Challenges and Opportunities in the Year of the Dog

Happy Chinese New Year. This is the year of the dog, which we are told will bring many great things. The trouble is, each year we are informed that every one of the twelve different animals of the zodiac will deliver its own mix of prosperity, health or happiness. Let’s hope so. In recent months the talk has been of critical battles ahead for China’s economic policy makers. Yet 2018 should not just be about challenges, it may also be an opportunity to celebrate China’s success to date. This is the 40th anniversary of China’s opening up policy, which started in late 1978.

Largely because of the success of that opening up, which has triggered China’s economic and geopolitical rise, we now take more note of China’s new year. In part, it leads to a temporary slowdown in Asian economies, as the long new year holiday takes place, but also, as with our own new year, it is a chance for the nation to reassess.

China increasingly linked to the rest of the world

China is now the world’s second largest economy. As we saw only a few years ago, a slowdown in China triggered a sharp fall in commodity prices, with significant implications elsewhere. China is increasingly interlinked with the rest of the world economy in ways in which it was not only decades ago, notably being a large holder of US Treasuries. Closer to home, it is also a big investor in the UK.

This week, at the major Chinese New Year dinner in London, the Ambassador spoke of The China-UK golden era 2.0 (two point zero, as he called it) following Prime Minister May’s visit to meet President Xi only a few weeks ago. There were many positives from that trip, building on what has been called a Golden Era. Disappointingly, though, for many, the UK did not officially endorse the Belt Road Initiative, the suggestion being this was in response to a request from the US.

That is a shame as the Belt Road offers great opportunities: it is the biggest infrastructure boost to the world economy, spanning perhaps as many as 60 countries, and the UK has an opportunity to become more involved in its financing, as well as directly in many aspects of the infrastructure.

Beyond the Belt Road

So what are the Chinese focusing on? Making a success of the Belt Road is clearly one aspect, but there are more. Last autumn witnessed the 19th National People’s Congress which not only cemented President Xi’s position but is likely to usher in a further period of political stability. Then, the President outlined his long-term vision, as we outlined in this piece.

Since then, the focus has been on implementation. In December the major annual economic meeting took place: the economic work conference. The main focus was on pursuing “high-quality development”. This fits with the ongoing desire to move China up the value curve. The main messages from this work conference were reiterated in Davos by Liu He, the senior China official present and one who is credited with much of its recent economic success.

In Davos Liu talked of global cooperation. That message would resonate well with the markets in 2018, but it would be wrong to ignore the tensions that exist on areas such as trade with the US.

The main focus of his Davos speech – and remember this would have been carefully thought through as a message to the world – was to highlight the three key current policy issues:

• Addressing the risks facing the country.
• Reducing poverty, particularly in rural areas.
• Curbing pollution.

The rest of the world should be reassured by such a focus. The message was aimed at showing that China is addressing domestic issues to stabilise and strengthen its economy.

Why stability matters

For investors and savers focusing on the financial markets and world economy, perhaps it is the first topic, managing risks, we should dwell on.

Ensuring financial stability was identified as one of the most important risks. Indeed, in December, attention was drawn to cracking down on illegal activities in the financial industry. It is hard to quantify these but it fits with the anti-corruption drive that Xi has pursued. In his October congress speech Xi received the most applause – and there were many – when he indicated cracking down on speculators in housing. That is an important part of stability within China.

Global investors, however, worry about the scale of the shadow banking industry in China. Reassuringly though, at the new year dinner in London, Professor Liu Ming Kang, the inaugural regulator in China when he headed up the China Banking Regulatory Commission, played down such worries. But he did note that debt levels are still high.

Indeed, how the Chinese authorities address these challenges is important for global markets. Debt levels are high, particularly in state owned enterprises, and hence the central bank is trying to reduce leverage. This should help minimise contagion risks. To reinforce this, the People’s Bank of China is also tightening monetary policy by raising interest rates gradually. They hiked last March and again in December, too. This looks set to continue.

Eyes will also be on the yuan. Last year there was increased concern about its potential volatility, prompting the central bank to act. Conditions now appear to be returning to normal and in January the yuan experienced its strongest monthly gain against the dollar since the present currency set-up began in 1994.

The rest of Asia will be reassured if the yuan is not devaluing but let’s also hope this is a vote of confidence in the authorities being able to ensure financial stability in the year of the dog.

China’s economy certainly has a lot more bite globally – so stability and growth there this year will fit in with the picture of a global economic recovery.