railway (gaotie)

• Next “big project” is to build subways – NDRC has received applications from 33 cities to build subways and approved 28. By 2020, the total mileage of subways could reach 6100 km (1.15 trillion public investment during 2010 – 2015)

Entry barriers of FDI

• China has never ever regarded foreign companies having the “rights” to enter into the Chinese market.

• The Chinese government has been having an opportunists’ view on FDI – that is, whether FDI is “useful” to the objectives of the government (not consumers)

• Consequently, the government could use its statutory power to abruptly close an initially open market – evidence: lots of complains from foreign firms after 2008– Why? SOEs lobbied the government for monopoly powers

Instruments in controlling FDIs

• NDRC continues to maintain an Industry Catalog of Foreign Direct Investment

• Administrative approval system• The Anti-Monopoly Law (2008) has been used

to block M&A (Coco-cola’s failed merger application)

• Government procurement policy significantly favors SOEs

• Industry-based regulations and rules

Opportunity for Australia’s services sector

• I’m quite pessimistic • Take the financial services as an example:

– Financial services industry is regarded by the vested interest group as the “next opportunity to make big money” – following the their manipulation of the stock market and the land (real estate) industry

– Very strict and non-transparent industry regulations– Other financial service providers have already adopt

the policy of “if you can beat it, join it” by employing relatives of government leaders and etc.