PLAAF Bomber Touches Down For First Time In Paracels

Screenshot of Woody Island from Google Maps

The PLA Air Force (PLAAF) and state media have published reports of bombers landing on what looks from the accompanying video to be the South China Sea reef of Woody Island in the Paracels (seen above).

Woody Island is called Yongxing Island by China and Phu Lam Island by Vietnam which also claims sovereignty over it. Taiwan claims it for its own, too. Earlier this year, the US Department of Defense in its National Defense Assessment declared the South China Sea as one of the greatest threats facing US security interests.

This is the first time China has landed or at least acknowledged landing, bombers on disputed territory in those waters.

Woody Island is one of those that China has been building out, including the addition of a 2,700-metre runway that the PLA Navy’s latest generation of fighter jets can take off and land from.

The aircraft in the video is an H-6K, a long-range strategic bomber capable of carrying supersonic cruise missiles and which would have the capacity to attack a US battle carrier group in the event of war. Flying from Woody Island the bomber would also have the range to launch missiles able to hit Alaska and Hawaii and any US base in South-east or East Asia.

China also appears to be building out its military aviation facilities in the Spratly islands to the south of the Paracels for long-range operations. The Subi, Mischief and Fiery Cross reefs all seem to be being kitted out to accommodate bombers and other large logistics aircraft such as Y-18 military transport planes and maritime patrol and refuelling aircraft.

H-6Ks based in the Spratlys could reach northern Australia and Guam.

The PLAAF has said China is developing its next-generation stealth strategic bomber, the H-20, that is believed to have a range of at least 10,000 kilometres, sufficient for intercontinental missions. Some reports say a prototype has been spotted, and the goal is to start testing a production model within two years. Also capable of being armed with nuclear weapons, the H-20 could be in operational service in four to five years.

 

 

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China Is Back In The Korea Game

China’s President Xi Jinping (right) greets North Korean leader Kim Jong-un at the Great Hall of the People in Beijing during Kim’s visit to China from March 25 to 28. Photo credit: Xinhua/Ju Peng.

THIS BYSTANDER WAS was reminded this week that it was then South Korean president Park Geun-hye who was invited to the grand military parade in Tiananmen Square in 2015, not neighbouring North Korea’s still newish leader Kim Jong-un. Beijing considered North Korea an anachronistic problem state, and except for the oldest generations of Party cadres, held it in disdain.

Relations between Beijing and Pyongyang remained cold to the point that by last November, China was enforcing international sanctions against North Korea’s missile and nuclear programme with a severity never before applied. As China accounts for 90% of North Korea’s trade, that hurt.

US President Donald Trump’s bellicosity towards Kim (and vice versa) then gave cause for China to patch up its relations with North Korea. The prospect of a US military strike against North Korea threatened not one but two of China’s red lines — no regime collapse in North Korea that would send millions of refugees flooding into northern China and no US or US-aligned troops up against its borders.

When in May, Trump boldly accepted an invitation from Kim for direct talks, temporarily sidelining China from what had long been six-party discussions over the peninsula’s future, Beijing swung into action, seeing the gains in influence it had made in the region, in part as a result of the Trump administration’s broader regional disengagement, being at risk.

Kim left his country for the first time, taking his armoured train to Beijing, where President Xi Jinping accorded him full pomp and ceremony. As the Kim-Trump summit in Singapore on June 12 approaches, Kim has been back to Beijing. There were close discussions before US Secretary of State Mike Pompeo visited Pyongyang in April and again earlier this month and North Korean delegations are in Beijing in number.

China is clearly signalling that Kim will not go into the meeting with Trump alone; he still has a powerful friend in China.

Beijing will also undoubtedly have been coaching Kim on dealing with Trump in person. Beijing is finally getting a handle on the mano-a-mano dynamics of US foreign policy under the Trump administration (learning now starting to be seen to good effect in the US-China trade dispute, too).

Beijing will also be doing what it can to ensure that any deal Trump and Kim strike is acceptable to it. It will not necessarily want to position itself as the guarantor of an agreement ensuring the security of the Kim regime in return for whatever ‘denuclearisation’ Kim and Trump agree on, but it will want any deal internationally embedded. Ideally, it would like a six-party treaty signed off at an international level and enshrined at the UN.

It is unlikely to get all that but will be satisfied by a deal that gets the Korean question sorted out, or at least contained for a generation in so far as that means stability on the peninsula. A cardinal principle of its foreign policy is not to have more than one troubled front on its borders at any time.

To that end, it has also been warming relations with Japan, primarily, and India.

Full denuclearisation is less of a priority for China than it is for the United States. The crunch question is not about dismantling the North’s nuclear weapon building capacity but whether or not there will be some capacity for North Korea to retain what is already has.

The Trump administration will try to get Kim to agree to remove as many nuclear weapons as possible as quickly as possible. However, Kim will push actively to keep some warheads.

The deal will thus likely be a thin one, with North Korea keeping some of its nuclear capacity for some time but not expanding it, and accepting international inspections for verification of compliance.

The other factor in play is sanctions, which Kim will want lifting (or at the very least for China to stop enforcing). He will, though, have to make concessions on exporting cyber terror and weapons technology.

Kim is now politically secure at home and can turn to prioritising economic development, though he has not entirely quashed domestic opposition to this.

Beijing has a strategic interest in his primary partner being China, not South Korea. Stability, not reunification (South Korean President Moon Jae-in’s objective) is what Beijing wants to see on the Korean peninsula.

There is plenty of risk to all sides in the Trump-Kim summit. Trump is unpredictable, and Kim is an unknown quantity in such a setting. However, both men have invested a lot in getting a deal — any deal. Beijing is now doing what it can to make sure it is not a bad deal but also one that would enable North Korea to be integrated into Chinese-led regional structures more efficiently.

A failure of the talks would be the least welcome outcome. In that event, Trump would most likely resume his bellicosity and resort to US military action. China and North Korea have a mutual defence pact that runs until 2021, so theoretically Beijing would have to come to Pyongyang’s aid if Washington attacked. It is highly unlikely in practice that it would.

However, it could also play into Beijing’s hands if a breakdown in talks further damaged US credibility in Asia, opening more space for Beijing’s plans for security and economic partnerships in the region. There is opportunity as well as risk for Beijing in the outcome of the Singapore summit.

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China’s Second Carrier Starts Its Sea Trials

China's second aircraft carrier and first indigenously built one being towed from its fitting out berth in Dalian, northeastern China, 2018.

SEA TRIALS HAVE begun for the first domestically built aircraft carrier, state media report. Accompanying photographs (above) of the vessel being towed from its fitting-out berth in Dalian on what looks like a misty morning probably date from last month. On May 5, a Z-18 helicopter, the sort used by the Liaoning, China’s first aircraft carrier, a refit of a Soviet-era carrier, conducted a test landing and takeoff, the same precursor to the Liaoning’s sea trials in 2012. The new carrier, which is still unnamed, is expected to be go into active service in 2020, adding national pride to an increasingly potent blue-water fleet.

 

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IMF Sees China’s Economy With Momentum To Face Headwinds

IN ITS LATEST World Economic Outlook, the International Monetary Fund has left its forecast for China’s growth this year and next unchanged from January’s 6.6% and 6.4% respectively.

Both numbers are one-tenth of a percentage point higher than the Fund’s forecast in October last year. They are also in line with the most recent forecasts from the World Bank and the OECD.

Faster than expected global growth and domestic policy support has sustained the economy in the form of resurgent net exports and healthy private consumption, giving it some momentum to propel it into the challenging headwinds of America First protectionism and still-risky domestic overleverage.

Thereafter, the IMF provides a familiar refrain:

Over the medium term, the economy is projected to continue rebalancing away from investment toward private consumption and from industry to services, but nonfinancial debt is expected to continue rising as a share of GDP, and the accumulation of vulnerabilities clouds the medium-term outlook.

And its obligatory silver lining:

Tighter regulation of nonbank intermediation in China, where nonfinancial corporate sector debt is still rising, is a welcome start of a needed policy response to contain the accumulation of vulnerabilities.

But it also highlights a missed opportunity:

Fiscal policy has played a vital part in shoring up short-term growth at the expense of eroding valuable policy space. Gradual consolidation, together with a shift of spending back onto the budget and away from off-budget channels, would help improve sustainability.

The Fund’s accompanying Global Financial Stability Report goes into greater depth about the elevated risks posed by what it says is the large-scale, tight and opaque linking of the banking system to the shadow banking sector (see diagram below) through its exposure to off-balance-sheet investment vehicles largely funded through the issuance of some 75 trillion yuan ($12 trillion) of investment products.

One-third of those by value are directly managed by the banks, who are seen as implicitly guaranteeing the products. A key challenge for authorities will be phasing out those implicit guarantees, which will require banks to improve their liquidity and capital buffers as there are large maturity mismatches between the products’ assets and liabilities.

Diagram of linkages within China's financial system. Credit: IMF Global Stability Report, April 2018

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China Shows Off Its Blue-Water Fleet

PLA-Navy warships including the aircraft carrier Liaoning and its latest submarines take part in a review in the South China Sea , April 12, 2018. Photo Credit: Xinhua/Mo Xiaoliang.

IT IS NO secret that China is building a modern blue-water fleet. What is notable is that more than half the PLA-Navy vessels that took part in the country’s largest naval review on April 12 have been commissioned since President Xi Jinping came to power in 2012.

The review was a high-profile affair, conducted in the South China Sea with Xi himself taking the salute from the deck of the Changsha, one of the PLA-Navy’s most advanced guided-missile destroyers. In a speech, Xi promised to speed up the fleet’s modernisation.

More than 10,000 service personnel were involved along with 48 ships sailing in seven groups according to their combat functions: strategic strike, submerged attack, open-sea operations, aircraft carrier strike, amphibious landing, offshore waters defence, and support.

The centrepiece was the aircraft carrier, Liaoning (seen in the picture above), itself a symbol of the reorienting of naval strategy. Sea trials of the country’s second, and first indigenous, carrier are imminent.

The warships involved in the review then headed off to join a three-day naval exercise off Hainan island that had started the day before. For the Liaoning that meant carrying out live-fire exercises for the first time. That these were held away from disputed waters suggests that this was also an exercise in power display rather than a provocation of neighbours that dispute Beijing’s territorial claims in the South China Sea.

Earlier in the week, Vietnam published draft legislation that would expand the powers of its coastguard to open fire to protect sovereign rights and particularly at ships operating illegally in Vietnamese waters that refuse requests to halt their activities.

Given Beijing’s preoccupation with its trade disputes with Washington and the Trump administration’s growing engagement with Taiwan (new US National Security Advisor John Bolton is expected to visit the island soon), China will have neither the will nor the diplomatic capacity to take on another crisis in the South China Sea — even if it has the ships to do so.

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Asian Development Bank Pushes Beijing On Tax Reform

Headquarters of the Asian Development Bank in Manila, Philippines, seen in 2016. Photo credit: ADB. Licenced under Creative Commons CC BY-NC 2.0

CHINA’S ECONOMY WILL grow by 6.6% this year and 6.4% next, according the Asian Development Bank’s newly published Outlook 2018. That is pretty much in line with the most recent revised OECD forecasts from mid-March.

The ADB sees strong consumer spending, rising exports and steady public spending underpinning current growth. It also joins the chorus calling for tax and other structural reforms to ensure that growth is both inclusive and sustainable as it resumes its measured glide path of slowing under the effects of excess-capacity reduction, the gradual resolution of the debt problem and the shift of growth drivers from capital accumulation to total factor productivity, to give a more technical description of the rebalancing of the economy.

In summary, the ADB says:

PRC growth accelerated on strong demand from home and abroad. The service sector grew by 8% on buoyant domestic demand, and net exports expanded as trade in intermediate manufactures rebounded. Assuming mildly tighter monetary and fiscal policies in the PRC, growth is expected to moderate from 6.9% in 2017 to 6.6% in 2018 and 6.4% in 2019. Further progress on reforms such as strengthening financial sector regulation and supervision, and addressing debt issues would lay a foundation for solid macroeconomic stability.

The ADB highlights the importance of services to rebalancing. In 2017, it notes, services were already the main driver of growth, expanding 8%, up from 7.7% the previous year, and contributing 4.0 percentage points to GDP growth. In contrast, industrial growth slowed to 6.1% last year from 2016’s 6.3%, and industry’s contribution fell to 2.5 percentage points.

The services sector also kept the labour market buoyant, creating 13.5 million new urban jobs last year (exceeding the official target of 11 million). But prices in the service sector are rising, meaning that inflation did not cool as much as it might otherwise. Consumer prices rose 1.6% in 2017, against 2% a year earlier. The ADB thinks inflation will pick up this year, to 2.4%, as consumer demand strengthens.

The ADB also notes in passing that services comprise barely 51% of GDP, low by international standards. As investment, in contrast, at almost 40%, is comparatively high, there is ample scope for further ‘rebalancing’.

The risks to the ADB’s forecast are pretty straightforward: a trade war with the United States, which could undercut exports and investment. It is not particularly worried about the tariffs the Trump administration imposed on steel and aluminium imports, seeing an unintended benign consequence of measures to tackle the corporate debt issue:

Prices for aluminum and iron ore (iron being the bulk of stainless steel) rose by 23% in 2017. This raised profits in the producers’ home economies more than enough to offset the impact of tariffs, had they been imposed a year earlier. Profits in heavy industry, including large steel producers in the PRC, rose by 21% in 2017 thanks to higher prices and government-imposed production quotas, allowing these industries to service their debt and reduce borrowing while trying to shed excess capacity. Thus, these producers should be able to manage lower demand expected from the US, given the small share of exports to the US directly affected.

However, it is the United States’ next round of tariffs on Chinese exports of intermediate inputs, especially for renewable energy, electricity generation and electrical and optical equipment, that is the immediate concern as they could undermine the business and consumer optimism. Absent Trump’s ‘massive trade deal’ with China, these will take effect in the next few months and would play directly into investment intentions, and especially those connected to US firms’ links to Asian value chains in manufacturing.

The double risk is that a strengthening dollar on the back of rising US interest rates could also spur greater capital outflows, irrespective of authorities’ discouragement.

However, the ADB believes, the government’s fiscal strength and political will enable the economy to weather any squalls. The question for this Bystander is how stormy the trade can weather get.

The particular area for structural reform tha is exercising the ADB is tax:

[The] ratio of tax revenue to GDP has stagnated at 17.5%, with heavy dependence on indirect taxes in the PRC atypical at its stage of development. The authorities there should broaden the tax base while ensuring that the revenue system is progressive.

The average tax revenue to GPP figure for OECD countries is 25%, and even in the ten emerging economies of the G20 countries, it is 21%. The combination of falling tax revenue and rising expenditure translates into rising budget deficits for Beijing, more public debt and thus contingent liabilities.

The ADB suggests that there is there is substantial potential to raise more revenue from personal income taxes, which are now paid by fewer than one in five wage earners. Personal exemptions are twice the annual average national wage, and the top rate (45%) kicks in at 35 times the annual average national wage. OECD averages are for personal exemptions of one quarter the average annual national wage and top marginal rates starting at four times that level.

This indicates some easy changes that could be made to broaden the income tax base and make it more progressive. (which are in train as was signalled at last month’s National Peoples Congress sessions). Structural tax reform is also central to tackling income inequality, a central concern of the Xi administration.

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A Sewbot In Time

CHINA IS THE world’s largest exporter of garments, worth some $170 billion a year. So far, the industry has escaped the retaliatory tariffs Washington is to impose on more than 1,300 Chinese exports, no doubt much to the relief of members of US President Donald Trump’s family with clothing brands whose merchandise is made in China.

If any industry is emblematic of China’s rise as an economic power on the back of low-cost export manufacturing, it is probably textiles and apparel.

Low-cost labour has underpinned an army of seamstresses and tailors churning out garments by the million for retailers from the world’s leading brands to cheapest stores. It has also enabled the growth of an extensive ecosystem of spinners, weavers, knitters, dyers, processors and finishers, not to mention makers of fasteners, zippers and trimmings, all backed by cheap and efficient trade logistics.

As happened in Japan and South Korea before it, this has lifted millions of people out of poverty. But rising wages and a greying workforce are putting an end to that model.

Like the car and electronics industries before it, textile and apparel manufacturers in search of lower costs first offshored production, particularly in cheaper labour nations like Bangladesh and Myanmar. The industry’s outbound foreign direct investment hit a record $2.7 billion in 2016.

Now it is turning to automation not so much there but in its developed markets.

One striking example of this that caught this Bystander’s eye. Suzhou-based Tianyuan Garments Co., one of the biggest apparel makers in the country and which numbers Adidas, Armani and Reebok among its customers, is opening a $20 million factory of 300 sewing robots (‘sewbots’) in the United States.

It will make T-shirts for Adidas; 23 million a year once it is running at full pelt by the end of this year, a volume of relentless production that means its economies of scale will make it impossible for cheap labour anywhere to compete with it. Robots can sow faster, indefatigably and more consistently than humans: sweatshops without the human sweat.

The 400 human jobs that will be created at the new factory will support and maintain the robots and in logistics. The twist to the tale is that the sewbots are developed by a US company, SoftWear Automation, whose initial R&D was funded by the US Department of Defence. The US military needs domestic manufacturers of uniforms, clothing and basics such as towels and mats as it has a mandate from the US Congress to buy ‘Made in America’ yet three decades of offshoring has decimated the US textile and apparel industry and thus its potential suppliers.

SoftWear’s sowbots use computer vision to steer the fabric first through cutting and then along the production line through series of sewing needles. This is an automated step beyond the sort of manufacturing companies like Adidas are doing in their robot-aided production lines in Germany.

Tianyaun’s new factory is located in Little Rock, Arkansas, with the state providing $3.2 million in incentives and a 65% break on property taxes to attract it. Another Chinese company, Shandong Ruyi Technology Group Co., is investing $410 million in an automated yarn spinning factory in Forrest City less than 100 miles from Tianyaun’s T-shirt operation.

Shandong Ruyi has a growing portfolio of some 40 global fashion brands, including Bally, Gieves & Hawkes, Aquascutum, the Paris-based fashion group SMCP (Sandro, Maje and Claudie Pierlot) and Italy’s Cerruti 1881. It is moving into an old Sanyo plant that closed in 2007, an unintended symbol of how the industrial world is turning — and one that raises some questions about what ‘America First’ really means in such circumstances.

Once tariffs, duties and shipping costs are factored in, the case for shortening supply chains by shifting production closer to consumers in developed markets becomes compelling. It makes the turnaround of new lines quicker, essential in the fickle and fast-moving world of fashion.

For Tianyuan (and Adidas) there is the additional benefit of its robots being able to sew “Made in the USA” labels into the T-shirts it will be making for its German client. Xu Yingxin, vice-president of the China National Textile and Apparel Council, says Arkansas is becoming another centre for China’s textile industry.

So far, sewbots are limited in their ability to replicate the dexterity of the human hand. They can manage something simple like a T-shirt, but even hemming is challenging, and it will be several years before they can produce more complex garments like a dress shirt.

The industry’s vision of on-demand custom-made clothing that can be delivered to a customer overnight is still far off, but no longer unimaginable. E-commerce retail giant Amazon recently received a patent for a manufacturing system that produces “on-demand” apparel.

For low-wage countries like Cambodia or Vietnam, hoping to follow China’s development path the prospect should be terrifying. The International Labor Organization estimates that more than 43 million people are employed in the textile industry in Asian developing countries. Those jobs will not just go elsewhere; they will just go. The ones that will replace them will require different skills.

With hefty government support, China’s textile and garment makers may be moving out of the labour intensive end of the industry and into higher value-added specialty textiles for medical, engineering, filtration and automotive applications and into highly automated mass production overseas at just the right time.

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