The world economy reached an interesting turning point in 2014, when China overtook the United States as the world’s largest economic power as measured by purchasing power parity. But this event has received little attention, and most of commentators have dismissed the historic significance of the passing of baton from the US to China.

Instead, we have started the year with a gloomier outlook for China, which has been regarded as the single most important engine for the global economy until only recently. The country has lost some of its lustre and many bears are busily proclaiming the end of the country’s economic miracle, which has lasted more than three decades.

Even the World Bank, which has been relatively upbeat on China, has changed its tone. The bank’s chief economist Kaushik Basu said this week “the global economy is running on a single engine… the American one. This does not make for a rosy outlook for the world”.

Rapidly falling iron ore prices are bringing the bad news home to Australia, which has enjoyed an amazing run on the back of a China-fuelled mining boom. One of the single biggest factors weighing on the minds of central bankers and business leaders in Australia is without doubt the economic health of our largest trading partner.

So what can we expect from China in 2015? In fact, we can expect much the same as in 2014. Many of the country’s economic ills such as burgeoning local government and corporate debt, excess industrial capacity and a stagnant real estate sector will be with us for many years to come. This year will be another testing year for Chinese policymakers who are trying to push through a host of difficult reforms without bringing about a hard landing.

The single biggest risk for the economy is still the interlinked and rising problems of shadow banking, local government and corporate debts and the stagnant real estate sector. The problem has been highlighted in the IMF’s most recent survey of the country’s economic risk and performance. It describes the risk as “a web of vulnerabilities” “across the key sectors of the economy”.

This web of risks work like this: Chinese companies and local governments borrow heavily from both the banking and shadow banking sectors to finance their investment. The borrowing binge was put on steroids after Beijing unleashed its 4 trillion yuan stimulus package and the accompanied 10 trillion yuan credit expansion.

This has resulted in a rapid increase of indebtedness for both government and corporate borrowers. For example, ratings agency Standard & Poor’s estimates that total outstanding corporate debt in China was around $US14.2 trillion at the end of 2013, compared with $US13.1 trillion for the US. 

As far as the Chinese local government debt is concerned, the picture is quite muddy despite the publication early last year of a comprehensive survey by the National Audit Office. According to the report, there has been explosive growth in local government debt, averaging 20 per cent increase for the last three years.

The total debt level, which includes both central and local government debt, is about 54 per cent of China’s GDP. The fiscal debt does not appear to be too alarming. However, a senior government adviser from the Development and Research Centre of the State Council, the Chinese cabinet, has warned about the risk of “hidden debt”.

“Hidden debt is more dangerous than official debt, it is much harder to regulate and control. In a way, the Chinese local government debt has become an invisible assassin that threatens the country’s economic security as well as social stability,” says Wei Jianing, a senior research fellow from the centre.

Many of strands of this web run through the real estate sector, which is one of the most important drivers of GDP growth. Banks and shadow banks are exposed to the sector through lending to developers as well as mortgage borrowers. Local governments are also heavily dependent on sales of land to developers as one of the major sources of tax revenues.

The IMF warns that “given these interconnections, a major shock to any part of the web would reverberate throughout the whole, creating a negative feedback loop that could considerably amplify the original shock.”

So how serious is the risk? Let’s hear it from the IMF first. The official verdict is “the government still has the capacity to absorb shocks and prevent the kind of loss of confidence or sudden stop that have triggered major problems in other countries -- such as a deposit run, freezing up of the interbank market, collapse of the real estate market, or capital flight”.

Andy Rothman of Matthews Asia reminds us that all major commercial banks in the country are state-owned and “there is no doubt that the Communist Party stands behind them”. Chinese banks are very liquid and have deposits equal to 140 per cent of GDP, compared to 55 per cent in the US. Both central and local government sit on trillions of dollars worth of high quality public assets not to mention the $4 trillion foreign exchange reserve war chest.

For people who like to draw an analogy between the US subprime crisis and the current housing downturn in China, there are few crucial differences. First of all, Chinese households are lightly geared and have to put down at least 30 per cent of the purchase price as a down payment before they can qualify for mortgages. In first tier cities such as Beijing and Shanghai, the minimum payment is 40 per cent.

Toxic products such as subprime mortgages and collateralised debt simply don’t exist in China.

Though analysts and commentators have been obsessed with debt and real estate, one of the biggest problems for China is actually the high cost of borrowing for small to medium size companies, which form the backbone of the economy. Consider these facts -- businesses with less than 1000 employees contribute to 70 per cent of GDP, 65 per cent of new patents and 90 per cent of new jobs.

However, the country’s state-owned banking sector favours large government and private enterprises over SMEs. Only 10 per cent of small companies can get credit from banks and 90 per cent of them have to resort to private lenders and pay usurious rates of up to 25 per cent, according to the deputy chair of economic and finance committee of the country’s national legislature.

So is there any good news to cheer about? In fact, there are a lot of silver linings to the dark clouds gathering around the Chinese economy. Lets start with the biggest misconception of all, China invests too much and consumes too little. Yes, the country invests a lot but at the same time, China also enjoys the strongest growth in consumer spending of any major economies, according to the IMF.

Consumption now accounts for 50 per cent of GDP in China. Though it is still considerably lower than the 70 per cent average for the developed countries, it is at least moving in a positive direction. The services sector has also overtaken the industrial sector as the largest segment of the Chinese economy and the re-balancing of the Chinese economy is steering in the right direction.

However, the long-term prosperity of China is really dependent on the ruling Communist Party’s revolve to push through a raft of bold reform policies announced at the end of 2013. Though many China watchers have been disappointed with the progress of reform so far, Arthur Kroeber of Gavekal Dragonomics, arguably one of the most respected China analysts, argues China’s record of reform is actually better than that of any major countries.

“Xi (Chinese president) and his premier Li Keqiang by contrast have done a neat job of running monetary and fiscal policies that are expansive enough to promote growth, but disciplined enough (so far) to limit the excesses that nearly took the economy off the rails in the previous administration,” he says.

The China research team at UBS also argues contrary to market perceptions, saying China has actually made substantial reform progress in 2014. Highlights include the lifting of the deposit rate ceiling and the draft plan for a deposit insurance scheme, new budget laws, local government debt solutions and mixed ownership reform for state-owned enterprises.

“We expect reforms to accelerate in 2015,” says a UBS research report on China’s economic outlook for this year.

At the start of 2014, many doomsayers were prophesying China’s own 'Lehman moment' and then shifted their focus to the real estate industry. After periods of hysteria and various scares, the sector stabilised with the economy managing to grow at a respectable 7.3 per cent. Not bad for a country that is supposed to be on the verge of collapse.

Professor Yu Yongding, one the country’s most distinguished economists and a former member of the monetary policy committee of the central bank has the following warning for China bears on an op-ed piece published on East Asia Forum.

“China has the extraordinary ability to muddle through and keep the economy going. In 2015, China should be able to hit its 7 per cent growth target. Despite vulnerability in its financial system, it is difficult to envisage how a crisis could play out in 2015. Betting on the coming collapse of the Chinese economy is a dangerous business. This is a lesson at least that China bears should have learnt.”

That China will muddle through another year seems to be the best possible bet. 

Wall Street Journal

The automobile has an outsized role in American mythology. Henry Ford and his assembly line. The 1950s, when everything from suburbanization to rock n’ roll was tied to private car ownership. The Big Three auto makers, the DeLorean in Back to the Future, Nascar: all cultural touchstones of a car-proud nation.

The US is hardly alone. Germany has the Autobahn and the design legacies of Audi andBMW . Italian luxury extends beyond high fashion to auto makers like Ferrari and Alfa Romeo. South Korea has the mighty Hyundai Motor Group . In each case, cars are part of a broader national brand.

But what about other countries? What if a major economy had missed out on nearly a century of intense automobile production and mass consumption? How might a desire to catch up manifest itself?

If that country is China, you get the Shanghai Auto Museum: a snapshot of the contradictions of 21st-century China, the self-congratulatory and the self-abasing, the insecure and the brutally honest.

The institution, billed as 'The First Dedicated Auto Museum in China', lies on Shanghai’s outskirts in Anting New Town. The location alone suggests an urban planner’s attempt to foster a cultural appreciation of cars. The museum is two metro stops from the Shanghai Circuit, site of the annual Formula 1 Chinese Grand Prix, and one stop from the Shanghai Volkswagen factory. Next door is the Shanghai Automobile Exhibition Center, home of the biannual Shanghai Auto Show.

On display is a wide range of cars, with sexier specimens like the 1983 Ferrari Testarossa and 1966 Mustang GT mixed in alongside novelties like the 1998 Volkswagen Lupo, known for its record fuel economy. There are also a number of Chinese makes, including a 1959 Hongqi CA72 -- a black, boxy number -- and a 1983 Shanghai Santana, an early product of the joint venture between Volkswagen and China’s SAIC Motor.

China’s familiar nationalism becomes more apparent with the dual Chinese-English text adorning the exhibitions. A plaque labeled 'Dreams of Mobility' notes that after years when cars were “far away from common people”, domestic production of automobiles now means that “China has shown to the world her national dignity and greatness”. Its conclusion: “The national dream has [sic] deeply rooted in people’s eagerness for cars. Today, the eagerness have come to true [sic]. Cars have become an indispensable part in Chinese people’s life.”

Then there are quasi-philosophical attempts to explain concepts like consumerism. Beneath longtime General Motors chief Alfred P Sloan ’s famous quote, “A car for every purse and purpose,” another plaque asks, “Have you ever been attracted by the variety of cars while you stood on the roadside? Have you ever been proud of the character of your own car while you drove it? Could you possibly imagine what it would be like if some day all the cars in the world were the same color and shape?” The museum suggests these questions have a correct answer: “Pursuing individuality is our nature”.

Sometimes the museum verges on the surreal. At one point, visitors can relax on a couch while listening to musical selections ranging from “Without the Communist Party, There Would Be No New China” -- a propaganda hit from the 1940s -- to ABBA ’s 'Dancing Queen'. A short film clip playing behind the display of a BMW Isetta 300 depicts a blond-haired couple setting up an Alpine picnic, their flirtatious German banter clouded by heavy Russian accents.

And yet moments of coherence exist. A timeline of global developments in the auto industry tells us that in 1995, when China’s population was 1.2 billion, the country had only 10 million automobiles. By 2006, it then explains, China was producing more than seven million autos of its own each year as the population rose to 1.3 billion. Such illustrations of China’s booming commercial power instill pride in Chinese and awe in foreigners.

Shanghai’s auto museum isn’t the best in the world. It isn’t on the average tourist itinerary. But its take on the automobile is unlikely to be found elsewhere, meshing the evolution of personal transportation with a nation’s pride, envy and healthy optimism. It also offers another aesthetic option to travelers bored by China’s more familiar temples and jade carvings. As the museum informs visitors, in mostly correct English: “The meaning of the antique car is far beyond itself. They are standing here, flashing the light of scientific technology and art to human dreams of eternal.”

Cameron White is a Princeton in Asia fellow at The Wall Street Journal Asia editorial page.

China's outbound investment topped $US100 billion last year and it will soon outpace inbound foreign direct investment, making the nation a net supplier of capital to the world, a senior commerce official said on Friday. 

"At this pace our outbound investment will soon overtake inbound investment, making us a net supplier of investment capital to the world," Zhong Shan, vice minister of commerce, told a news briefing. 

"This will be an historic turning point." 

Chinese companies invested $US102.9 billion in foreign markets last year, up 14.1 per cent from the previous year, according to the official. 

China is expected to announce inbound foreign investment for 2014 sometime next week. 

In the first 11 months of last year, China recorded foreign direct investment of $US106.24 billion, up 0.7 per cent from a year ago, while non-financial outbound direct investment was up 11.9 per cent at $US89.8 billion. 

"We are encouraging overseas investments and we support our companies as they go out into the global market," the vice minister said. 

Investments to the US were up 23.9 per cent last year and investments to the European Union surged 170 per cent, the official said. 

The service sector saw a 27.1 per cent rise in outbound investments from the previous year while mining -- once one of the key areas for outbound investments by Chinese companies -- declined by 4.1 per cent. 

The official added that outbound manufacturing and service investments were likely to show gains this year while a major government initiative to boost infrastructure of neighboring countries would also help boost the outbound investment total.

The China flagship of French telecom equipment group Alcatel-Lucent says one of its managers is missing, following reports he made corruption claims.

Alcatel-Lucent Shanghai Bell said on Monday it had "lost contact" with Jia Lining and was helping police and his family locate him.

A company statement described Jia as a mid-level manager in the human resources department.

However, influential magazine Caixin last week reported Jia was head of HR and had accused "many" high-level executives at the company and its subsidiaries of corruption and abuse of power in a social media posting.

The company said Monday the posting on messaging app WeChat was inaccurate.

"The content of the Jia Lining WeChat has clear discrepancies with the facts," it said, adding the posting contained "several" fabrications and distortions.

The original entry could not be found. A 3500-word version circulating online, whose authenticity could not be confirmed, listed nine names - all Chinese - of former and current company officials.

Relatives and friends said they lost contact with Jia on Wednesday and his car was found parked on Shanghai's Yangpu bridge, Caixin reported.

A police statement confirmed a car had been found, giving the owner's surname as Jia, and said it received a report of a possible suicide attempt.

Shanghai Bell, set up in 1984, was a pioneering venture, said to be the first foreign-invested stock company in China.

Despite its partly foreign ownership it reports directly to the central government's State-owned Assets Supervision and Administration Commission.

Alcatel-Lucent said earlier this month it had appointed a 26-year veteran of the group, Luis Martinez-Amago, as Shanghai Bell's chief executive officer.

SHANGHAI—The average price of new homes in 70 Chinese cities fell at a slower pace on a month-to-month basis in December as developers pulled back on price cuts at year-end after Beijing unexpectedly cut interest rates in November.

On a year-on-year basis however, the home-price decline widened in December.

China’s real-estate market saw a sharper-than-expected downturn last year and some analysts had expected some stabilization in the market this year after authorities cut interest rates and loosened mortgage rules last year.

But high inventories in many Chinese cities and concerns over property developers’ cashflow are driving some uncertainties about the sector’s health.

On a month-over-month basis, prices in December slipped 0.4 per cent, compared with a 0.6 per cent fall in November, according to calculations by The Wall Street Journal. It was the fourth consecutive month that average prices fell less sharply than in the previous month.

On a year-over-year basis, the average price of new homes declined 4.3 per cent in December compared with a 3.6 per cent fall in November and 2.5 per cent drop in October.

Excluding public housing, private-sector home prices fell in 68 of the 70 cities surveyed in December from a year earlier, unchanged from the 68 cities that posted declines in November, according to data posted by the National Bureau of Statistics on Sunday. On a month-on-month basis, home prices fell in 66 of 70 cities in December, down from November’s 67.

Policymakers, who are concerned about the slowdown China’s economy, have been injecting liquidity into the market through piecemeal and targeted measures in recent months. Supporting the property market is also on their radar, as the real-estate market is estimated to account for nearly one-quarter of gross domestic product when construction, along with related industries such as furniture and raw building materials, are factored in.

Housing sales in the 70 cities surveyed rose 9 per cent in December from November, due to adjustments in mortgage policies, the interest-rate cut and stepped up efforts by developers to reduce their inventories, said Liu Jianwei, a statistician at the National Bureau of Statistics in a statement on the bureau’s website.

But it may be premature to say that the housing market is on the mend, some analysts noted.

While China’s monetary data released earlier this week showed loosening in both the bank and shadow-banking sectors in December, it still isn’t clear whether the broader economy responded to the interest-rate cut in November, said investment bank North Square Blue Oak in a recent research note. “Mortgage lending actually fell in December from November, suggesting limited response in the household sector to the interest-rate cut,” NSBO added.

HONG KONG—Chinese investment firm Legend Holdings Ltd., the largest shareholder of personal-computer maker Lenovo Group Ltd. , plans to raise US$2 billion to US$3 billion with a Hong Kong initial public offering in the second half of this year, people familiar with the matter said Monday.

Legend is working closely with banks to plan the IPO, though it hasn’t officially appointed underwriters, one of the people said.

Legend, which holds a 30.6 per cent stake in Hong Kong-listed Lenovo, invests in a wide range of industries from technology to real estate to agriculture. In 2013, its revenue was 244.0 billion yuan (US$39.0 billion) and total assets were 207.0 billion yuan (US$33.1 billion), according to its website.

Legend representatives couldn’t immediately be reached for comment.

Chinese smartphone maker Xiaomi Corp. will buy a 3 per cent stake in software maker Kingsoft Corp. from Tencent Holdings Ltd. , as the company expands its investments after raising $1.1 billion in new funding in December.

Xiaomi, China’s largest smartphone maker by shipments, will buy 35.3 million shares of Kingsoft at 14.93 Hong Kong dollars (US$1.93) per share, for a total of HK$527 million (US$68 million), according to a Kingsoft filing Monday.

At that price, Xiaomi would be paying a 5.7 per cent discount to Kingsoft’s Friday closing price of HK$15.84 a share.

Xiaomi’s founder and Chief Executive Officer Lei Jun is also Kingsoft’s chairman and was previously the CEO of the software maker. Beijing-based Kingsoft makes productivity software, similar to Microsoft Corp.

The investment comes as Xiaomi expands its sights after becoming the world’s most valuable startup in December with a valuation of more than $46 billion. Xiaomi is looking to expand in content and software, announcing in November that it would put $1 billion toward the acquisition of video content. It is also looking for new partnerships with device makers, as it seeks to connect its phones to more everyday devices, Xiaomi’s president Bin Lin said in an interview last week. Xiaomi has invested in companies in recent months ranging from Baidu Inc. ’s video arm to home appliance maker Midea Group Co.

After the acquisition, Xiaomi will hold 2.98 per cent and Chinese Internet giant Tencent will hold 9.6 per cent of Kingsoft’s total shares. Since Xiaomi is a controlled corporation of Mr. Lei, Kingsoft’s chairman and largest shareholder, the acquisition increases Mr. Lei’s stake in Kingsoft to 29.9 per cent.

Kingsoft said in a public statement that the acquisition reflects Xiaomi’s strong confidence in the company, and that Tencent will remain an important business partner.

The share transfer is expected to be completed by Jan. 30.

China’s economy expanded 7.4 per cent in 2014, just short of an official growth target of 7.5 per cent, making it the first time the Chinese government has missed its aim since 1998.

The pace of growth was also the slowest since 1990, when China was hit by international sanctions following the bloody Tiananmen Square crackdown.

The gross domestic product (GDP) reading of 7.4 per cent for the year compared with 7.7 per cent in 2013.

GDP for the fourth quarter of 2014 came in at 7.3 per cent, unchanged from 7.3 per cent previously and just above analysts expectations of 7.2 per cent growth.

Economic growth is expected to slow further in 2015 as Chinese leaders emphasise a "new normal" of slower expansion and continue to unveil key reforms.

The slow down in growth is a far cry from its peak in 2007 when the economy was enjoying annual growth of over 14 per cent.

Some analysts expect Beijing to revise its growth target for 2015 to around 7 per cent with others expected more stimulus measures as real estate contracts.

China’s stock markets were down almost 8 per cent yesterday -- the biggest fall since 2008 in response to moves by securities regulators to reign in brokers.

At a plenary meeting of the State Council on Monday, Premier Li Keqiang said there was downward pressure on the Chinese economy in 2015.

"As the global economy is undergoing a deep restructuring and slow recovery, China's government will likely face heavy tasks in tackling the difficulties," Li said.

China is facing slowing domestic demand, over capacity in various sectors, heavy corporate and local government debt as well as a real estate downturn.

China shares rebounded from Monday's sharp drop to gain 1.5 per cent Tuesday morning even as the country reported its weakest economic growth since 1990. 

The Shanghai Composite Index was last up 1.5 per cent at 3162.80 after China's National Bureau of Statistics said the economy grew 7.4 per cent last year and 7.3 per cent in the fourth quarter. Beijing targeted 7.5 per cent growth for last year. 

Investors had sent stocks on the mainland to their worst daily decline in more than six years on Monday, as Beijing clamped down on margin trading, a driver of a rally that helped put the market up 53 per cent last year. 

Shanghai's bounce on Tuesday helped lift Hong Kong's Hang Seng Index, which was up 0.7 per cent. Hong Kong-listed Chinese firms rose 2.2 per cent. 

Elsewhere, the Nikkei Stock Average was up 1.5 per cent as the US dollar traded at Yen118.26, from Yen117.81 late in Asia on Monday. A stronger dollar bodes well for Japanese exporters repatriating US dollar revenue. 

Stocks in Australia were off 0.1 per cent as oil prices fell overnight, with little evidence that a recovery was in sight. 

The fall in oil prices has hurt other commodities, including iron ore, a key export of Australia. Shares in mining giant Rio Tinto were down 1.2 per cent, after the company reported it dug up record volumes of iron ore in Australia last year, adding to a ballooning global glut that has driven down prices of the commodity to the lowest level since 2009. 

China’s GDP growth expanded 7.4 per cent in 2014, its slowest pace since 1990 when the Chinese government sent in tanks to clear out student protesters at Tiananmen Square. But there's no need for doom and gloom. The good news is the Chinese economy is officially in the $US10 trillion club; the only other member is the US.


Though China's GDP growth dipped below the official target of 7.5 per cent for the first time since 1998, it is still above market expectations of 7.3 per cent. The better-than-expected performance is largely due to the country’s booming services sector, which now accounts for about 50 per cent of the country’s GDP.


The contribution to GDP growth from the services sector exceeded the manufacturing sector during 2014, highlighting a positive trend towards rebalancing the economy. The outstanding growth in China’s e-commerce sector is one example of the country’s rapidly growing services economy. E-commerce retail sales in China grew 49.7 per cent last year.


E-commerce and internet-related industries are expected to become the new growth engine for China. The McKinsey Global Institute estimates the industry is expected to contribute to 7 to 22 per cent of total GDP growth from 2013 to 2025. You only need to look at Alibaba's shares to remind you of the sector’s promising future.


While we are still on the topic of sales, Chinese consumption growth also performed quite well during 2014, once again expanding at double digits. Who says the Chinese don’t consume enough? China’s consumption is, in fact, the strongest among major economies, according to International Monetary Fund. Consumption grew 10.9 per cent last year.


The strong growth in consumption is underpinned by the rapid increase in wages. Chinese real income adjusted for inflation increased 8 per cent last year and rural income grew 11.2 per cent, even faster its urban counterpart. That these wages are growing rapidly despite a slowing economy is an indication taht the country’s labour force is shrinking.


This takes us to the all-important jobs data, which is in some ways more important than the GDP growth target.  


The reason that Beijing has an official growth target is to ensure that the economy creates enough jobs every to absorb all these new jobseekers every year. People used to believe the country needed to grow at 8 per cent just to mop up these jobseekers.


In fact, the more services-oriented economy has a greater capacity to absorb jobseekers than a manufacturing-centred one. The country just added more than 10 million urban jobs last year despite a slowing economy. This is a key reason why the Chinese leadership is more tolerant of slower growth.


One of the key headwinds against the economy in 2014 was real estate investment, which has been one of the largest economic drivers in the country. Real estate investment grew 10.5 per cent, compared with 19.8 per cent in 2013. New floor space under construction declined 10.7 per cent compared with last year and sales values also dropped.


We can still expect strong headwinds against the sector this year. The market has already been spooked by a large property developer that defaulted on $SU23 million in interest payments of its offshore bonds this month. A lot of Chinese property developers are highly leveraged and are vulnerable to the declining housing market. The volatile housing market will continue to be one of the biggest risk factors to the economy this year.


In 2015, all eyes will be on the Chinese central bank, which has been relatively reluctant to cut interest rates to stimulate the economy. 


ANZ predicts the central bank will cut the reserve requirement ratio by as much 150 basis points next year. The head of monetary policy at the central bank says it will strike a balance between preventing a more dramatic slowdown and curbing further expansion in corporate and government leverage.


All recent data suggest China does not need to expand at a high official growth target to maintain a high level of employment as well as wage growth. Beijing is expected to become more tolerant of slower expansion and focus more on the quality of growth. The silver lining to the country’s ever-slower GDP growth is that the much-needed rebalancing is taking place, which would set China on a more sustainable path.

Foreign Direct Investment into China is set to double over the next six years, as Beijing relaxes its tough investment regime to make it more attractive for investors, a new report has found.

FDI into China is predicted to rise from $1.26 trillion or 6.6 trillion yuan in 2014 to 13 trillion in 2020. As a share of overall GDP, FDI is expected to rise to 2.8 per cent, according to a study by King & Wood Mallesons

“Over recent years, the Chinese authorities have taken steps to make investment into China easier and to change investor perceptions of the Chinese market and its opportunities” said Stuart Fuller, global managing partner at King & Wood Mallesons, “The government has identified a range of areas that need foreign investment so that China can meet domestic demand and successfully rebalance its economy towards quality growth.”

The draft new foreign investment rules propose to relax controls on foreign investment by only regulating sectors where activity is restricted. Sensitive sectors will be grouped together into a "negative list” and anything sitting outside of the list will be open to foreign investment.

At the moment, foreign ownership is prohibited in key areas of the Chinese economy, including in finance, media, education and the internet.

But one measure that is likely to cause concern for overseas investors proposes to change how many Chinese companies listed on overseas bourses are treated. Under the proposed change, foreign enterprises on the Chinese mainland that are controlled by overseas investors will be considered foreign.

Paul Gillis, a visiting professor of accounting at Peking University’s Guanghua School of Management, says that reform is needed in the foreign investment rules.

"If all they do is treat the VIE as an FIE [Foreign Invested Enterprise], it is a disaster” he said, "That means none of the VIEs in restricted sectors — nearly all of them — are legal."

China’s FDI rose 1.7 per cent last year with a record US$119.56 billion coming into the country compared to US$117.6 billion in 2013.

China's production of crude steel, an indicator of its industrial demand, fell to its slowest pace of growth on record last year, according to data released on Tuesday by the National Statistics Bureau. 

Output of the metal rose just 0.9 per cent from 2013 to 822.7 million metric tons, underscoring how China's vast steel complex, which produces half the world's steel, has fallen to Beijing's push for a cleaner, consumption-led economy. 

The pace was far below that of China's broader economic growth, which last year slipped to 7.4 per cent, the nation's weakest level in 24 years. 

The steel slowdown was widely expected among officials and analysts, amid a years-long effort by the government to consolidate industry overcapacity and force older mills to produce more value-added, less polluting products. 

"The direct reason is due to slower demand from fixed asset investment and real-estate investment," Xu Lejiang, president of the state-backed China Iron and Steel Association, said. "As our country's economy enters a new normal, it's bringing enormous pressures to the steel industry." 

Apparent steel demand, measured by The Wall Street Journal based on official data, rose 2.6 per cent last year from 2013, offset by a flood of cheap steel exports. China usually exports about 5 per cent of its steel output, and in 2013 that figure reached 5.8 per cent. But last year, China sent 8.3 per cent of its total steel production overseas -- a record volume of steel exports -- in search of urbanizing markets in Southeast Asia and sections of the US energy industry as its own builders slowed demand at home. 

Other major indicators of industrial production also showed a sharp slowdown last year. Power output rose 3.2 per cent to 5.46 trillion kilowatt-hours, less than half of the 7.6 per cent pace posted in 2013 and the slowest in more than a decade. 

However, crude oil refinery throughput, the measure of China's oil processing, rose 5.3 per cent last year compared with 3.3 per cent in 2013, likely due to sharply falling crude import prices toward the end of the year, analysts say.

A rapid build-up of US dollar debt in emerging economies is increasing the links between monetary policy in major economies with that in the developing world, posing a growing risk as the direction of interest rates diverge between major central banks. 

Global investors have rushed to buy into an unusually large amount of US dollar debt sold in emerging economies since the global financial crisis, and into advanced economies that were not hit by the crisis, the Bank of International Settlements said in a working paper on Monday. 

But this "implies that the monetary policy of the Federal Reserve or the ECB is transmitted directly to other economies," the BIS said. And, borrowers can choose to borrow in dollars instead of their domestic currencies, so they "side-step their own central bank's monetary policy." 

With the US Fed expected to raise interest rates this year, and the European Central Bank looking instead to additional stimulus measures, the divergence in interest rates and global growth has caused turbulence in financial markets in recent months, with emerging markets especially hit as investors pull money out and run to safer assets. 

As central bank globally expanded their balance sheets and undertook massive stimulus programs, pumping cash into their financial systems and pushing interest rates down to record-lows in the major developed economies, investors sought out higher yielding assets in countries where interest rates are higher. 

The researchers found that lending from banks and bond investors now totals $US9 trillion to non-bank borrowers outside the United States. While dollar credit to Brazilian, Chinese and Indian borrowers has "grown rapidly," totaling $US1.5 trillion, the euro area, the UK and China hold the most offshore dollar debt. 

In the post-crisis era, the investor base has shifted from banks to bond market investors, and has diminished the role of banks in US dollar debt. And, "non-bank investors have not only taken up the large increase in outstanding dollar bonds, but have also absorbed the bonds released by deleveraging banks," increasing their holdings from $US1.3 trillion to $US3.1 trillion between the fourth quarter of 2007 and the same quarter in 2013. For instance, US bond investors hold a third of $US4.0 trillion issued at the end of 2013. 

With the stock of bonds outpacing that of loans, the BIS noted, that "an even larger divergence" in growth was seen during the Asian financial crisis in the 1990's. This offshore boom in US dollar-denominated debt is far larger than debt denominated in other major currencies like the $US2.6 trillion in euros and $US0.6 trillion in yen.

China's economy is not set for a sharp slowdown, Prime Minister Li Keqiang has told business and government elites gathered in Davos, as he sought to allay fears over the Asian giant's growth outlook.

"What I want to emphasise is that regional or systemic financial crises will not happen in China and that the Chinese economy will not head for a hard landing," Mr Li said.

"If I could compare China's economy to a running train, this train will not lose speed or momentum but will be powered by a stronger engine."

Mr Li's special address at the World Economic Forum's annual meeting came a day after China posted its weakest growth in a quarter of a century.

The 7.4 per cent announced by the National Bureau of Statistics (NBS) was slower than the 7.7 per cent seen in 2013, raising concerns at a time when the global economy is looking to the Asian giant to maintain growth momentum.

DAVOS, Switzerland—China’s central bank is confident that the country’s economy is stable with a relatively high growth rate, People’s Bank of China Governor Zhou Xiaochuan said Wednesday, despite recent data showing China’s growth rate slipped to its lowest level in nearly 25 years.

Speaking on a panel organized by The Wall Street Journal at the World Economic Forum in Davos, Mr. Zhou said the central bank would keep its monetary policy stable. It is the “new normal,” he said. The old economic-growth pattern wasn’t sustainable and China is willing to sacrifice a little growth to make its economic expansion more sustainable, he added.

Mr. Zhou also said that lower oil and commodities prices were positive factors for GDP growth and job creation. However, he expressed concern that the low oil price could affect investment in renewable energy as the country is going through structural reforms.

He declined to comment on the rate at which he thought China’s economy would grow, noting that the Chinese parliament would meet in March to discuss the target, along with the rate of inflation.

BEIJING—The Chinese government is proposing to regulate a murky corporate structure that has allowed China’s Internet giants to court foreign shareholders. The move could effectively ease a much-flouted ban on foreign investment in sensitive industries.

Under new draft rules issued this week, Beijing appears to be giving tacit approval to the billions of dollars foreigners have invested via that structure in off-limit sectors—primarily the Internet and education. The structure, known as a variable interest entity, or VIE, is used by companies like e-commerce giant Alibaba Group Holding Ltd. and video-streaming company Youku Tudou Inc. It lets foreigners invest indirectly in companies in banned industries without taking a direct stake.

The workaround has been crucial to many of China’s biggest companies: Without it, Alibaba’s $US25 billion initial public offering last year on the New York Stock Exchange wouldn’t have been possible.

Devised by financial advisers in the late 1990s, VIEs get around restrictions on foreign investment by setting up two entities, one based in China and one abroad. The Chinese entity holds the permits and licenses that foreigners aren’t allowed to own but that are required to do business in China.

The second entity is an offshore holding company in which foreigners can buy shares. The holding company doesn’t own the VIE, which is often controlled by its top executives.

Instead, contractual agreements bind the companies, allowing profits to flow through to the foreign investors.

The draft rules from the Ministry of Commerce, part of wider investment reforms in the Chinese economy, will ensure that control of China’s overseas-listed Internet giants remain in Chinese hands. Under the new rules, officials will assess whether ultimate control of the VIE actually resides with the foreign investors, despite the foreign investors’ efforts to avoid direct ownership. It is likely that most companies won’t be affected by changed rules, since they are still controlled by Chinese nationals.

With the focus of the regulator shifting to the nationality of the people who control a company, rather than the origin of its shareholders, the new rules could be the first step toward allowing foreigners to invest in restricted Chinese companies directly, said Zhang Ning, senior counsel at law firm O’Melveny & Myers LLP.

Analysts say the changes potentially bring peace of mind to foreign investors concerned that Beijing might crack down on the workaround structure and vigorously enforce the ban on foreign investment.

The Commerce Ministry didn’t explain in detail how new VIE rules would be implemented.

Still, it is uncertain whether companies where the founders have sold a majority stake to foreign shareholders, or where the founders themselves are no longer Chinese nationals, will face restructuring.

“The right to define who is or who is not the actual controller [of a company] will fall with officials,” said You Yunting, partner of DeBund Law Offices, adding he expects Beijing to allow a period of adjustment. “I don’t believe the Chinese government wants to bring about earthshaking changes to the industry and those companies.”

A spokesman for Youku Tudou declined to comment. A spokeswoman for Alibaba said the company will comply with all relevant regulations. A Baidu Inc. spokesman had no immediate comment.

Despite VIEs being used to openly circumvent China’s rules, the government has long declined to move against them, adding a degree of risk for investors unsure of whether Beijing would one day reassert its investment restrictions.

The structure has also drawn criticism from some corporate-governance experts who argue that it gives foreign investors little control over key assets of the company. In response to concerns from the U.S. Securities and Exchange Commission, in recent years Chinese companies listing in the U.S. have disclosed increasingly detailed explanations of how their VIEs work.

In a 2011 dispute that propelled the problems of VIEs into the spotlight, the individuals who controlled Alibaba’s Chinese entity split off the assets of an important payments unit and put them under the control of Alibaba founder Jack Ma —over the objections of Yahoo Inc., a major shareholder in the foreign entity.

BEIJING—China’s aspirations for wider use of its currency are gaining ground, with the yuan used for nearly a quarter of all transactions across China’s borders last year.

Chinese officials have been actively promoting the yuan, trying to give it a larger role in global trade and investment and hoping it will one day become a global reserve currency alongside the dollar, the euro and the yen.

The currency, also called the renminbi, was used for 9.95 trillion yuan ($US1.6 trillion) of international payments in 2014, according to a statement posted online Tuesday by China’s central bank. There were no comparison figures for 2013, as such data aren’t issued on a regular basis, but the bank said, “The scale of cross-border and international use of the renminbi continues to grow quickly.”

That takes the country one step closer in its push for the yuan as an international currency. The People’s Bank of China promised in the same statement to “resolutely promote cross-border renminbi services.”

Fifty countries now use the currency for at least 10 per cent of their trade with China, according to Swift, the international payments provider. It is the seventh most widely used currency in terms of Swift payments, up from 20th place three years ago.

There are now 14 offshore clearing centres for the yuan, most important Hong Kong, while 28 central banks have swap agreements with China. Most recently, China agreed to a 7 billion yuan currency swap line with Kazakhstan in December. It already has similar agreements in place with Russia, the U.K. and the European Central Bank.

Such deals can help a country stay afloat when it runs short of hard currency. Last year, Argentina’s central bank borrowed more than $US2 billion from its Chinese counterpart under a swap agreement.

Access to the yuan is restricted by China’s capital controls, which prevent the free flow of money in and out of the country. But yuan accounts have been available in Hong Kong since 2004, and more recently cities like London and Singapore have begun competing for offshore yuan business.

Borrowers ranging from the Chinese government to McDonald’s have raised yuan-denominated debt in the so-called “dim sum” bond market. Issuance more than doubled in 2014, according to estimates by RBS, although the bank added that this could be a slower year as the outlook for the currency becomes more uncertain.

After years of steady appreciation against the dollar, the yuan stumbled last year in a sudden reversal that many analysts attributed to a deliberate Chinese policy of introducing more uncertainty into the exchange rate.

Last year China also allowed the exchange rate to fluctuate in a range of 2 per cent up or down from the benchmark set daily by the central bank, compared with 1 per cent previously.

In a sign of Beijing’s wider ambitions for the yuan, China’s Ministry of Commerce said Wednesday that from next month the ministry’s press statements would no longer include foreign investment data in dollars, only in yuan—although most foreign investment is actually denominated in the U.S. currency.

“Does the U.S. use the yuan?” said Shen Danyang, a spokesman for the ministry. “No, it uses the dollar.”

He added that “there are also considerations about promoting the internationalization of the yuan.”

China's economy is not set for a sharp slowdown, Premier Li Keqiang has told business and government elites gathered in Davos on Wednesday, as he sought to allay fears over the Asian giant's growth outlook.

"What I want to emphasise is that regional or systemic financial crises will not happen in China and that the Chinese economy will not head for a hard landing," Li said on Wednesday.

"If I could compare China's economy to a running train, this train will not lose speed or momentum but will be powered by a stronger engine."

Li's special address at the World Economic Forum's annual meeting came a day after China posted its weakest growth in a quarter of a century.

The 7.4 per cent announced by the National Bureau of Statistics (NBS) was slower than the 7.7 per cent seen in 2013, raising concerns at a time when the global economy is looking to the Asian giant to maintain growth momentum.

China has announced a major overhaul of its foreign investment regime, in what will amount to the single largest reform to foreign investment in China since the beginning of the "opening and reform" era over thirty years ago.

The PRC Ministry of Commerce, or Mofcom, on Monday issued a public exposure draft of a new Foreign Investment Law which would scrap numerous decades-old joint venture laws, introduce a national security review process, and for the first time formally regulate the so-called "VIE" structures commonly adopted by Chinese internet companies such as Alibaba.

The new Foreign Investment Law proposes to scrap China’s existing approach that focuses on regulating the permitted "entities" -- in particular, Sino-foreign joint ventures and wholly-foreign owned entities -- through which foreign companies can invest in China. Instead, Mofcom will regulate foreign investment on the basis of the identity of the investor and proposed investment activity. 

Foreign investors will also no longer require PRC government approval on a case-by-case basis for each individual investment project, and PRC regulators will no longer review individual joint venture contracts and articles of association. This reform alone promises to cut miles of red tape from the foreign investment process in China.

Instead, the "negative list" approach to regulating foreign investment that is currently being trialled in Shanghai's Free Trade Zone, will be rolled out nationwide. Under the negative list system, foreign investors are permitted to invest in any industry sector provided that it is not listed on the negative list as being prohibited or restricted for foreign investment. Mofcom has said that this new approach to regulating foreign investment will mean that most foreign investment projects in China will no longer require government approval, and ensure "national treatment" for foreign invested companies, putting foreign investors on the same legal footing as domestic Chinese companies.

However, all foreign investors will still be required to submit periodic "information reports" to the PRC government on their investment activities in China, ensuring the PRC government will continue to keep a close eye on foreign businesses in China.

The other key piece of the new draft legislation is the proposal for a new national security review mechanism. The review will consider the effect of particular foreign investment projects on national defence, technology, vital infrastructure, communications and network security, energy and food security, and public interest and public order, among other factors. Mofcom have said that they intend to borrow fully from the national security review policies adopted by other "relevant countries" in formulating their new approach.

In announcing the new draft Foreign Investment law, Mofcom also addressed head-on the dilemma posed by the so called "variable interest entities", or VIEs. VIEs are structures whereby a foreign company enters into contractual control arrangements with a domestic Chinese company to circumvent restrictions on foreign investment directly in particular industries. VIEs are the structures commonly adopted by Chinese internet companies such as Alibaba when listing on overseas stock exchanges.

Mofcom has stated their intention that VIEs will be treated as foreign investors in future, and will be subject to the new Foreign Investment Law, including the restrictions on the "negative" list which presumably will continue to restrict foreign investment in the internet industry, and therefore prevent VIEs from being used to invest in the internet and other restricted industries in future.

For existing VIEs already in place when the law comes into force which are operating in a restricted industry -- including Alibaba and the countless other Chinese internet companies listed overseas -- Mofcom proposes three different possible solutions:

First, where the ultimate controller of the foreign party to a VIE structure is Chinese, they would simply report their Chinese controller to the PRC government and be permitted to continue operations unhindered.

Second, VIEs with Chinese controllers may be required to apply for government approval of their Chinese controlling status, following which they may continue their operations.

Third, and most stringently, VIEs would have to apply to the PRC government for approval in order to continue operations, and the PRC government would consider, among other factors, the nationality of the ultimate controllers when determining whether to permit the VIEs to continue operations.

The focus in all cases seems to be whether or not the offshore portion of the VIE is ultimately Chinese-controlled. Given that Jack Ma, a Chinese citizen, is the ultimate controller of the foreign-listed Alibaba company, it appears that the end result will leave Alibaba and other VIE companies with Chinese controlling shareholders unaffected by the new approach, while VIEs where the ultimate controller is indeed a foreign investor may be forced to cease operating.

Mofcom state that they will further research their approach to VIEs after "broadly listening to social opinions" on the issue, a recognition that regulation of VIEs will be sensitive both domestically and abroad.

The draft law is open for public comment now before it works its way through China's legislative process, which is expected to take up to twelve months.

Antony Dapiran is a Hong Kong-based lawyer and writer. Twitter @antd

East Asia Forum

The Chinese economy is widely perceived to have entered a ‘new normal’ — annual GDP growth has slowed to between 7 per cent and 7.5 per cent from the double-digit levels of previous years. This was something that policymakers expected: an inevitable result of economic restructuring.

Following the global financial crisis of 2008, the Chinese government moved quickly to implement a large-scale stimulus package of as much as 4 trillion yuan (about US$586 billion). This involved ambitious investment in infrastructure and manufacturing, as well as loose monetary policy. As a result, the Chinese economy — which became the world’s second largest after the US in 2010 — grew at a fast pace until 2012.

But the large stimulus package also had numerous negative effects on the Chinese economy. It created overcapacity in labour-intensive traditional industries and also in high value-added emerging industries. The stimulus also led to an oversupply of liquidity, which created a huge bubble in the real estate market. Local governments worry that if prices start to drop rapidly, the proportion of nonperforming debt held by commercial banks and financial institutions will sharply increase. And the stimulus spending, combined with the oversupply of money, has sent local government debt soaring. If this debt is not properly managed, a regional banking crisis could eventually destabilise the national banking system.

The combined effects of these three factors have dented the dynamic growth of the Chinese economy in recent years. But while the Chinese economy is slowing, there are factors that will help maintain growth of at least 7 per cent a year.

China has great scope for expansion in both production and consumption. The rise of e-commerce in China has greatly aided the transformation of the Chinese economy to a model based on domestic consumption and services. Rapid urbanisation and the growth of the middle class will continue to provide a big boost. The central government is able to mobilise adequate resources to deal with a crisis or systemic risk caused by bad debt or shadow banking. The US economy is getting stronger, giving an extra boost to the global economy and the Chinese economy. And crude oil prices are dropping; if they fall below US$60 a barrel (which seems likely), the Chinese economy will benefit from lower production costs. Meanwhile, President Xi Jinping’s government has strengthened China’s economic diplomacy. China’s ‘New Silk Road’ initiatives (named China’s Marshall Plan by Western media) aim to tap the growth potential of other countries in the region, which will further boost the Chinese, regional and global economies.

The Chinese leadership under Xi announced a 60-point reform program at the 18th Party Congress in late 2013. Though some progress has been made, implementation of the reforms has been difficult. The mode of growth and governance has not changed very much over the past year.

There has been a lot of discussion about the reforms that need to be undertaken. The government needs to speed up deregulation and limit government approval for investment in order to let the market allocate resources. The government should be limited to the role of regulator and not an investor; investment should be governed by market forces. The government must also reform SOEs and cultivate a truly mixed economy by attracting private capital into SOEs. They should push financial reforms, including the marketisation of interest rates and exchange rates. Since oversized SOEs have privileged access to bank loans, privately-owned enterprises hope that these reforms can reduce their own financing costs.

If market-oriented reforms like these are implemented smoothly, they would give a powerful push to the economy. So far, progress has been limited, and the reforms need more momentum. The leadership in Beijing recognises that it needs to move quickly to achieve its goals in order to deal with external competition (such as the US-led Trans-Pacific Partnership) and domestic pressure to sustain growth. As in past cases of reform, balancing economic goals (the rise of the private sector) and political goals (keeping the Chinese Communist Party in power) will continue to pose a challenge for Chinese leaders.

In 2015, China’s economic growth will be shaped by two opposing forces. Given the circumstances of the new normal, it is unlikely China will be able to manage growth of 7.5 per cent or above. But we can be cautiously optimistic that 7 per cent growth is possible and sustainable. At the same time, we should watch carefully for the risks that could be a barrier to growth: overcapacity, a drastic fall in property prices, and a worsening international environment.

2015 will likely see the Chinese economy achieving slower but steady growth of about 7 per cent or even a little bit higher, which is still higher than other major economies, despite the downside pressures. In short, welcome to the new normal.

Wang Yong is a professor at the School of International Studies, Peking University, and director, the Center for International Political Economy, at the university. He is also a member of Global Asia’s editorial board.

The full version of this essay was originally published in the journal of Global Asia, Vol.9, No.4, Winter 2014. This version was republished on East Asia Forum on 22 January and republished here with permission.