China Economic Quarterly Q4 2016

China announces new measures to attract foreign investment in 2017

February 2017

Major economic indicators p1/Policy updates p12/Hot topic analysis p13

www.pwccn.com/ceq

ContentI. Major economic indicators 1

II. Policy updates 12

III. Hot topic analysis

What China plans to do in 2017?

What's next for the Renminbi under Trump’s presidency?

13

13

15

1.70%

2.20%

1.60%

1.70%

1.80%

1.90%

1.70%

2.00%

1.70%

1.80%

1.50%1.30%

1.9%

1.8%

1.7%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

0.00

5.00

10.00

15.00

20.00

6.7%6.9%

7.30%7.80%

Major economic

indicators

China’s GDP in the fourth quarter of 2016 increased by RMB 21.13 trillion or

6.8%. As a result, GDP for the whole year of 2016 reached RMB 74.41 trillion,

6.7% higher than in 2015.

In the fourth quarter, the primary industry, the secondary industry and the

tertiary industry (services) grew 3.3%, 6.1% and 7.8% respectively. Overall,

services accounted for 51.6% of total GDP and consumption contributed 64.6%

to economic growth. In 2017, GDP growth is likely to retain its growth

momentum, though growth rates could fall slightly as supply-side structural

reform progresses and global economic uncertainties escalate.

Quarterly GDP values and quarterly and annual GDP growth rates

I

PwC 1

Quarterly growth Annual GDP growth

GD

P (

Tri

llion

s o

f R

MB

)

Source of data: Unless otherwise stated, economic data is from the National Bureau of Statistics and financial data from the People’s Bank of China.

GDP composition

2 China Economic Quarterly Q4 2016

2%

4%

6%

8%

10%

12%

14%

16%

20%

30%

40%

50%

60%

70%

80%

90%

Fixed asset investment/GDP

YOY growth rate of GDP (the right of the vertical axis)

Source: Wind

Fixed asset investment

remained a key driver in China’s

economic growth. By the end of

2016, fixed asset investment rose

steadily by 8.1% from last year to

RMB 59.65 trillion, around 80% of

GDP. Among them, state sector

investment rose by 18.7% year-on-

year, while private investment,

accounting for 61.2% of the total

investment, only increased by 3.2%

in the year. This shows subdued

business confidence, though its

growth in the fourth quarter was

slightly higher than in the previous

quarters.

Investment in the tertiary industry,

which accounts for 58% of total

investment, rose by 10.9% in line

with overall GDP growth trend.

Investment in infrastructure

swelled by 17.4% to RMB 11.89

trillion, or 20% of total investment.

In 2017, the government will

continue its massive investment in

major state projects in the areas of

clean energy, transport,

communication and oil & gas

pipelines, environmental

protection, modern logistics, city

rail, emerging industries and

upgrading of manufacturing, as

included in the 13th Five-Year Plan.

Yet the challenges are how to deal

with the diminished marginal

returns on investment and how to

ensure future funds will flow into

productive sectors instead of

“zombie enterprises”.

In 2016, the scale of PPP (public

private partnership) projects surged

to a couple of trillion yuan. It was

originally designed to boost private

investment mainly for

infrastructure, but state-owned

enterprises ultimately became the

leading force.

Fixed asset investment as a proportion of GDP is increasing

constantly in China

Fixed asset investment: accumulated growth rate P

erc

en

tage

Month

PwC 3

The real estate sector became

another booster of the economy

after experiencing a surprisingly

high growth in 2016. Sales of

commercial properties rose 22.4%

year-on-year, and real estate

investment jumped by 6.9% (7.5%

in real terms if deducting price

factor) over the previous year to

RMB 10.3 trillion, which is 17% of

total fixed investment. The boom in

real estate has also triggered growth

of related industries, such as steel,

construction, home decoration and

furniture. However, due to the

rapid rise of property prices in

many cities, the government has

recently staged new regulations to

restrict further investment and

“speculative” purchases by residents

and investors. It is expected that this

will have a knock-on effect on the

housing market in 2017.

Growth rates in real estate

4 China Economic Quarterly Q4 2016

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0

20

40

60

80

100

120

140

160

180

Narrow Money (M1)

Broad Money (M2)

Official Reserve Assets: Foreign ExchangeReserves

(RMB trillion)(USD trillion)

China’s money supply and foreign reserves

China has maintained an aggressive

monetary policy throughout 2016.

Money supply (money & quasi-

money) rose from RMB 141.4 trillion

at the beginning of the year to RMB

155 trillion by the end of 2016,

making China’s stock of currency in

circulation equivalent to that of the

US, the EU and Japan combined.

Meanwhile, bank loans jumped

13.5% year-on-year to RMB 12.65

trillion, RMB 925.7 billion more

than in 2015. Due to under-

development of the financial market,

bank loans accounted for 69.9% of

China’s total financing for the real

economy, and bond and capital

markets only provided 16.8% and

7% of financing.

Massive money supply has exerted

great pressure on RMB’s exchange

rate, which fell from RMB 6.55 per

dollar at the beginning of the year to

RMB 6.92 per dollar at the end of

2016. Renminbi depreciation

expectations and the explosive

growth in outbound investment by

Chinese companies had raised the

demand for foreign currencies,

causing China’s foreign reserves to

shrink from US$ 3.23 trillion at the

beginning of the year to US$ 3.01

trillion at the end of 2016 (falling

below the mark of US$3 trillion in

January 2017), which brings the total

to a six-year low.

PwC 5

China's manufacturing

purchasing managers’ index

(PMI) experienced the highest

performance since 2012 in the

fourth quarter of 2016, reaching

51.2%, 51.7%, and 51.4%

respectively for the last three

months, thanks to booming

domestic demand, rising prices and

growing activities in high-end

manufacturing. A figure above 50%

indicates expansion.

In December, PMI for large-sized,

medium-sized, and small-sized

enterprises stood at 53.2%, 49.6%

and 47.2% respectively. Meanwhile

China's non-manufacturing PMI

recorded a much stronger growth of

54.0%, 54.7% and 54.5% for the last

three months of the year. These

positive growth trends are likely to

continue in 2017.

46.0%

47.0%

48.0%

49.0%

50.0%

51.0%

52.0%

53.0%

54.0%

55.0%

56.0%

201

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Manufacturing Non-manufacturing 50% breaking point

Perc

en

tage

Purchasing managers’ index

6 China Economic Quarterly Q4 2016

In the fourth quarter, industrial

added values maintained its stable

growth of 6.1%, 6.2%, and 6.0% in

real terms in the last three months.

For 2016, industrial added values

expanded by 6%, 0.1% lower than in

2015. By ownership, industrial

added values of SOEs went up 2.0%,

collective enterprises fell by 1.3%,

joint-stock enterprises rose 6.9%,

and foreign-owned enterprises

expanded by 4.5%. Among all the

industries, manufacturing and high-

tech industry registered the highest

growth rates of 6.8% and 10.8%,

respectively.

As for PMI, another positive

development is industrial profits for

enterprises above certain scales have

reversed the downward trend and

grown by 8.5% in 2016 over last

year. While profits for mining

industry declined by 27.5%, profits

for equipment manufacturing and

high-tech manufacturing rose by

8.4% and 14.8% respectively,

signaling that China was on track to

grow its Industry 4.0 capabilities.

Month

Perc

en

tage

Growth of industrial added values (for companies over certain scales)

PwC 7

Retail sales of consumer goods: accumulated growth rate

Domestic consumption

sustained its role as one of the most

important drivers of economic

growth in 2016, with total retail

sales of consumer goods increasing

by 10.4% year-on-year (the real

growth rate was 9.2%) to RMB

33.23 trillion. On a quarterly basis,

it was 10.3%, 10.2%, 10.5% and

10.6% respectively with a stable

growing trend.

The national online retail sales of

goods and services, accounting for

16% of total retail sales, stood at

RMB 5.16 trillion, up by 26.2%

from last year. As China’s online

shopping has gained popularity and

will further expand, it will continue

to erode traditional retail sales in

the coming years.

China’s national per capita

disposable income continued its

growth momentum, rising by 8.4%

(real growth of 6.3%) from last year

to RMB 23,821 in 2016. Per capita

consumption expenditure rose by

8.9% (6.8% in real term) from last

year to RMB 17,111. It is expected

that domestic consumption will

remain active and a major driving

force for economic growth in 2017.

Month

Gro

wth

rate

8 China Economic Quarterly Q4 2016

The total value of China’s imports

and exports in 2016 fell by 6.76%

year-on-year to US$3.685 trillion,

with exports falling by 7.7% and

imports contracting by 5.5%,

leading to a reduced trade surplus

of US$510 billion, as compared

with US$594.5 billion in 2015.

In December, exports slipped 6.1%

from a year ago and imports rose

3.1% year-on-year, much in line

with expectations.

China’s trading situation is unlikely

to improve significantly in the

coming year, given the enduring

sluggish global demand and

heightened trade frictions with the

developed markets, especially with

the US.

Quarterly balance of trade

PwC 9

Source: Wind

The Producer Price Index (PPI)

has dramatically improved in the

last quarter of 2016, rising to 1.2%,

3.3%, 5.5% respectively from

October to December, thanks to

surges in commodity prices and

the after-effect of the supply-side

structural reform for cutting

industrial capacity and inventory.

As a result, both industrial

production and market demand

had increased.

For the whole year of 2016, PPI

went down by 1.4% year-on-year.

PPI turned positive in September

after 54 consecutive months of

decline. It is expected to stay above

zero in 2017.

The consumer price index (CPI)

remained stable for much of 2016,

with the overall CPI increasing by

2.0% year-on-year. It is worth

noting that most price hikes came

from the food sector, where prices

for fresh vegetables and pork went

up 11.4% and 16.9% respectively

due to cyclical supply shortages.

Meanwhile, prices for healthcare

went up 3.8%, as a result of rising

demand for high quality services,

and prices for household services

rose 4.4% due to shortage of skilled

labour. For 2017, we expect that

CPI is likely to stay in the same

positive range.

Month

Gro

wth

(con

traction

) ra

teProducer price index and consumer price index

10 China Economic Quarterly Q4 2016

-8

-6

-4

-2

0

2

4

6

8

98

98.5

99

99.5

100

100.5

101

101.5

102

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PPI CPI

Policy update

Meanwhile, the government vows to

improve protection of intellectual

property rights (IPR) and set up IPR

arbitration centres in China.

These measures are released against the

background of dwindling foreign

investment in China, especially in

manufacturing, in recent years, rising

cost of production, depreciating RMB,

more Chinese companies relocating to

lower cost neighbouring countries and

even to America, and bold tax cut plans

by the US and the UK for strengthening

their competitiveness. They also

resonate with the calls of President Xi

Jinping at the World Economic Forum

in Davos for opposing protectionism

and promoting further globalisation

and opening-up.

Yet it remains to be seen when the

details and timetables for enforcing

these measures will be released by the

designated government departments.

At times, reform measures announced

by the top were delayed or watered

down by interest groups.

China has issued its 13th Five-

Year Plan (2016-2020) to

strengthen the protection and

utilisation of intellectual property

rights. According to the plan, China's

invention patent ownership should

increase from 6.3 per 10,000 people in

2015 to 12 in 10,000, and international

applications will double from 30,000 in

2015 to 60,000 by 2020. Meanwhile,

intellectual property royalties earned

abroad will rise from US$4.44 billion in

2015 to US$10 billion in 2020. The plan

laid out seven major tasks for the

development of IPRs, such as

improving the legal system and

protection for IPRs, promoting

industrial upgrading and international

cooperation.

China’s State Council announced

on 17 January 2017 an

unprecedented set of new

measures to attract foreign

investment. According to the

document, the government will lower

market entry restrictions on foreign

investment in banking, securities,

insurance, futures, credit rating,

accounting and architecture design,

and gradually open up markets of

telecommunications, Internet,

education and transport.

On manufacturing, the government will

lift restrictions in the production of rail

transport equipment, motorcycle, fuel

ethanol, and animal fat. Foreign

invested enterprises (FIEs) are

encouraged to invest in high-end, smart

and green manufacturing, participate in

infrastructure projects in energy, water

conservation and environmental

protection.

Thresholds in oil shale, oil sand and

shale gas will be lowered, and the time-

consuming project approval system for

Sino-foreign cooperation on oil and gas

will be shifted to registration only.

More liberal measures are in the

financial sector. For the first time, FIEs

will be allowed to list in the Shanghai

and Shenzhen exchanges, including

mainboard, SME board and growth

enterprise market, and to issue bonds

in the Chinese markets to expand

financing channels.

FIEs are encouraged to set up research

and development centres in China and

step up cooperation with domestic

peers. They are also allowed to join

national science and technology

programmes, which were previously

off-limits to them.

II

12 China Economic Quarterly Q4 2016

Hot topic analysis

• Pursue a “proactive fiscal policy”

to partly cope with the needs for

the supply-side structural reform

(SSR) and a “robust monetary

policy” to maintain stable

liquidity. Hopefully this will help

keep a reasonable level of GDP

growth (above 6%), though no

specific figure was mentioned,

given the huge uncertainties ahead

and the dent-on effect by SSR.

• Improve regulation to ensure

there will be no systemic financial

risk. The government will step up

efforts to curb the debt-driven

financial markets, reduce leverage

ratios of SOEs and regulate the

debt-raising from local

governments. A few rule-breaking

cases are expected to be exposed

and dealt with as a warning sign.

• Establish a market-oriented long-

term property market mechanism

that can curb real estate bubbles

and prevent erratic fluctuations

through land, investment, legal,

fiscal, taxation and financial

means. Credits for speculative

house purchasing will be

prohibited, as “houses are built to

be inhabited, not for speculation”,

in President Xi’s words.

• Keep a relatively stable exchange

rate of the currency. This means

the government is likely to

continue its current practice of

market interventions to prevent

over-fluctuation of the Renminbi

against the dollar.

China has managed to achieve an

impressive economic growth of 6.7%

in 2016 despite all the difficulties. Yet

2017 will be a more challenging year

for the country, due to rising

protectionism around the world and

downward economic pressures and

financial risks at home. It is also a

crucial year as the all-important 19th

Party Congress will be held in

autumn 2017, when the current

leadership team will be significantly

reshuffled. China needs an amicable

and stable macro environment to

ensure a smooth running of the

meeting.

Understandably, “seeking progress

while maintaining stability” was

adopted as the core theme for 2017 by

the annual tone-setting Central

Economic Work Conference

concluded on 16 December 2016.

Centred on improving quality and

effectiveness of growth, the

government sets the goals of

“stabilising growth, deepening

reform, adjusting economic structure,

benefitting the people and preventing

financial risks” in 2017, according to

the statement of the conference.

To maintain stability, the government

plans to:

IIIWhat China plans to do in 2017?

PwC 13

Meanwhile the government aspires

to drive some major changes and

growth in a number of areas, as it

plans to:

• Deepen the SSR process, with a

focus on increasing efficient

supply, improving supply quality

and enhancing compatibility of

supply with demand.

• Further reduce industrial

capacity in coal and steel

(possibly extending to include

auto and new energy sectors);

shut down a plethora of loss-

making “zombie enterprises”

through mergers and

reorganisations while making

arrangements for laid-off

workers; allow the market to

play a bigger role in industrial

restructuring.

• Cut taxes, fees and other costs

for companies and streamline

administrative approval

procedures.

• Speed up the creation of a

flexible and efficient market-

oriented operation mechanism

for SOEs; push through mixed-

ownership reform, especially in

electricity, oil and gas, railway,

civil aviation, telecoms and

military industries; conduct

pilot reforms for state-owned

asset investment companies

where the state will act as a

stakeholder rather than a SOE

manager; encourage debt-for-

equity swaps through market

and law-based instruments to

lower corporate leverage.

• Advocate “quality first” among

businesses, raise national

quality standards and adopt

comprehensive quality

management by upholding “the

craftsman spirit” and building

up corporate brands; encourage

“innovation-driven”

development and boost growth

of strategic emerging industries

and industrial upgrading.

• Build a law-based business

environment to attract more

foreign investment; level the

playing field for small and micro

businesses by providing better

conditions on market access and

resources allocation.

• Accelerate the legislation of a

civil code to better protect

property rights; overturn wrong

convictions concerning

infringement of property rights

for enterprises, and protect and

support entrepreneurship. To

improve access to financing for

the private sector, the

government will allow the

setting up of more private banks.

• Press ahead with “people-

centred” urbanisation and

promote the overall

development strategies for

western, central, northeast and

coastal regions; further promote

the “three grand strategies” for

the development of Beijing-

Tianjin-Hebei cluster, Yangtze

River Economic Belt and the

Belt and Road region.

In summary, while the Chinese

government is committed to

resolving the inherent structural

issues such as industrial

overcapacity, housing bubbles, SOE

reform and rejuvenation of the real

economy, don't expect to see a bold

reform plan in 2017, as stability will

be the priority. It won’t be smooth

sailing, and the prospect of

heightened trade frictions with

developed countries will make it

more difficult. Watch out.

14 China Economic Quarterly Q4 2016

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0 Source: Wind

Average exchange rate USD:RMB (1994.8.3 - 2017.1.24) (days)

Contrary to these statements, the Renminbi has appreciated sharply

against the dollar instead of depreciation over the past decade since 2004.

Since the appreciation of the dollar started from mid-2015, the Chinese

government has painstakingly made efforts to slow down the speed of the

yuan's depreciation against the dollar. China’s central bank is believed to

have spent about USD 800 billion from its foreign currency reserves to

stabilise the Renminbi.

China has significantly changed its exchange rate formation mechanism

over the past decade, as it has shifted from “hard peg” to the US dollar

nearly ten years ago, to a “managed float regime”. Currently, the

Renminbi’s exchange rate is based on a basket of currencies, not only the

US dollar. According to the IMF definition, this is “crawl-like

arrangement” which is one type of “soft peg”.

During his presidential campaign, Donald Trump has indicated that the

Chinese government may have intentionally depreciated the Renminbi to

gain a competitive advantage for Chinese exports. However, this is a far

cry from reality.

What's next for the Renminbi under

Trump’s presidency?

PwC 15

China’s reform on liberalising its

exchange rate regime has been

widely recognised, especially by the

IMF. Last September, to mark the

launch of the new SDR basket

including the Chinese currency, Ms.

Christine Lagarde, Managing

Director of the IMF, commented

that the Renminbi’s inclusion

reflects the progress made in

reforming China’s monetary,

foreign exchange and financial

systems, and acknowledges the

advances made in liberalising and

improving the infrastructure of its

financial markets.

Earlier this year, former Federal

Reserve Chairman Ben Bernanke

also indicated that calling China a

currency manipulator “doesn't fit

with reality." He acknowledged,

“China right now is working very

hard to keep the Renminbi from

falling.”

Nevertheless, what are the

prospects of Renminbi’s exchange

rate in 2017? What actions should

China take under the current

situation?

According to IMF, there are some

65 countries that have currently

adopted the floating exchange rate

regime, which means the market

dictates movements in the

exchange rate. Though Japan and

the UK intervene their exchange

rate to a great extent, it is still a

floating exchange rate, while the

Canadian dollar is regarded as a

pure floating currency.

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

(100 million USD) Source: Wind

China's foreign currency reserves: monthly data (1986.12 - 2016.12)

16 China Economic Quarterly Q4 2016

In order to avoid the possibility of

being labelled as a "currency

manipulator", the best option for

China is to press ahead with the

liberalisation of the yuan exchange

rate, transforming from the current

managed exchange rate regime to

floating rate regime as soon as

possible. Meanwhile, capital control

measures would continue to serve

as the firewall to prevent

unpredictable capital outflow from

China, even as this policy is

believed to have caused extra

barriers to China’s overseas

acquisition deals.

Going forward, the Renminbi’s

exchange rate against the dollar in

2017 will be affected by many

factors, including China’s economic

performance and changes to its

interest rate. Externally the US

dollar remains the biggest variable

as it still carries the heaviest weight

in Renminbi’s currency basket.

Thus far the US markets have

rallied but uncertainties linger over

which policies the Trump

Administration may enact and what

their immediate and long-term

effects will be on the US economy.

To date, the US dollar index is close

to historical highs. Even if

President Trump's economic

policies stimulate the US economy

with higher growth rate, there could

be limited room for the dollar to

rise any further. Besides, a too

strong US dollar could be a

restraint for the full recovery of the

US economy.

Given these circumstances, we

expect that the Renminbi could

further depreciate at least a few

percentage points to the dollar in

2017, as the majority of investors

have expected, but an appreciation

could be not be ruled out, at least

for the short term.

50

55

60

65

70

75

80

85

90

95

100

105

110

115

120Source: Wind

Real dollar monthly index: the major currencies (1986.1 - 2016.12)

PwC 17

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Marketing and Communications

Cynara TanHead of Marketing and Communications Asia Pacific+852 2289 8715cynara.sl.tan@hk.pwc.com

Authors

Allan Zhang Chief EconomistPwC China+86 (10) 6533 7280allan.zhang@cn.pwc.com

G. Bin ZhaoSenior Economist PwC China+86 (21) 2323 3681bin.gb.zhao@cn.pwc.com