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Can Abbott crack China's FTA challenge?

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Tony Abbott said before the election that he will make China the second stop after Jakarta on his first overseas visit as prime minister. While the sentiment to make an early visit to our biggest trading partner, source of foreign fee-paying students and tourist spending is laudable, he should do so only after visiting Tokyo. Japan is in a state of existential anxiety over its diminishing world role and especially its declining power relative to its bigger neighbour and former colony.

Symbols of relevance and importance matter enormously to Japan these days, whereas China is confident in its rising power and status. It doesn’t seek reassurance from Australia or other smaller powers. But an early visit to Australia’s biggest customer is sensible. 

China will want to hear directly from the new prime minister what his vision is of the relationship and his expectations for it. Beijing will be looking for reassurance that the prime minister appreciates the mutual dependence that now exists in the economic relationship and hence the need for stable and consistent policies towards it.

An early visit also provides the opportunity to re-visit the free trade agreement negotiations afresh. After 19 rounds over eight years of inconclusive negotiations, a new government can set aside the negotiating approach, which has yielded so little. A new government will also have the political authority to deal with interest groups that may otherwise hold up negotiations with unrealistic and unrealisable demands. And China’s new leadership may well wish to use the conclusion of the FTA to mark a symbolic new phase in our bilateral relations.

The change in negotiating approach will require Australia to move away from the rhetoric of negotiating a “high-quality, fully comprehensive, liberalising” FTA. Former Chinese commerce minister, the now disgraced Bo Xilai, used to say to former Australian trade minister Mark Vaile, you are “too bookish, too stubborn”. Practically in the negotiations this has meant that the Australian side would not countenance carving out for exclusion any sectors or industries. This was something to which the Chinese could never agree. 

As our competitors in New Zealand, Chile and elsewhere have done, we will need to have a concise list of market access priorities to discuss with the Chinese. While it is anathema to Australian officials, the reality is that today everything cannot be on the table if we are going to conclude a negotiation.

The game has now changed. Australia was the first developed economy with which China agreed to commence negotiations (though New Zealand actually started negotiations before Australia). At the time, Australia was ahead of the pack and looking to steal a march on its competitors. Eight years later Australia is behind, playing catch up, trying to defend market share in China from competitors that now enjoy substantial preferential tariff margins.

The new government will need to use its political authority to decide on a list of negotiating priorities. These would obviously start with those items where our competitors have stolen a march on us – namely dairy, sheep meat, beef, wine and horticulture. We should aim to get as much access as our competitors achieved, but only where it is commercially sensible for us to do so. 

We should not (as happened in the US FTA with respect to beef quotas) use negotiating coin for access that we cannot supply. Similarly, while some industries will not be included in the initial list, notably sugar, excluded industries will be no worse off. The government needs to avoid being pressured into compensating industries that miss out – as happened with sugar in the US FTA – but are not disadvantaged by the agreement.

Australia has taken an ambitious position on financial services in the negotiations to date. We have real interests but China has refused to budge, hiding behind a fixed position that it can only negotiate if existing laws do not have to be changed to accommodate the outcomes. Again this will not change, but with Beijing about to embark on a new round of economic reforms and with financial sector reforms expected to be at the forefront, new opportunities might present themselves.

The long-standing demand that Australian banks be allowed to increase their equity preferentially in county and municipal banks will not be accommodated. But since the negotiations began, our banks’ interests have become much more diversified and complex. Licenses to conduct other types of business, which have been granted only to some foreign financial institutions, could be extended to Australian financial institutions. A deal on financial services, however, would probably only come at the very end and would probably require prime ministerial intervention.

The main coin Australia brings to the negotiations is the possibility of adjusting Foreign Investment Review Board thresholds for both Chinese state-owned enterprises and private investors. The Chinese demands are aggressive, but that is what one should expect at this stage of the negotiations. It was a major shock to the Chinese when former trade minister Craig Emerson announced unilaterally that investment would not be covered. 

Investment, including some form of investor-state dispute resolution, will have to be covered by the FTA. The Chinese understand that the final result will depend on the value of the package to Australia. The more there is in it for Australia, the more we should be prepared to give in this area.

More difficult politically for the new government is China’s request on movement of natural persons (skilled labour movement). Addressing this issue will require high-level political engagement with China to set out the sensitivities in Australia around this issue and the constraints on our government. 

The Chinese side understands that Australian ministers will need to be able to sell politically a package which is balanced and of real commercial value. But this is a long way from the “fully comprehensive” mantra of past approaches of Australian governments.

An FTA, however, involves a lot more than settling just the key market access issues. Over the years, while no result has been achieved, officials have done a great deal of work on the rules that will apply when, and if, an FTA is concluded. Consequently, if the market access issues can be settled, an agreement can be reached quickly now.

Whereas it is neither necessary nor wise for the prime minister to go to China ahead of some other countries, the new trade minister should make an early trip to Beijing to restart the negotiations. Beijing should be the first overseas port of call as no country matters to Australia commercially as much as China. Cabinet will need to approve the minister’s negotiating list of issues with full knowledge that there will be some political push-back from interest groups that feel left out. 

It is unlikely all issues could be resolved by the trade minister, but as much work as possible needs to be done by ministers to prepare the way for the prime minister to conclude the few remaining issues during his first visit to China, whenever that occurs.

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Australia can't have everything it wants in a China free trade agreement. After eight years of negotiations we’ve fallen behind, and it’s time for Tony Abbott to get moving.
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China growth targets reachable: Li

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Dow Jones

Chinese Premier Li Keqiang said Wednesday that he's confident the government will achieve this year's economic growth target and reiterated Beijing's resolve to push ahead with reforms. 

The nation's economic indicators over the past two months--including gauges of manufacturing activity, industrial output and trade--have all been picking up, Mr Li said, adding that market confidence has improved. 

"Such steady development [in economic growth] makes us strongly believe that China's economic growth targets...will be achieved this year," he told the World Economic Forum, an international economic conference which is being held in this northeastern Chinese city. 

China has set a full-year target for gross domestic product growth of around 7.5 per cent. But economic growth slowed over the first half, and until recently, economists had been expressing doubts about the nation's ability to reach the target. 

Mr Li said potential economic growth has slowed but reiterated the government's position that it does not see a need for short-term stimulus measures. 

"We think that such [short-term stimulus] measures do not help in addressing deeper problems," he said. 

Mr Li also said that China will not expand its budget deficit to boost growth. The budget deficit for this year has been set at about two per cent of gross domestic product. 

He repeated a litany of reform goals, including plans to move ahead with interest-rate liberalization, the launch of bank deposit insurance, pursuing an opening of the nation's capital account and reform of the yuan's exchange-rate mechanism. 

He added, however, that to move ahead with these measures, the government needed to strengthen its regulatory capabilities. 

He also touched on the nagging issue of local government debt, which he described as "controllable." 

Vice Finance Minister Zhu Guangyao has conceded that the government does not know the real extent of local government debt. An audit is currently under way. 

In an apparent reference to the U.S. Federal Reserve's plans to gradually end its bond-buying program known as quantitative easing, the premier also called on developing nations to consider the impact of their macro-economic policies on emerging markets. 

Mr Li also had some praise for regional trade pacts, saying they could help the global trading system, alongside multilateral arrangements. But he added that these regional pacts needed to help promote integration of world trade. 

He did not mention any of these regional trade pacts, but Beijing has suggested that it might be in favour of the Trans-Pacific Partnership talks, which include Japan and many market-oriented economies in Asia and Latin America but not China.

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Chinese premier says he is confident, but warns recovery fragile.
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Number of Chinese billionaires rising sharply: report

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AAP

A billionaire Chinese real estate developer who bought one of the biggest United States cinema chains last year has emerged as the country's new richest tycoon.

The Hurun Report, which follows China's wealthy, says a surge in stock prices helped to boost the number of Chinese worth at least $US1 billion by 64 to 315 this year, compared with none a decade ago. The top five saw their wealth double.

Wang Jianlin, whose Dalian Wanda Group Co operates hotels, cinemas and department stores, was ranked No.1 for the first time on Hurun's annual list of Chinese tycoons with a fortune of $US22 billion ($A23.7 billion). Last year's No.1, beverage entrepreneur Zong Qinghou, was second with $US18.7 billion.

Wang's company bought AMC cinemas last year for $US2.6 billion in the biggest Chinese acquisition of a US company to date.

The latest rankings reflected the rapid changes in China's economy and shifts in wealth from one industry to the next.

One in four of the 1021 people on the Hurun Rich List made their money from real estate, which passed manufacturing to become this year's top source of wealth.

Hurun says 559 of those on the list have seen their wealth grow, while 252 saw their fortunes shrink.

Real estate prices in China have soared, driven partly by a flood of government spending and bank lending in response to the 2008 global crisis. That is despite government curbs imposed on lending and purchases to cool housing costs.

The surge in asset prices has helped to widen a gulf between China's wealthy elite and the poor majority, fuelling social tensions. China has more US dollar billionaires than any other country except the US.

No.3 on the Hurun list was Ma Huateng, also known as Pony Ma, founder of Tencent Inc, a popular provider of online games and entertainment, at $US10.1 billion.

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Annual report names real estate developer as China's richest person.
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Fonterra, CIC eye VDL: report

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New Zealand dairy giant Fonterra and the state-owned China Investment Corporation (CIC) have proposed to buy Australia's oldest dairy producer, Tasmania-based Van Diemen's Land (VDL), according to The Australian.

The proposed deal could see CIC emerge with nearly half of VDL as part of a $200 million deal that could join ADM's $3 billion bid for GrainCorp Ltd as an early test of the incoming coalition government's approach to foreign investment.

VDL is currently owned by the investment management arm of the New Plymouth District Council in New Zealand and had been widely flagged as being for sale, with CIC identified as an interested potential buyer.

VDL is already a supplier for Fonterra and late last year Fonterra was rumoured to have held talks with CIC about investment opportunities.

As part of the proposed deal, VDL would partner with Fonterra to buy half of the VDL business.

The Australian reported that VDL chief executive Michael Guerin declined to comment on the speculation, as did Fonterra.

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Chinese investment fund part of proposal to buy Aust dairy producer.
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Aussie jingoism jangles in the Chinese century

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Anxieties about investment in Australia by Chinese state-owned enterprises continue to surface, often conflated with worries about an overarching (if nebulous) geostrategic strategy led from Beijing.

“It’s the Communist People’s Republic of China, 100 per cent Communist-owned, buying up sections of the country and minerals in the ground which they will then sell to the Communist People’s Republic of China” claimed Senator Barnaby Joyce.

Even Kevin Rudd pandered to economic protectionism against Chinese SOE inbound investment in the lead-up to the election. “I'm not quite as free market as Tony on this stuff,” the prime minister said.

When thinking about Chinese SOE investment, the default position has often been to retreat from the unknown, and followed up with economic jingoism. The Australian foreign investment debate has demonstrated woefully unsophisticated discourse about the pros and cons of Chinese SOE investment.

In actual fact, the motivations of Chinese SOE managers are far from simple. Chinese SOE-outbound investment to Australia, and OECD economies more generally, faces an inherent tension: the execution of state industrial and political objectives versus self-interested profit maximisation.

What has been overlooked is that when this tension meets Australia’s ambivalence towards Chinese SOE investment, a favourable risk management environment is created. That is, the heightened political and media scrutiny Chinese SOEs face in Australia mitigates the danger that an SOE would brazenly sacrifice commercial self-interest in favour of industrial and/or political interests.

As part of the Chinese government’s concerted effort to improve its comprehensive national power – whereby an SOE is viewed as either a de facto or de jure extension of the state – national prestige and image throughout OECD economies increasingly matters to Beijing. As a result, the consequences of an SOE being perceived as acting for motives other than commercial interest are becoming increasingly dire, and not worth the risk.

So it is important for Australia to deal effectively with the challenge of economic jingoism. The alternative is to risk losing investment capital and enhanced access to Chinese markets.

Tempering the hysteria that occasionally surrounds inbound Chinese SOE investment will reduce the chances of Chinese geopolitical and economic backlash. Granted, investment and national security safeguards must never be ignored when dealing with inbound Chinese SOE investment. However, economic nationalism and protectionism must not trump balanced analysis.

The Brookings Institute’s Erica Downs has carried out extensive research on the behaviour of Chinese SOE outbound investment in pursuit of China’s energy security objectives. She concludes that the extent to which China’s cross-border energy acquisitions are the product of coordination between Chinese firms and the Chinese government is limited.

Outside observers have explicitly or implicitly assumed that China Development Bank’s deals, including a range of energy backed loans, are the work of China, Inc: China’s government, state-owned banks and SOEs operating as an aligned enterprise in a global pursuit of energy. The main finding of Downs’ study was that the China Development Bank's energy backed loans are the result of coordination between government and business, but the motive frequently attributed to these transactions – to secure oil and natural gas supplies for Chinese consumers – is just one of the multiple commercial and national interests that underpinned the transactions.

Downs’ research found no support for the notion that Chinese SOEs were “mere puppets of the state executing directives of their political masters”. Further, Downs’ findings suggest that where private and state interests have conflicted, private interests have trumped state industrial and political goals. This conclusion is reinforced by the Asia Society’s research that stated that “China’s [SOEs]… typically put self-interest and profitability above all else”.

The inflow of select Chinese capital into OECD markets like Australia presents a profusion of opportunities. But if Chinese SOEs perceive that Australia is thumbing its nose at their investment, Chinese capital will simply re-direct its investment flow to other resource-rich competitor nations. Perception matters. Australian economic jingoism must not trump reasoned analysis this Asian (read: Chinese) century.

Henry F Makeham is founder and director of the Australia-China Youth Dialogue (ACYD). Gregory Ainsworth is manager of Partnership Development for the ACYD and runs an early-stage healthcare technology company in Boston.

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Australia's ambivalence towards foreign direct investment by Chinese state-owned enterprises doesn’t stack up with the companies’ motives or their relationships with the central government.
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Huawei sees 10% annual revenue growth over next five years

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Chinese telecom equipment firm Huawei expects to grow its revenues by 10 per cent annually over the next five years from the $US35 billion it achieved in 2012.

"This growth will come mainly from consumer devices and enterprise," Huawei's Vice President of Western Europe sales, Gaston Khoury said at a media presentation in Stockholm.

Huawei, whose arch rival in mobile networks is Sweden's Ericsson, said this diversification would mean the share of carrier networks in its overall sales would fall from around 73 per cent of the total in 2012 to around 60 per cent in 2017.

The company said in July it had revenues of 113.8 billion yuan ($US18.59 billion)in the first half of the year and that it was on track to increase revenues by 10 per cent in the full year 2013.

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Chinese telecom equipment maker expects solid, sustained growth in consumer device and enterprise space.
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China vows to improve air quality

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AAP

China has vowed to reduce levels of atmospheric pollutants in Beijing and other major cities by as much as 25 per cent to try to improve their dire air quality.

China's State Council, or cabinet, said on Thursday that "concentrations of fine particles" in the capital's air will fall by "approximately 25 per cent" from 2012 levels by 2017.

Other major Chinese cities on China's affluent east coast, including Shanghai and Guangzhou, will see reductions of between 10 and 20 per cent from 2012 levels over the same period, said a plan posted on the central government's website.

Cities across China have been hit by intense air pollution in recent years, much of it caused by emissions from coal-burning power stations, with levels of small particles known as PM2.5 reaching as high as 40 times World Health Organisation (WHO) limits this year.

The pollution has been linked to hundreds of thousands of premature deaths, and has tarnished the image of Chinese cities including Beijing, which saw an almost 15 per cent drop in tourist visits during the first half of this year.

The plan said pollution levels would be cut by slowing the growth of coal consumption, so that its share of China's total energy consumption falls to 65 per cent by 2017.

China relied on coal for 67 per cent of its energy needs last year, environmental group the World Wide Fund for Nature (WWF) said in a statement.

"We call on the Chinese government to set a more positive target, to more strictly limit coal consumption," WWF China's climate and energy project manager Lu Lunyan said in the statement.

China is the world's biggest coal consumer and is forecast to account for more than half of global demand next year.

Three of China's most populated coastal regions - including the areas surrounding Shanghai, Beijing, and the manufacturing hub of the Pearl River delta - should "strive to achieve a reduction in total consumption of coal", the plan said.

But it did not state any precise targets for reductions, and activists gave the proposals a mixed assessment.

The plan "takes very important steps" towards controlling rapid growth in coal consumption, said Li Yan, climate and energy campaign manager at Greenpeace East Asia.

But to reduce air pollution significantly "it will be necessary to limit coal consumption in other areas as well", she said in a statement.

The plan did not call for cuts in coal consumption in China's vast inland provinces, which researchers earlier this year said are responsible for 80 per cent of China's carbon dioxide emissions, mostly as a result of coal-burning.

China's coastal areas are "outsourcing" pollution internally to meet emissions reduction targets, researchers wrote in the Proceedings of the National Academy of Sciences this June.

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Govt commits to reducing pollutants in Beijing and other cities.
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China vows to ban coal-fired plants

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AAP

China says it will ban new coal-fired power plants in three key industrial regions around Beijing, Shanghai and Guangzhou in its latest bid to combat the country's notorious air pollution.

The action plan from the State Council announced on Thursday also aims to cut the country's percentage of total primary energy use stemming from coal to below 65 per cent by 2017. The US government estimates that China currently gets about 70 per cent of its energy from coal.

The government has come under increasing pressure from a growing middle class to clean up the country's air pollution, much of which comes from the burning of coal.

Environmental group Greenpeace welcomed the plan, saying it would significantly slow growth in coal consumption and set an important precedent that other major economies should follow.

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Govt says it will ban new plants in three key industrial regions.
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Bishop defends China policies

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Foreign minister-elect Julia Bishop has defended the incoming coalition government's foreign investment policies, arguing plans to tighten rules affecting Chinese firms will not affect free trade negotiations, according to The Australian Financial Review.


The coalition has been questioned by the likes of former trade minister Craig Emerson about whether the new government can hope to ink a free trade deal with China while also tightening rules affecting Chinese firms' ability to invest in Australia.

The coalition has said it plans to lower the investment threshold for scrutiny of Chinese investment Australian farmland from $248 million to $15 million.

Mr Emerson said the Chinese will never sign a free trade agreement so long as Australia plans to increase scrutiny of Chinese investments in Australia.

However, Ms Bishop said the two goals can be accomplished.


“China ... is well aware of the elements of our discussion paper on investment policy, our zero threshold for [state-owned enterprises] and our national interest test,” Ms Bishop said, according to the AFR.

“I have had discussions with China's new ambassador to Australia, Ma Zhaoxu, and he has not indicated the Chinese see any impediment as a result of the coalition's policy.

“What we want is far greater transparency around foreign investment.”  

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Minister-elect says coalition investment reforms will not hurt trade talks.
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Video: The problem facing Australian banks

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Paul Schulte, a top ranked investment strategist based in Hong Kong believes Australia should have much higher interest rates. In this video interview with Alan Kohler, the former strategist for Nomura and Bank of NY Mellon also says China's banks are dangerously leveraged.

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Paul Schulte, a top ranked investment strategist based in Hong Kong believes Australia should have much higher interest rates. In this video interview with Alan Kohler, the former strategist for Nomura and Bank of NY Mellon also says China's banks are dangerously leveraged.
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Why China faces four per cent growth: Pt. 2

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This article is the second in a two-part series. The first half was published Friday 13 September, where Michael Pettis argued the upper limit of growth in China over the next ten years was four per cent because China would struggle to achieve a consumption rate of 70 per cent of GDP and investment could not be sustained at 49 per cent of GDP, an historical anomaly for emerging economies. He continues below.

So I assume that investment must drop as a share of GDP. One way or another, either because Beijing forces changes in the growth model, or because Beijing does nothing and allows debt to build to the point where debt capacity constraints are breached, after which investment collapses automatically and the investment share of GDP will drop substantially.

How long will it take? I am going to assume Beijing has ten years to bring investment levels down to the new “optimal” level just to make my calculations easier, but as in the case of taking ten years for consumption to adjust, I think this is an heroic and frankly implausible assumption. Debt levels are simply too high in China for it to continue this level of investment growth for so many more years.

To repeat the exercise, then, let me make two separate assumptions: that investment will drop to 40 per cent of GDP in ten years and that investment will drop to 35 per cent of GDP in ten years. In either case, I will assume that investment is currently 46 per cent of GDP, although it is probably closer to 49 per cent.

It turns out that it is fairly simple arithmetic to work out the implications of each of these assumptions relative to GDP growth. Rather than start with growth assumptions in consumption and investment and use these to determine what the corresponding GDP growth rate is likely to be, I thought it would be more useful if I reverse the process and simply assume a bunch of GDP growth rates ranging from -2 per cent to 10 per cent. These are the different average GDP growth rates possible under different scenarios for the next ten years.

We will assume two sets of adjustments for investment and consumption. The “easier” adjustment scenarios have household consumption growing from 35 per cent of GDP to 50 per cent of GDP, while investment declines from 46 per cent of GDP to 40 per cent of GDP. The “tougher” adjustment scenarios have household consumption growing from 35 per cent of GDP to 55 per cent of GDP, while investment declines from 46 per cent of GDP to 35 per cent of GDP.

The table below lists the consumption and investment growth rates needed for rebalancing to take place at each of the highlighted GDP growth rates.

Graph for Why China faces four per cent growth: Pt. 2

To read the table, let us start by assuming, as an example, that we believe the average GDP growth rate over the ten-year period will be 6 per cent. For China to do a minimal amount of rebalancing that gets consumption to 50 per cent of GDP and investment to 40 per cent of GDP, we can quickly figure out what the corresponding growth rates of consumption and investment must be. Consumption must grow by 9.9 per cent a year and investment must grow by 4.5 per cent a year to get us there.

Notice the reason why I do it this way rather than the “normal” way most other economists would. Instead of estimating what I expect the growth rates in consumption and investment will be, and then calculating the implicit GDP growth rate from those numbers, I start with an assumed GDP growth rate and then calculate what the implicit growth rates in consumption and investment must be in order for rebalancing to take place. I am not making predictions, in other words. I am simply working out logically what any GDP growth rate must imply in terms of consumption and investment growth rates in order for China to rebalance.

This allows me to make statements like this: If you think that China’s GDP will grow by 7 per cent a year over the next decade, and if you expect a minimal amount of rebalancing, then you are implicitly predicting that consumption will grow by 10-11 per cent a year for ten years and that investment will grow by 4-5.5 per cent. If you believe these two implicit predictions are plausible, then your 7 per cent prediction is also plausible.

Trade is a residual

Notice that for the changes to work, we are implicitly assuming that the GDP share of the sum of other consumption (government and business) and the current account surplus changes automatically to allow the equation to work. For example, if consumption rises from 35 per cent of GDP to 50 per cent of GDP, while investment falls from 46 per cent of GDP to 40 per cent of GDP, the other sources of demand (mainly other consumption and the current account) must have reduced their share of GDP from 19 per cent to 10 per cent. This probably means a sharp contraction in the country’s current account surplus and perhaps even a current account deficit.

I want to state again that these numbers are not predictions. They are simply the arithmetically necessary growth rates that are consistent with our assumptions. To return to the interpretation of the table, let us assume again that China does the minimal amount of rebalancing so that in ten years, household consumption is 50 per cent of GDP and investment is 40 per cent of GDP. What are the investment and consumption growth rates consistent with, say, 6 per cent GDP growth, and are they plausible?

It turns out that average GDP growth rates of 6 per cent require, as an arithmetical necessity, that household consumption grow by 9.9 per cent a year over the next ten years and that investment grow by 4.5 per cent, after many years of high double-digit growth and more recently growth in the low-double digits. Is this plausible?

I would argue that positive investment growth rates for another ten years are highly likely to result in our reaching debt capacity constraints well before the end of the decade, so I am sceptical about the investment implications of this scenario. By the way, some analysts have mischievously pointed to the very poor construction quality in China to argue that investment growth rates have to stay high just in order to account for higher-than-estimated depreciation costs, and that this suggests that China can grow faster than what we might otherwise assume.

This, of course, is nonsense. The fact that buildings and infrastructure are poorly constructed means that China is worse off, not better off, and that investment projects will ultimately be required to generate sufficient returns to pay off even more debt than originally estimated. Because it is debt capacity constraints that constrain investment, anything that creates debt without creating additional productivity to service the debt cannot possibly be a solution. Higher-than-expected depreciation increases debt relative to debt-servicing capacity.

More importantly, I would argue that if annual investment growth drops to 4.5 per cent and GDP growth to 6 per cent, it will be very difficult — without significant and politically painful transfers from the state sector to the household sector — for consumption to grow at anywhere close to 9.9 per cent a year for ten years. Consumption growth is, after all, positively correlated with investment growth, especially in the internal provinces upon which a lot of useless investment has been lavished.

In order to get Chinese households to increase their consumption by nearly 10 per cent every year, I would argue that household income would have to grow at that rate, which means that wages, interest rates, and the value of the renminbi should in the aggregate increase rapidly to get consumption to rise fast enough. Of course, since it is precisely low-wage growth, low interest rates, and an undervalued currency that goose GDP growth, reversing them is not consistent with high GDP growth.

Can consumption grow at close to 10 per cent for ten years while household income grows much more slowly? Yes, of course it can, if the household savings rate declines. But as China’s economy slows and as concerns about debt rise, it seems to me a tad optimistic to assume that the household savings rate will decline sharply. Rising income and rising uncertainty both suggest that we should expect higher (not lower) household savings rates, which in turn imply that household income must grow faster (not slower) than household consumption.

All of this suggest to me that while 6 per cent GDP growth for the next ten years might not be impossible, it is extremely unlikely because it requires implausible assumptions about the ability to maintain and increase already-high levels of investment without increasing the debt burden unsustainably and about the rise in the growth rate of household income as both GDP and investment growth drop sharply. This is why even 6 per cent annual GDP growth rates, which are still lower than most current growth projections for China, are implausibly high.

What about if you believe that reducing investment is a much more urgent priority than raising consumption? In that case, you might argue that China can grow at 6 per cent while the household consumption share of GDP rises to 50 per cent and the investment share of GDP declines to 35 per cent.

In that case, you are implicitly assuming that household consumption will grow on average by 9.9 per cent a year for ten years while investment grows by 3.1 per cent a year. Is this possible? Of course it is. Is it plausible? Again, only if you believe that investment growth can drop sharply while the growth in household consumption rises to nearly 10 per cent a year for ten years.

So what is plausible? My working assumption, which I acknowledge is probably still optimistic, is that somehow Beijing can keep household consumption growing at around 7-8 per cent a year, even with a sharp decline in the investment growth rate and with the pressing need to clean up the banking system. (Remember that traditionally, in China and elsewhere, cleaning up the banking system always means finding ways of getting the household sector to pay for the losses.)

I know many consider assumption this to be a little optimistic. But if Beijing is worried about the social implications of adjustment, this is probably the target it will need to meet, and it can do so even with much slower GDP growth if the leadership implements mechanisms that transfer wealth from the state sector to the household sector. I discuss why this is the right growth rate for to target in more detail in a recent piece published on the Carnegie Endowment website and in an OpEd piece in the Financial Times.

The table above shows that if China is to do the minimal amount of rebalancing, which requires that the world accommodate large Chinese trade surpluses for another ten years, and that debt can continue to grow – quickly but at a lower rate than in the past – for another ten years without pushing China up against its debt capacity constraints, 7-8 per cent growth in household consumption is consistent with roughly 3-4 per cent growth in GDP. It is also consistent with more or less no growth in investment, which would bring the investment level down to 35 per cent of GDP after ten years.

These numbers are plausible, if still a little optimistic. This is something that I think Beijing can reasonably pull off – if it is able to manage political opposition from the domestic elite – because it can transfer resources from the state sector to the household sector at a pace necessary to keep the growth rate of household income and household consumption fairly high. However GDP growth rates significantly above 3-4 per cent, I would argue, require assumptions that are unlikely to be met unless Beijing is able radically to transform its attitude to state ownership and the power of the elite, and so embark on a major transfer of assets from the state to the household sector.

This is why I have argued since 2009 that 3-4 per cent average GDP growth for a decade is likely to be the upper limit once Beijing seriously begins to rebalance the Chinese economy. If the administration of President Xi and Premier Li is able to pull this off, it would be a huge accomplishment.

China would rebalance substantially, the problem of debt would have been managed relatively well, and the income of average Chinese households will have nearly doubled over the decade. The key assumption, of course, is that in the face of a sharp drop in investment, Beijing is nonetheless able to maintain current high levels of consumption growth.

Before closing it is worth pointing out that many analysts have told me that they do not think it is possible for household income growth to exceed GDP growth for many years. But why not? After all, state income growth exceeded household income growth for many years, and if Beijing reverses the mechanism that accomplished this – albeit with political difficulty – it can reverse the relative growth rates.

Japan did just this after 1990, when GDP grew by around 0.5 per cent annually but household income and household consumption grew by between 1 per cent and 2 per cent. The US did this too in the early 1930s when, if I remember correctly, household income and household consumption dropped by a lot less than GDP (around 35 per cent) and investment (around 90 per cent).

But notice these two examples. One occurred under conditions of no growth and the other under conditions of negative growth. Severely unbalanced systems always rebalance in the end, but the process of rebalancing is rarely easy.

Michael Pettis is a senior associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management. He blogs at China Financial Markets.

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China's great rebalancing will not result in the rapid growth in consumption many analysts predict.
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China to meet growth target: World Bank

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China is likely to achieve its growth target of 7.5 per cent this year despite planned structural reforms to rebalance the world's second-largest economy, the World Bank president says.

Jim Yong Kim is making a four-day visit focusing on issues relating to carbon emission reductions and China's urbanisation push.

"We think the growth (for China this year) will be at about 7.5 per cent," Kim told a press conference in Shanghai yesterday.

"The data from August suggests that China will reach its goal of 7.5 per cent."

Earlier this month, the government announced a series of better-than-expected indicators for August, including strong exports and industrial output, that pointed to a pick-up in the domestic economy.

China's economy expanded 7.7 per cent last year, its slowest growth since 1999.

Growth eased to 7.5 per cent in April-June, from 7.7 per cent in the first quarter of this year and 7.9 per cent in the final three months of 2012.

Authorities have so far been reluctant to introduce large-scale stimulus measures. But they have pledged to push forward structural reforms to shift the economy from dependence on big-ticket investments and more towards consumer demand as the key growth engine.

"The government is committed to financial sector reforms and also fiscal policy reforms that we think will pave the way for meeting the long-term growth," Kim told reporters in Shanghai.

"We think this is the right path."

China is preparing an "experimental" free trade zone (FTZ) in its commercial hub Shanghai as it tries to promote economic reforms.

Unfettered exchange of the yuan currency will be allowed within the proposed zone, according to a draft plan seen by AFP.

"I think it's a very positive development," Kim said of the FTZ.

"This free trade zone will allow China to become more competitive."

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August data shows country set for 7.5% growth this year, Jim Yong Kim says.
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China airs confession by detained blogger

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One of China's best known online commentators appeared in state media on Sunday to admit to spreading irresponsible internet posts after China adopted tough measures to crack down on online rumors.

People will be charged with defamation if posts online that contain rumors are visited by 5,000 internet users or reposted more than 500 times, according to a judicial interpretation issued this month by China's top court and prosecutor.

That rule, which could lead to three years in jail, is part of a recent government efforts to rein in social media, increasingly used by Chinese people to discuss politics, despite stringent censorship.

Detained Chinese-American venture capitalist Charles Xue, known for making controversial remarks on social and political issues, told state broadcaster CCTV and the official Xinhua news agency that "freedom of speech cannot override the law".

"My irresponsibility in spreading information online was a vent of negative mood, and was a neglect of the social mainstream," Xue said.

Xue, also known as Xue Manzi, had 12 million followers on Sina Weibo, China's Twitter-like microblog site. He was shown on state television in August after being detained on an accusation of visiting prostitutes.

Police are now investigating reports from internet users that Xue's online activities may have involved crimes, Xinhua said.

Several foreign and Chinese executives, detained for various reasons, have made confessions recently on state television leading to worry in the business community about a trend that some lawyers say makes a mockery of due process.

Confessions have long been part of China's legal landscape but rarely have senior business figures been put on television in prison jumpsuits to confess.

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One of China's best known online commentators admits to spreading irresponsible internet posts as Beijing implements online crackdown.
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Samsung invests $US500 million in new China facility

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Samsung Electronics Co Ltd will invest $US500 million to build a packaging and testing facility in northwestern China, the official China Daily reports, as South Korea's biggest company expands operations in China.

Samsung's new plant investment comes on the heels of last year's $7 billion chip complex, also in the industrial city of Xi'an, and January's $1.7 billion injection into the firm's operations in Kunshan, a fast-growing manufacturing hub west of Shanghai.

Samsung, the world's largest maker of handsets, memory chips and televisions, is seeking to diversify its clients and exert greater control over its sprawling manufacturing network, which includes 250 supplier factories in China.

Construction of the packaging and testing facility is expected to begin in January 2014 and aims to be finished by the end of that year, said the report.

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South Korean giant to build a packaging and testing facility in northwestern China as part of its expansion strategy.
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INSIDE INVESTOR: A return to the golden days of ore

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This time last year, we suggested everyone get out of anything to do with iron ore.

The timing was just right. Iron ore prices halved shortly afterwards, falling well below $US90 a tonne. The share prices of all the big miners headed south with the metal.

But this year, despite all the predictions by the experts and all the talk about the end of the mining boom, not to mention the dire forecasts of a slowdown in China, iron ore prices are heading back towards record levels.

That has been helped along by the decline in the Australian dollar. But it has been rising steadily in American dollar terms, too. And there are good reasons why it should remain at healthy levels for quite some time.

Most of the experts put one and one together and came up with three. They figured that if China’s growth is slowing, then it would result in less demand for the key steelmaking ingredient.

To make matters worse, with the mine expansions of the past few years, this was going to happen just as extra supply flooded the market. That added up to price collapse.

It was a compelling argument. So what has gone wrong? For a start, China’s growth may be slowing but its economy is so much bigger now that each year it adds the equivalent of a Switzerland to its national output. That requires a lot of extra infrastructure.

But there is more fundamental reason. China’s steel industry now is massive. A decade and a half ago, it was comprised of large numbers of small mills that could be easily shut down. Since then, it has rationalised, amalgamated and expanded. Today, China boasts some of the world’s biggest mills.

These huge operations pour out steel in astounding quantities and have a voracious appetite for raw materials. Slowing down output is not easy. Shutting them down is even more difficult and could be extremely costly.

That explains why, in times even when steel prices have been depressed, they’ve continued to churn out steel at a cracking pace.

About the only way a manager can cut costs is to stop buying ore and run down the stockpiles. But this can’t be maintained indefinitely. Sooner or later the stockpile becomes dangerously low. And if all the mills have run them down and they all resume buying around the same time, then up goes the price.

This is what has happened in recent months. While it is likely prices will retreat again, don’t count on an extended crash until you start reading about steel mill closures in China. Until then, look for buying opportunities among miners when prices are low.

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The massive growth of China’s steel industry and its demands for infrastructure have seen iron ore prices defy investors’ expectations.
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China cracks down on foreign business

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Chinese policeman

The view from the trenches at that moment among the foreign business community is that doing business in China has become more difficult, not less. The most recent European Union Chamber of Commerce in China ‘Business confidence survey’ (June 2013) showed 53 per cent of respondents citing market access barriers as being a significant challenge to their future business in China, while 47 per cent cited discretionary enforcement of regulations. In the same survey, 30 per cent of respondents said that the regulatory environment has increasingly discriminated against foreign investors or is generally much less fair now than it was two years ago.

 The ‘FDI Regulatory Restrictiveness Index’ compiled by the Organisation for Economic Co-operation and Development (OECD) identifies China as having the most ‘closed’ economy among all OECD and G20 nations, having regard to foreign equity limitations, screening or approval mechanisms, restrictions on the employment of foreigners and operational restrictions.

Sectors that remain restricted or wholly closed to foreign investment include key areas where Australian businesses possess particular know-how and competitive advantage: energy and natural resources, and agriculture. These also happen to be the sectors that are most attractive to Chinese investors seeking to invest in Australia.

While this is patently unfair, the gap also presents an opportunity for Australian policy-makers to push their Chinese counterparts for a policy of ‘reciprocity’ to prevail – to highlight that Australia welcomes Chinese investment, but expects the same treatment for its companies in China as it affords Chinese investors in Australia. This reciprocity should extend to market access, approval processes and other restrictions.

One of the biggest challenges facing foreign investors has been fairness in treatment and consistency in application of regulations and policies. This has been manifested in three key areas;

Food and health safety and standards.

Food safety is an increasingly sensitive political issue in China as numerous food scandals – from melamine-tainted milk powder to diseased pork, from cadmium rice to exploding watermelons – have drawn the ire of the populace, putting pressure on the authorities to investigate and punish offenders and reassure its people that they can eat safely.

However, foreign companies appear to be frequent and public targets of these investigations, as local officials eager to show that they are serious about tackling food safety issues see foreign operators as easier targets, as they are not entrenched local interests, and lack political protection. Such food safety crackdowns are often accompanied by adverse publicity campaigns in state-run media.

Recent targets have included:

  • Wal-Mart, which was subject to a number of charges, including mislabelling regular pork as more expensive organic pork, a scandal which led to the temporary closure of thirteen stores and the arrest of two employees, and selling products with hazardous levels of chemicals. Wal-Mart has since agreed to invest RMB100 million to strengthen food safety management at its stores in China.
  • KFC, one of the most long-standing and successful Western businesses in China, which faced an online outcry and falling sales after Chinese food regulators announced they had found excessive levels of antibiotics and hormones in chickens from some KFC suppliers, and more recently a CCTV media reported that its ice cubes contained excessive levels of bacteria.

Anti-trust and consumer investigations

Since China introduced its first comprehensive trade practices law in the form of the Anti-Monopoly Law of 2008, much of the focus internationally has been on the role of the Ministry of Commerce (‘Mofcom’) in overseeing merger control under the new law. Mofcom has made rulings on a number of overseas merger and acquisition transactions, as it seeks to become a globally influential antitrust regulator alongside the US Department of Justice and the European Commission.

However, it is the lesser remarked upon role of the National Development and Reform Commission (‘NDRC’) as the frontline regulator on pricing practices and anti-competitive behaviour that is having an increasing impact on foreign business on the ground in China. Its actions in preventing monopolies and unfair pricing practices also serve a political goal: pushing down prices for consumers is good public relations for the Chinese government, and at the same time supports Beijing’s efforts to boost the consumer-led economy.

Again, foreign companies have been apparently disproportionately subject to the NDRC scrutiny, in a number of recent cases:

  • In 2011, global consumer products giant Unilever was fined RMB2 million for announcing to the media that intended to raise prices. Prices were never actually raised, but Unilever was fined in any event for allegedly creating a consumer panic through its public statements.
  • A group of the five largest global infant formula manufacturers – including Nestlé and Danone among other prominent global players – agreed to reduce the prices of their infant formula products in China after the NDRC announced it was investigating the companies for alleged price fixing in China. The NDRC subsequently levied significant fines on a number of the companies.
  • The latest NDRC investigation has apparently been into foreign pharmaceutical pricing, although that has led to a broader corruption investigation, discussed below.

Bribery and corruption

Corruption is endemic in China, affecting all levels of government and business. Foreign companies also find themselves the target of corruption investigations, although again the timing and motivation for such investigations raise some questions.

In the most notable case for Australia, several Rio Tinto executives were jailed for accepting bribes and stealing commercial secrets. While not questioning the conclusions of the Chinese judicial process that found the Rio employees guilty, it is notable that the investigation came shortly after the collapse of Chinese state-owned mining giant Chinalco’s attempted investment in Rio Tinto and during a fraught annual benchmark iron ore price negotiation process.

Most recently, British pharmaceuticals giant GlaxoSmithKline has been charged with a scheme of bribery involving payments to officials and doctors. In the context of a chronically underfunded health system, rampant counterfeiting of drugs and poorly paid doctors who seek to supplement their salaries – whether with kickbacks from pharmaceutical firms or bribes from patients’ families to ensure priority treatment – there is clearly much that needs to be fixed in China’s health system. It is curious that a large foreign drug company should be the starting point. Notably, following the charges being laid, GlaxoSmithKline announced price cuts at the same time as confirming that some of its executives appeared to have breached Chinese law.

A way forward

None of the above is intended to excuse foreign companies for their misbehaviour in China. All companies must fully comply with the local law in all countries where they do business, and those that do not should be penalised in accordance with the law. However, concerns remain about the consistency and fairness with which such laws are applied to foreign businesses in China. There are also concerns that the public relations exercises in state-controlled media that generally accompany regulatory investigations appear to be part of a strategy to discredit or constrain foreign businesses in their attempts to compete in the domestic consumer market.

Australian policy-makers should press their Chinese counterparts to ensure that:

laws and regulations are clearly drafted and publicly disseminated, and do not contain vague provisions that can be subject to discretionary interpretation by regulatory authorities;

foreign and domestic companies are treated fairly and consistently when it comes to the application of laws and regulations; and,

investigations are conducted transparently, sound evidence is provided to support allegations of misconduct and state-owned media are not favoured in dissemination of information on regulatory actions.

At the same time, foreign businesses in China need to understand that public relations and active image management is now just as important in China as it is in any other market. There once may have been a perception that China was ‘just’ a developing market, where investors could ignore public relations and take a lax approach to regulatory compliance. This is clearly no longer the case.

Greater fairness and equal treatment is needed in both directions: from foreign companies in operating their businesses in China, and from the Chinese government in regulating foreign business. This would lead to benefits for all involved. Australian governments and businesses should seek to be leaders in this respect, and place themselves at the forefront of a new era of engagement between China and the world.

Antony Dapiran is a partner of the international law firm Davis Polk & Wardwell, based in the firm’s Hong Kong office, where he advises on capital markets transactions and Chinese inbound and outbound mergers and acquisitions.

This article originally was published in the Australia-China Agenda, a publication of the Australian Centre on China and the World of ANU. It is has been edited for length.

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As China moves from manufacturer to consumer, foreign firms are coming into direct competition with domestic players. Plenty of evidence suggests they're getting treated unfairly.
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China to slap dumping duties on U.S. solar material

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REUTERS

China said on Monday that it would impose preliminary anti-subsidy duties on some imports of U.S. solar-grade polysilicon, a move that could intensify trade tensions between the world's two largest economies.

China's Commerce Ministry said it would hit U.S. imports of the material used to make solar panels with relatively low duties of up to 6.5 percent, amid trade frictions in the struggling global solar industry.

That follows the ministry's much heftier anti-dumping duties - used for goods sold below market value - of 53.3 to 57 percent on U.S. polysilicon in July, a move which many saw as a bid to protect China's struggling domestic industry. Washington called those duties disappointing.

According to its investigation, "subsidies exist and China's polysilicon industry suffered substantial harm", the ministry said in a statement on its website.

Beginning on September 20, importers of polysilicon from Hemlock Semiconductor Corp and AE Polysilicon Corp will have to pay the duties.

The ministry said other companies, including REC Solar Grade Silicon LCC, REC Advanced Silicon Materials LCC, and MEMC Pasadena Inc., would not be subject to anti-subsidy duties because they had not been subsidised or the rates were too low.

China has also locked horns with the European Union and South Korea over the solar industry.

European companies accuse Chinese rivals of benefiting from unfair state aid, allowing them to dump about 21 billion euros ($28 billion) worth of solar panels at below cost in Europe last year, putting European firms out of business.

Europe planned to impose heavy tariffs on Chinese solar panels but, wary of offending China's leaders and losing business, a majority of EU governments - led by Germany - opposed the plan, which led to the compromise deal in July.

EU governments must decide in December whether to back the July price deal.

China's polysilicon sector, which has around 40 companies employing 30,000 people and has received investment of 100 billion yuan ($16 billion), suffers from low quality and chronic over-capacity as local governments poured in money to feed a fast-growing solar panel industry.

Demand for solar panels has eased since the global financial crisis, forcing governments worldwide to slash solar power subsidies and leaving China sitting on idle capacity and mounting losses.

Of the 69,000 tonnes of solar-grade polysilicon China consumed in January-June, 41,000 tonnes were imported, according to industry data. China's solar panel makers prefer imported polysilicon, which has a higher purity that helps in energy conversion, company executives say.

Domestic business lobbies have been a major force pushing the Commerce Ministry to curb polysilicon imports that exceeded $2.1 billion in 2012.

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China's new Silk Road drives Middle East diplomacy

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Chinese President Xi Jinping clapping in parliament with tea

The Conversation

As intense negotiations between Moscow and Washington draw to a close, the Chinese Government will be heaving a sigh of relief that diplomacy seems to have triumphed over the use of force in Syria.

China’s pleas to the international community to solve the crisis through dialogue were all about the leadership’s obsession with maintaining economic growth. It was about stabilising export markets and keeping the lid on consumer prices, rather than an ideological commitment to the sanctity of international consensus or a belief in the efficiency of the UN Security Council.

On the sidelines of the G20 summit in St Petersburg, China’s deputy finance minister contended that a $US10 increase in the price of crude oil could trim 0.25 per cent off global growth.

As China’s new leadership consolidates its grasp on power and grapples plateauing industrial output and single digit GDP numbers as the new norm, an international conflict would seriously undermine the fundamentals of the Chinese economy and dent the Communist Party’s credibility.

New Silk Road

The Middle East’s position as China’s bridge between Asia and Europe is a critical part of the Chinese government’s pitch to embed a “New Silk Road” as a centrepiece of its economic policy.

From building a new rail link that will connect central China’s emerging logistics and manufacturing hub of Chengdu to Germany, to building the Shanghai Cooperation Organisation as an enabler of regional currency convertibility and transport agreements to bolster regional trade, Central Asia and the Greater Middle East are emerging as key pillars of Chinese foreign policy.

Xi Jinping’s foray into this fascinating area of foreign policy is just as much about appealing to a domestic political audience as it is about building China’s global influence and countering US hegemonic power.

The “New Silk Road” is a direct ideological appeal to the heart of the Chinese people and harks back to a golden age of imperial Chinese civilisation, evoking powerful imagery of China as an enabler of world trade.

This is a deliberate policy designed to generate wealth in China’s central and western provincial hinterland, which has lagged significantly behind the post-Mao development of China’s eastern seaboard.

A big part of this is driven by political and economic self-interest imperatives. Generating wealth in East Turkestan (also known as China’s Xinjiang Province) is seen as an essential component to quelling ethnic discontent and a not always peaceful movement led by Uyghur independence activists.

None of the recent ideology has occurred in a state of splendid isolation.

Over the past decade, China has accumulated significant runs on the board and the emergence of Xi Jinping’s ideological window dressing is occurring against the backdrop of significant Chinese investment in energy assets and economic activity in the region.

Breaking oil dependency

China’s ideological appeal is firmly about unshackling Beijing from oil dependency in the Middle East and diversifying its investment footprint into the wider region.

The Middle East accounts for more than 60 per cent of China’s oil imports and is a vital cog in the wheel of the Middle Kingdom’s growing appetite for crude oil. In 2011, China imported almost three million barrels of oil per day from the region. By next month, China is forecast to exceed the US in net oil imports.

While sanctions have made acquiring equipment to service assets in Iran problematic, state-owned giants such as Sinopec and China National Petroleum Corporation (CNPC) were quick to invest in premium Iraqi oil assets in the aftermath of the collapse of the Baathist regime and the US-led invasion.

It should be pointed out that China’s investment in the Middle East is starting from a small base – Chinese investment accounts for less than 2 per cent of total foreign direct investment in the region.

Yet this has been growing. In 2012, China invested $US8.2 billion in the UAE, $US12.9 billion into Saudi Arabia, $US120 billion worth of hydrocarbon contracts in Iran, supervises at least $US4 billion worth of oil assets in Iraq, and has signed an ambitious new trade and investment partnership to bolster transactions with Egypt.

This investment and ideology has been accompanied by an increased willingness by Beijing to play an active role in the region, including a sense of political will to invest in the Middle East peace process.

World role

The West has been urging China for years that its new-found economic and political power needs to be matched by a willingness to behave as a responsible international stakeholder.

Few could have imagined the powerful optics accompanying Xi Jinping’s foray into the Middle East peace process in May this year. Beijing hosted Palestinian President Abbas and Israeli Prime Minister Netanyahu within a day of each other.

The symbolism of these immaculately timed visits was accompanied by the release of Xi’s so-called “four point” Middle East peace plan involving a road-map to an independent Palestinian state, stopping settlements, lifting the blockade of the Gaza Strip and securing the release of political prisoners.

Coupled with China’s evolving economic interests in the region, its growing soft power diplomacy and its new sense of confidence assuming a voice on regional affairs, it seems the “New Silk Road” is here to stay and will become a normal part of life in the evolving dynamics of the Asian Century.The Conversation

This article was originally published at The Conversation. Read the original article.

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Aust banks miss out on Shanghai FTZ

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Australian banks have been left out of the first round of financial liberalisation in the Shanghai Free Trade Zone, according to The Australian Financial Review.


The newspaper reported that only four foreign banks were “invited” by the China Banking Regulatory Commission to participate initially in the round, which will be launched by Chinese premier Li Keqiang on September 29.

All four of the invited banks are Hong Kong-based, with the AFR reporting that the four are Bank of East Asia, Standard Chartered, HSBC and Citigroup.


Four or five Chinese banks have also reportedly been invited to open up branches in the free trade zone.

The zone is seen as crucial to China's efforts to liberalise its financial system, as well as its shipping, logistics and commodities trading sectors.

However, the lack of Australian banks, or banks from beyond the region, suggests the Chinese government is treading cautiously in its liberalisation efforts.

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Zone, key to Chinese liberalisation, to exclude many global banks at first.
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China’s FDI obstacle course

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The requirement that investments from China over $248 million be referred to the Foreign Investment Review Board for approval is reportedly a sticking point for Australia-China Free Trade Agreement negotiations. Beijing wants the review-free threshold raised to $1 billion in line with concessions offered to American and New Zealand investors, arguing that the review system is discriminatory against China.

Those such as Barnaby Joyce would argue that the investment review regime is far more onerous and obstructive for foreigners in China and that Beijing should not complain about the rules from our side. Putting aside whether we are actually well served by a tit-for-tat approach (i.e., whether a more open attitude to Chinese FDI irrespective of restrictions in China’s investment regime will aid or harm our national and economic interests) there has been little written about how China’s approval and review process actually works.

As you can see from the details below, the labyrinthine process that foreigners have to go through, and China’s investment regime overall, is even more restrictive and politically motivated than many Australians realise.

The approval process for budding foreign investors in China can involve up to eight steps. The article will outline the most significant hoops that foreign investors must jump through, and where the obstacles really lie.

The first is the Pre-Establishment Approval process which is issued by the Ministry of Commerce and the National Development and Reform Commission which reports to the State Council, the country’s peak legislative body. These organisations issue a Foreign Investment Catalogue detailing industries for foreign investors that are ‘encouraged’, ‘restricted’ and ‘prohibited’. Industries that are ‘encouraged’ will attract a far lower level of scrutiny than those that are ‘restricted’. Any other industries not listed are generally permitted.

The classification for various industries is largely based on China’s industrial policies encapsulated in documents such as the Five Year Plan. For example, ‘national champions’ are encouraged in so-called ‘strategic industries’ such as bio-technology, alternative energy, high-end equipment manufacturing, energy conservation, clean-energy vehicles, new materials and information technology. Other designated ‘important’ industries such as fossil fuel energy, heavy industry, chemicals, banking and finance, insurance, construction and property generally fall into the ‘restricted’ categories.

Importantly, newly announced industrial policy by various ministries can override the Foreign Investment Catalogue guidance at any time, without notification, and with no recourse to appeal. In particular, the NDRC has a record of continually changing the goalposts through announcing policy to enhance domestic ownership (especially by state-owned-enterprises or SOEs) at short notice. Ongoing policy also consistently removes industries from the ‘encouraged’ classification to the ‘restricted’ or ‘prohibited’ classification, making it harder or impossible for foreign firms to enter or thrive in these sectors.

The next stage is to formally obtain government approval. To do so requires negotiating past a two-step review process. First, under China’s Anti-Monopoly Law, the Ministry of Commerce will review any merger or acquisition of assets by a foreign company when the joint turnover of the foreign and domestic entity (in the case of a joint venture) or the foreign entity (in the case of a wholly owned foreign enterprise) in China exceeds RMB 400 million or about $US65 million. The Ministry simply access whether the transaction has the capacity to ‘eliminate or restrict competition’, with little consistent guidance as to how it reaches that assessment.

Second, government approval is subject to a ‘National Security Review’ if the foreign enterprise will gain ‘formal’ or ‘actual’ control of the local asset. A panel of representatives from the Ministry, NDRC and other unspecified departments and agencies will assess whether the acquisition involves entry into the ‘Military and military support’ space, is located in the vicinity of key and/or sensitive military facilities, is an enterprise associated with ‘National Defence and Security’, or is an enterprise engaged in sectors that ‘relate to national security.’

This latter specification covers a broad range of sectors and includes key technologies, major equipment manufacturing, agricultural products, energy and resources, infrastructure and transportation services. Once again, the definition of sectors that ‘relate to national security’ changes according to industrial policy, not just national security policy.

If this obstacle is negotiated, there are then a number of formalities, ranging from getting corporate name approval to approval for site registration. There are also some fairly normal administrative hoops to jump through including getting project and environmental approval for the business activity which are not unique to the Chinese system.

The fifth step is to gain approval from the Ministry of Commerce. This is another opportunity to knock back FDI based on wide-ranking criteria which includes ‘Damage to China’s sovereignty or the social public interest’, risk to ‘state security’ and failure to ‘comply with the requirements of the development of China’s national economy.’ Note that a common complaint is that the criteria for approval during this step are somewhat at odds with aspects of China’s World Trade Organisation commitments.             

The final steps are not prima facie controversial and involve various administration tasks such as registration and offering documentary proof of stated business intention and activity etc. However, the final licensing requirements required at the local levels are often used by local officials to protect their turf for SOEs or else line their pockets through demand for bribes.

It is clear that foreign companies are increasingly complaining about China’s FDI regime for the following broad reasons: that the categories of restricted and prohibited industries are increasingly widening based on an increasingly protective and mercantilist national mentality in the name of national development; that the process and review of decisions is opaque, arbitrary and even highly corrupt; and that local officials impose arbitrary licensing restrictions and demands on foreign entities.

None of this is itself an economic argument that we should have a more restricted regime against Chinese FDI. The position that we will need an increasing amount of Chinese capital to further develop key sectors of our economy is compelling.

But understanding the reality of the process and implementation of China’s own FDI regime will provide an effective counter against Chinese accusations of Australian xenophobia. As our trade negotiators should point out, our regime is far more welcoming of Chinese and other foreign capital than China is of FDI – with the majority of it still destined for the export manufacturing sectors.  

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Foreigners are complaining about China’s FDI approval process for good reason: it’s onerous, arbitrary and vastly different to what Beijing seeks from Australia.
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