China’s Economy: Normal Slowing Will Resume in 2018

THE ECONOMY STORMED along in the second half of last year, taking growth for the year to 6.9%, comfortably outstripping the official target of ‘around 6.5%’.

It was riding the coattails of the fiscal stimulus introduced in the first half of the year and also the pick-up in global trade, partly helped by the robust growth in the United States and some recovery in Europe, which boosted China’s exports. At 8.7% of China’s GDP growth, net export volumes made their largest contribution to growth since 2008.

Policymakers have been managing a slowdown from the giddy decades of double-digit growth. The overall lesson from last week’s figures is that economy is fitfully rebalancing and that there was some slowdown in credit growth as official efforts to cool the property market, deleverage and upgrade industrial capacity gained some traction.

That last year turned out to be the first acceleration since 2010 should prove to be an anomaly. Normal slowing will resume this year. And especially if policymakers push ahead with measures to control financial risks.

The most recent forecast from the World Bank, which recently upped its estimate of GDP growth in 2017 to 6.8% (a 0.3 percentage point increase from its forecast a year ago and reiterated in June) says it expects 6.4% growth this year (a 0.1 percentage point increase from its previous number).

Beijing has plenty of headroom in meeting its 2010 target of doubling aggregate and per capita growth by 2020. The economy needs to average no more than 6.3% growth to achieve that.

That headroom will also let Beijing tackle its most pressing economic-related problems: curbing escalating debt; cutting excess heavy industrial capacity; becoming environmentally cleaner; and dealing with the risk of unemployment as the economy is rebalanced towards domestic consumption and higher-value-added manufacturing.

Where the margins of safety are considerably thinner is if there is a trade war with the United States.

As we noted recently, US President Donald Trump is itching to impose tariffs on Chinese steel and aluminium imports into the United States. More recently Washington has said that an investigation into intellectual property transfers to China has been launched, with Trump warning that China is in for “a very big intellectual property fine”.

His self-restraint because he needs Beijing’s help with North Korea is wearing thin. Nor will it have been helped by the revelation that an ex-CIA officer arrested in New York this week may have been the mole responsible for passing information to Chinese intelligence that led to the dismantling and death of the CIA’s intelligence network in China between 2010 and 2012.

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The Weighty Matter of China’s Carrier-Borne Aircraft

CHINA’S FIRST INDIGENOUSLY designed aircraft carrier is expected to start its sea trials shortly, probably immediately after lunar new year.

The sister ship to the Liaoning, a refitted former Soviet carrier, was launched in April and has since been being fitted out in the Dalian yards where it was built (see below).  The Liaoning is currently at sea on a training mission for the crew that will man the new carrier.

Satellite image of China's first indigenous aircraft carrier being fitted out at Dalian, 2018

The still unnamed new carrier is pencilled in to enter active service at the end of this year.

Meanwhile, in the Jiangnan yards in Shanghai, work is proceeding on the next generation of Chinese carriers — and this time under a roof to hide the construction  from prying eyes in the sky.

The Type 002s will be conventionally, not nuclear powered and about 40% larger than the Type 001/001As (which at 60,000 tons displacement are mid-sized at best for carriers).  Their most significant difference is that they will employ a catapult system, not a ‘ski-jump’ to launch their aircraft.

Building the first of the next generation of carriers had been held up while the PLA-Navy (PLA-N)’s crack marine engineers solved the problem of how to power the catapult system.

The PLA-N had always wanted to go straight to an electromagnetic aircraft launch system (EMAL), similar to the ones on the latest US carriers. EMALs impose less wear and tear on the planes than steam-catapult launches, allow faster launches than with either ski or steam-catapult systems and allow the aircraft to carry heavier payloads.

Most importantly, the only carrier-borne aircraft the PLA-N has is a marine version of the J-15, based on 30-year old Soviet designs and the heaviest active carrier-based fighter jet in the world. Steam catapults would struggle to launch them.

However, EMALs are energy-ravenous. To date, only nuclear-powered carriers can utilize them. Conventionally powered carriers in all navies have to use steam-power, and China is not yet at the point of development of its carrier fleet where the vessels can be nuclear powered (though that is only a matter of time).

However, the PLA-N’s engineers have cracked the problem of generating enough power for an EMAL on a non-nuclear powered vessel with a head-to-tail redesign of a ship’s energy generation, storage and distribution systems. As a bonus, it will also potentially provide the power needed to launch missiles and other weapons systems.

Our man with the blueprints and T-square says that the solution ‘builds on’ the first-generation integrated propulsion system used on the United States’ Zumwalt-class guided missile destroyers which were launched in 2013.

Solving the power problem had held up development of the Type 002 carriers, which state media has previously reported had started in 2015, because the choice of launch system affects the design of the ship.

The logjam was reportedly only cleared in November after an intensive year of testing and development. Rear Admiral Yin Zhuo  told state television that month that J-15s had conducted thousands of take-offs using the electromagnetic launch system. The Navy has built a land-based test rig, just as it has a test aircraft deck in Wuhan.

China has been trying to develop a lighter fighter, the FC-31/J-31 fifth-generation stealth fighter, to replace the J-15. Shenyang Aircraft Corp., which also makes the J-15, has built two prototypes. One was shown off at the Zhuhai air show back in 2014.

However, further development has, we hear, been bedevilled by technical problems. The first test flight of a prototype was not until the end of 2016, and with a larger plane than initially intended. The proposed carrier version is larger still, leaving the PLA-N little better off regarding weight than it is with the J-15.

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World Bank Ups Its Prospects For China’s Economy

THE WORLD BANK has become more bullish on China, at least for the near-term. In its newly published annual Global Economic Prospects, it has upped its estimate of GDP growth in 2017 to 6.8% (an 0.3 percentage point increase from its forecast a year ago and reiterated in June) and said it expects 6.4% growth this year (an 0.1 percentage point increase from its previous number).

China benefited, the Bank now says, from the recovery in world trade last year, fiscal stimulus and the rebalancing of the economy, which eased the drivers of the economy away from state-led investment. Inflation rose but was still within target and housing price increases moderated in response to policy measures.

The current account surplus continued to narrow, but the clampdown on capital outflows meant that exchange-rate pressures eased and foreign-exchange reserves recovered modestly.

On the flip side, non-financial sector debt continued to grow, reaching 260% of GDP, regardless of further monetary and regulatory tightening. Credit growth still outpaces nominal GDP growth.

The Bank says that financial sector vulnerabilities — particularly high corporate indebtedness in sectors with overcapacity and deteriorating profitability — are one of the key downside risks to growth.

Others include the possibility of protectionist policies in advanced economies (for which read the United States) and rising geopolitical tensions (for which read mainly North Korea).

The Bank also expects the economy to continue its measured deceleration, averaging 6.3% growth in 2019 and 2020, and less beyond that as adverse demographics kick in over the next decade.

A steeper-than-expected slowdown or debt- or geopolitical-driven financial stress would have impacts well beyond China’s borders.

The Bank’s view is that authorities have substantial ‘policy buffers’ to absorb financial shocks. Nonetheless, it, like others, calls for further structural reform to reallocate economic activity towards more productive sectors.

This would include financial and corporate sector reform as well as greater efforts to deleverage and improve the fiscal sustainability of provincial, municipal and local government.

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China Caught Between Smuggled Oil And Trade Wars

BOTH CHINA AND Russia deny Western accusations that their vessels have been involved in ship-to-ship transfers of oil on the high seas to North Korean tankers in likely contravention of UN sanctions against the Pyongyang regime for its missile testing programme.

Since November, South Korea has detained two ships — one Hong Kong- and the other Panama-registered, alleged to have been involved in such transactions while the UN Security Council has blocked three North Korean- and one Palau-flagged ships from docking at international ports on suspicion of carrying or transporting goods banned by sanctions.

The United States has a list of six more such vessels it wants internationally sanctioned, five China-flagged and one Hong Kong-flagged. Last week, Beijing blocked Washington’s efforts at the UN to have the six ships blacklisted.

In September, the UN cut North Korea’s allowed imports of refined oil to 2 million barrels a year. Its latest round of sanctions further cut the annual quota to 500,000 tonnes and 4 million barrels of crude oil, required the repatriation of all North Korean contract workers abroad within 24 months, and a crackdown on ships smuggling banned items including coal and oil to and from the country.

The United States had wanted a complete ban on oil imports and a freeze of the overseas assets of the government and its leader, Kim Jong-un. That it did not get them, seems to have frayed the patience of the ever-mercurial US President Donald Trump. He told the New York Times last week,

“I have been soft on China because the only thing more important to me than trade is war…If they’re helping me with North Korea, I can look at trade a little bit differently, at least for a period of time. And that’s what I’ve been doing. But when oil is going in, I’m not happy about that.”

Trump had earlier tweeted that China had been “caught RED HANDED” (his all caps) allowing oil into North Korea.

The prompt for that public accusation was a Chosun Ilbo report quoting South Korean government sources as saying that U.S. spy satellites had detected Chinese ships transferring oil to North Korean vessels about 30 times since October. Which is a very roundabout way for a US president to make an accusation based on his own country’s intelligence, especially since U.S. State Department officials have confirmed Washington had evidence that vessels from several countries, including China, had engaged in transshipping oil products and coal to North Korea.

China had long turned a blind eye to smuggling to North Korea but in 2017 started to crack down on it as it shifted stance and began to turn the economic screws on Pyongyang.

The question now is whether Beijing is still turning a selective blind eye. Or is North Korea’s smuggling network, which includes bartering via Russian ports and forging the nationalities and destinations of ships, so well organised that it is beyond being able to be shut down?

The broader concern is that either way Trump will take it as an excuse to move onto his confrontational anti-China trade agenda in 2018. Trump has long argued that foreign countries are taking advantage of America and that America needs to fight back — and that is a message he wants to use to rile up his base support, in 2018 ahead of the US mid-term elections, and again in 2020 when he will be running for re-election as president.

The White House is split on the wisdom of starting a trade war. However, the word from our man in Washington is that the ‘America First’ economic nationalists among Trump’s advisors are currently ascendant and pushing to strike early ahead of the mid-terms while the president himself is itching to slap tariffs first on Chinese electronics and then on steel and aluminium.

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Carbon Trading In China Is A Slow Burn

A coal-fired power plant in Shuozhou, Shanxi province, China. Licensed under the Creative Commons Attribution 3.0 Unported license. Photo credit: Kleinolive.CHINA, THE WORLD’S biggest polluter, is taking the slow road to market-based initiatives to tackle climate change.

As far back as June 2011, Wang Shu of the National Development Reform Commission (NRDC)’s Climate Change office said, “The initial plan is to establish carbon emissions trading schemes in some pilot regions, and try to establish a unified national system in 2015.”  By 2015, the deadline for a national carbon market had been pushed back to 2017, though pilot markets had started running in seven cities from 2013.

On December 19, the NRDC finally announced a nationwide carbon emission trading system. That sort of met the delayed deadline. But only sort of.  It will cover only the power generation industry — such as the coal-fired power-generation plant in Shuozhou seen above — and not the total of eight heavy industries originally proposed.

Also, implementation details are still to be worked out. The start of trading is probably at least a year away.

Nonetheless, the announcement marks a milestone on the way to establishing a what will be by some distance the world’s largest national carbon market. With more than 1,700 power-generating firms with aggregate carbon-dioxide emissions of 3.3 billion tonnes — about one-third of China’s greenhouse gas emission — the new market will surpass the EU’s Emissions Trading System (EU-ETS) in size to become the world’s largest.

By comparison, the seven pilot markets traded emission quotas covering 200 million tonnes of carbon dioxide (with a traded value of 4.6 billion yuan, or $700 million).

Both the EU and China’s are cap-and-trade markets. In these, governments set a cap on allowable emissions and then issue companies with emissions credits adding up to that cap. The market incentive is for companies to cut their emissions so they can sell unused allocations to corporate polluters who are exceeding their share of the cap; and for the heaviest polluters to reduce their emissions to cut their costs. In a perfect world, carbon pricing drives innovation in low-carbon technologies and promotes a shift to a clean energy economy.

Environmental economists have a rule of thumb that a price of at least $35 for a tonne of carbon is needed to make companies change their behaviour. In the EU-ETS, carbon is trading at around $7 a tonne and has done for several years.

That is likely to be the initial price when China’s national market starts. The challenge will be to steer the market, so it gets the price to above $35 a tonne.

Plenty of details still have to be worked out.  National systems for reporting data, registration and trading will have to be set up. Once trading starts, there is also likely to be a phase of free trading so companies can get used to market. That could last as long as a year.

Only then will the market be able to be expanded beyond electricity generators. There are some 7,000 companies in industries from cement making to paper production that are likely eventually to be brought under the carbon market regime.

A successful cap-and-trade scheme relies on a strict but feasible cap that decreases emissions over time. China at least has a starting point in that regard. In its voluntary targets submitted to the UN’s climate talks in Paris in 2015, Beijing said it aimed to cut carbon dioxide emissions per unit of GDP by 60-65% from the 2005’s level by 2030, the year in which it is expected to hit peak emissions.

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A Better Quality Economy

WHAT CAUGHT THIS Bystander’s eye from the annual Central Economic Work Conference, the key closed-door economic policy meeting of the year held in the PLA’s Jingxi Hotel in Beijing last week, was that economic policy priorities were set for the next three years rather than the usual one.

That will take policymaking to the midpoint of President Xi Jinping’s second term and the start of what should be the next cycle of leadership regeneration. It likely signals that there will be no alternative economic path than the one that leads to making good on Xi’s promise to build a “well-off society” by then.

The work conference was the first gathering of the Central Committee since the 19th party congress. It marked a start to translating Xi’s concepts of the next stage of China’s development being a transition from ‘rapid growth’ to ‘high-quality growth’ into plans and targets that each province and ministry will then have to turn into tasks and initiatives.

Xi has greatly tightened his grip over economic policy since taking power five years ago.The State Council, the mechanism through which the prime minister had formed economic policy, has become an implementation agency. The Central Leading Group of Financial and Economic Affairs, headed by Xi, is where the decisions that matter now get taken.

The outcome of the discussions at the work conference, which involved the 400 most important officials in the country, will not be disclosed until next March when they will be announced within the government’s work report to the annual parliamentary session as the economic targets for 2018.

All that is known at this point from state media is the already well-advertised transition from rapid to high-quality growth involving an economic model with “more focus on fairness, the environment and a joyful life”. The top three priorities for delivering that are alleviating poverty, pollution and financial risks.

Parsing that suggests that poverty relief will take precedence over maximising overall GDP growth, and financial stability over reform and liberalisation. Thus financial policy will focus on deleveraging through controlling credit growth rather than reducing existing corporate debt. Monetary policy will tighten in 2018; the external account will be kept stable, rather than opened up.

Systemic financial industry corruption will be tackled, particularly by cracking down on murky practice within shadow banking; more regulation in this area, particularly for asset management products, is likely next year. The introduction of a 3% value-added tax on some financial products will also provide a useful administrative tool for policymakers to bring shadow banking more in line.

It all adds up to a gamble on steering the real economy clear of financial risk through controlled growth and economic management. The gamble is probably most vulnerable to an external economic shock such as a deterioration in economic relations with the Trump administration in the United States.

The concern for Beijing is not the general macroeconomic one from US monetary policy ‘normalising’ but the danger that Washington’s China hawks get the upper hand in the administration and attempt to constrain China’s access to and trade in technology thereby crimping the innovation so necessary to rebalancing the economy.

What is less uncertain is that Beijing’s efforts to tackle environmental problems, and particularly air pollution, will be driven forward aggressively, regardless of the cost. That is for reasons of domestic stability, new-industry development and international leadership.

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China’s Giant Fish Dragon Takes To The Air

China's first home-grown large amphibious aircraft, the AG600, is seen flying in Zhuhai, Guangdong Province, December. 24, 2017. Photo credit: Xinhua/Liu Dawei.

IT WAS MORE than a year later than initially expected — and unexplained eight months after its ground tests — but state-owned AVIC’s giant seaplane, the AG600 (above), has finally made its maiden flight. Codenamed Kunlong or the Giant Fish Dragon (Kun was the monstrous fish form of the mythical Peng bird), China’s first indigenous large amphibious aircraft took off from Zhuhai in southern Guangdong Province today. After a one-hour flight over the South China Sea, it returned to flag-waving crowds and martial music.

It is not China’s first seaplane. The PLA-Navy has five 1980s-era SH-5 patrol seaplanes in service. But it is the largest, indeed the world’s largest, surpassing Japan’s Shinmaywa US-2.

The AG600 is capable of carrying 50 people and staying airborne for half a day. Its purported mission will be maritime rescue, fighting forest fires and marine monitoring.

However, planes that can operate on water have military value to a country whose national interests concern the disputed waters of the East and South China seas and the increasing projection of littoral power. Japan uses its four Shinmaywa US-2s and three other older seaplanes to patrol islands.

As we noted last year:

The turboprop AG600 could undertake patrol and supply roles for China’s expanding islands in the South China Sea (all that dredging creates ideal landing channels for seaplanes), and, alongside China’s blue-water amphibious assault vessels, be part of an amphibious assault force. With a range of 5,000 kilometres, they could project power far beyond the littoral.

That is the same range as the large military cargo plane, the Y-20, which made its maiden flight in 2013.

The third of China’s trinity of home-grown large aircraft is the C919 passenger aircraft, a potential rival to the Airbus 320 and Boeing’s new generation 737, which had its maiden flight in May and is now undergoing long-flight testing. The second prototype C919 made its maiden flight earlier this month.

 

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