BMI China Business Forecast Report Q2 2014

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Q2 2014
www.businessmonitor.com
CHINA
Business Forecast Report

includes 10-year forecast to 2023
Published by Business Monitor International Ltd
Reforms No Silver Bullet
ISSN 1744-8778
Published by Business Monitor International Ltd.
Copy Deadline: 17 January 2014
6,592
4,994
GDP per capita, US$ [7]
GDP per capita, EUR [7]
18.7
3,500.0
2.5
224.8
2.3
2014f
17.3
3,600.0
1.7
167.8
1.6
159.1
2,498.8
2,657.9
-0.9
-91.3
7.82
6.16
6.00
3.0
2.6
5.0
1,393.8
5.0
42.6
9.0
14.0
8.4
35.5
7.1
5,723
7,269
7,977.2
62,407.1
10,131.0
2015f
15.9
3,700.0
1.0
111.1
1.0
108.1
2,799.4
2,907.5
-0.5
-56.4
7.66
6.22
5.75
3.2
2.8
5.0
1,401.6
4.5
42.0
8.5
14.4
8.2
36.3
6.0
6,335
7,792
8,879.1
67,985.3
10,921.3
2016f
14.7
3,800.0
0.8
97.1
0.9
100.8
3,094.7
3,195.5
-0.2
-26.2
7.50
6.25
5.75
3.5
2.7
5.0
1,408.9
4.0
41.3
8.0
14.7
8.0
37.0
5.8
6,992
8,390
9,851.0
73,882.7
11,821.2
2017f
13.0
3,700.0
0.6
81.3
0.7
90.8
3,421.6
3,512.4
-0.0
-2.7
7.50
6.25
5.75
3.7
2.7
5.0
1,415.8
4.0
40.6
8.0
15.0
8.0
37.8
5.8
7,563
9,076
10,707.8
80,308.5
12,849.4
2018f
11.4
3,600.0
0.4
59.9
0.6
77.5
3,783.7
3,861.2
-0.0
-5.7
7.50
6.25
5.75
4.0
2.7
5.0
1,422.1
4.0
39.9
8.0
15.3
8.0
38.6
5.8
8,183
9,820
11,637.3
87,279.9
13,964.8
2019f
10.0
3,500.0
0.2
32.2
0.4
60.5
4,184.8
4,245.2
-0.1
-9.4
7.50
6.25
5.75
4.0
2.7
5.0
1,427.8
4.0
39.2
8.0
15.6
8.0
39.4
5.8
8,857
10,628
12,645.8
94,843.2
15,174.9
2020f
8.8
3,400.0
-0.0
-7.3
0.2
34.7
4,629.1
4,663.8
-0.1
-13.6
7.50
6.25
5.75
4.0
2.7
5.0
1,432.9
4.0
38.5
8.0
15.9
8.0
40.2
5.8
9,586
11,504
13,736.1
103,020.9
16,483.3
2021f
7.7
3,300.0
-0.3
-57.6
0.0
2.8
5,121.5
5,124.3
-0.1
-18.5
7.50
6.25
5.75
4.0
2.7
5.0
1,437.3
4.0
37.9
8.0
16.2
8.0
41.0
5.8
10,383
12,459
14,923.0
111,922.3
17,907.6
2022f
6.8
3,200.0
-0.6
-125.8
-0.2
-36.2
5,667.3
5,631.1
-0.1
-24.2
7.50
6.25
5.75
4.0
2.7
5.0
1,441.1
4.0
37.2
8.0
16.6
8.0
41.9
5.8
11,253
13,504
16,216.7
121,625.5
19,460.1
2023
6.1
3,200.0
-1.0
-217.1
-0.4
-89.1
6,272.3
6,183.3
-0.1
-30.8
7.50
6.25
5.75
4.0
2.7
1,444.2
4.0
36.6
8.0
16.9
8.0
42.8
5.8
12,202
14,642
17,621.9
132,164.2
21,146.3
Notes: e BMI estimates. f BMI forecasts. 1 One-Year Lending Rate; 2 Fiscal years ending June 30 (2011=2010/11); 3 Fiscal years ending June 30 (2011=2010/11). From FY2010 onwards, 2007-08 = 100.; 4
Weighted Average Lending Rate, (2011=FY2010/11); 5 SBP Reverse Repurchase Rate, (2011=FY2010/11); 6 GDP at Market Costs, 2011=2010/11. Sources: 7 National Bureau of Statistics, BMI; 8 World Bank/
UN/BMI; 9 National Bureau of Statistics; 10 IMF, BMI; 11 Peoples Bank of China, BMI; 12 BMI; 13 Pakistan Bureau of Statistics/BMI; 14 State Bank of Pakistan/BMI; 15 Ministry of Finance/BMI.
Import cover, months [10]
Foreign reserves ex gold, US$bn [10]
Current account balance, % of GDP [7]
Current account balance, US$bn [7]
Balance of trade in goods and services, % of GDP [7]
211.6
2,240.8
Goods and services imports, US$bn [7]
Balance of trade in goods and services, US$bn [7]
2,452.4
-1.3
Goods and services exports, US$bn [7]
Budget balance, % of GDP [7]
-117.5
8.21
Exchange rate CNY/EUR, ave [12]
Budget balance, US$bn [7]
6.22
3.0
Lending rate, %, ave [10]
Exchange rate CNY/US$, ave [12]
2.6
Consumer price inflation, % y-o-y, ave [7]
6.00
5.0
1,385.6
4.3
43.4
9.0
13.8
8.0
35.1
Unemployment, % of labour force, eop [9]
Population, mn [8]
Fixed capital formation, real growth % y-o-y [7]
Fixed capital formation, % of GDP [7]
Government final consumption, real growth % y-o-y [7]
Government final consumption, % of GDP [7]
Private final consumption, real growth % y-o-y [7]
Private final consumption, % of GDP [7]
7.6
6,919.5
Nominal GDP, EURbn [7]
Real GDP growth, % y-o-y [7]
56,811.6
Nominal GDP, CNYbn [7]
2013
9,133.7
Nominal GDP, US$bn [7]
Central Bank policy rate, % eop [1,11]
CHINA MACROECONOMIC INDICATORS
china Q2 2014
Business Monitor International Ltd
Contents
Executive Summary.................................................................................................................................. 5
Core Views.......................................................................................................................................................................................5
Major Forecast Changes.................................................................................................................................................................5
Key Risks To Outlook.....................................................................................................................................................................5
Chapter 1: Political Outlook..................................................................................................................... 7

SWOT Analysis........................................................................................................................................................... 7
BMI Political Risk Ratings......................................................................................................................................... 7
Foreign Policy ............................................................................................................................................................ 8
China's New Air Defence Zone: Seven Crucial Factors...............................................................................................................8
China's establishment of an Air Defence Identification Zone (ADIZ) overlapping the disputed Senkaku/Diaoyu Islands will increase
geopolitical risks in Asia, and potentially undermine Beijing's standing in the region, as it fuels a backlash. More Asian countries will turn
to the US to counterbalance China's influence.
Table: Political Overview............................................................................................................................................................................... 8
Long-Term Political Outlook................................................................................................................................... 10

Major Challenges Over The Coming Decades............................................................................................................................10
China faces myriad economic, social and environmental challenges over the coming decades that could seriously test the Communist
Party of China's ability to govern. The best-case scenario for any eventual political transition would entail an elite-led liberalisation of the
authoritarian system, while the worst-case scenario would involve a violent change of regime.
Chapter 2: Economic Outlook................................................................................................................ 15

SWOT Analysis......................................................................................................................................................... 15
BMI Economic Risk Ratings.................................................................................................................................... 15
Economic Activity.................................................................................................................................................... 16
Can Reforms Prevent The Credit Hangover?.............................................................................................................................16
We continue to believe that the hangover effects of China's economic stimulus are yet to be felt, and cooling credit growth is likely to
reveal these effects over the coming quarters. Newfound reform momentum has the potential to help the economy grow out from under
its credit excesses. However, several obstacles stand in the way of this, including the likelihood that reform efforts could exacerbate any
economic downturn. We are forecasting real GDP growth to come in at 7.1% in 2014, before slowing further to average 6.1% growth
over the next five years.
TABLE: ECONOMIC ACTIVITY............................................................................................................................................................................... 16
Fiscal Policy ............................................................................................................................................................. 18

Reforms May Fall Short Due To Lack Of Funding......................................................................................................................18
The Chinese government is looking to control the burgeoning debt load at the local government level, while at the same time promoting
regional rebalancing, improving social welfare, and reducing the reliance on unsustainable land sales. These goals seem incompatible
and suggest that fiscal reforms will be difficult to achieve in practice.
table: FISCAL POLICY......................................................................................................................................................................................... 18
Monetary Policy........................................................................................................................................................ 19
Inflationary Forces Evenly Balanced...........................................................................................................................................19
Notwithstanding the surge in credit in recent years, China's consumer price inflation rate has remained remarkably benign, while
producer price inflation has been consistently negative. We believe that the flood of capital into the nation's property market helps to
explain these trends.
Table: MONETARY POLICY................................................................................................................................................................................. 19
Balance Of Payments............................................................................................................................................... 21
Digging Deeper Into Export Trends.............................................................................................................................................21
China's exports are recovering and are likely to remain relatively strong as we enter 2014. However, beyond this cyclical upswing, the
stronger yuan is likely to begin to bite, and we are forecasting exports to grow by just 8.0% in 2014 in nominal terms, from an estimated
8.3% in 2013. Some interesting export trends are developing throughout the region, though, which are likely to reduce China's exposure
to external shocks, such as greater export diversification, with shipments to the US, Europe, and Japan, continuing to decline in overall
share.
Table: CURRENT ACCOUNT................................................................................................................................................................................ 21
china Q2 2014
Chapter 3: 10-Year Forecast................................................................................................................... 23

The Chinese Economy To 2023.............................................................................................................................. 23
6.0% Is The New 10.0%.................................................................................................................................................................23
Chinas economic growth in the coming decade will be much slower than in the previous one, as the savings rate declines, the economic
liberalisation process slows and population growth falls. These dynamics will result in real GDP growth averaging 6.2% over the next
decade as opposed to the 10.7% average of the past 10 years. Private consumption will be a major outperformer, averaging growth of
8.2% and rising in importance as a share of GDP.
Table: Long-Term Macroeconomic Forecasts..................................................................................................................................... 23
Chapter 4: Business Environment......................................................................................................... 27

SWOT Analysis......................................................................................................................................................... 27
BMI Business Environment Risk Ratings.............................................................................................................. 27
Business Environment Outlook.............................................................................................................................. 28
Introduction....................................................................................................................................................................................28
Institutions................................................................................................................................................................ 28
Table: BMI Business & Operation Risk Ratings...................................................................................................................................... 28
Table: BMI Legal Framework Rating.......................................................................................................................................................... 29
Infrastructure............................................................................................................................................................ 30
Table: Labour Force Quality....................................................................................................................................................................... 30
TABLE: ASIA ANNUAL FDI INFLOWS................................................................................................................................................................. 31
Table: Trade & Investment Ratings........................................................................................................................................................... 32
Market Orientation.................................................................................................................................................... 33
Operational Risk....................................................................................................................................................... 34
Chapter 5: Key Sectors........................................................................................................................... 37

Autos ........................................................................................................................................................................ 37
Table: Autos Sector Production And Sales..................................................................................................................................... 38
Food & Drink ............................................................................................................................................................ 39

Table: Food Consumption Indicators Historical Data & Forecasts, 2010-2017.................................................................... 41
Table: Hot Drinks Value/Volume Sales Historical Data & Forecasts, 2010-2017................................................................. 42
Table: Mass Grocery Retail Sales Historical Data & Forecasts, 2010-2017.......................................................................... 45
Other Key Sectors.................................................................................................................................................... 47

Table: Freight Key Indicators..................................................................................................................................................................... 47
Table: Oil and Gas Sector Key Indicators.............................................................................................................................................. 47
Table Pharma Sector Key Indicators...................................................................................................................................................... 47
Table: Telecoms Sector Key Indicators................................................................................................................................................. 48
Table: Defence and Security Sector Key Indicators........................................................................................................................ 48
Table: Infrastructure Sector Key Indicators.................................................................................................................................... 48
Chapter 6: BMI Global Assumptions..................................................................................................... 49

Global Outlook.......................................................................................................................................................... 49
Momentum To Continue In H114..................................................................................................................................................49
Table: Global Assumptions.......................................................................................................................................................................... 49
Table: Developed States, Real GDP GrowtH, %.................................................................................................................................... 50
Table: BMI VERSUS BLOOMBERG CONSENSUS REAL GDP GROWTH FORECASTS, %............................................................................. 50
Table: Emerging Markets, Real GDP Growth, %................................................................................................................................... 51
Executive Summary
Core Views
Major Forecast Changes
We continue to believe that the hangover effects of Chinas economic
Since our last Business Forecast Report we have made some slight
stimulus are yet to be felt, and cooling credit growth is likely to reveal
changes to Chinas economic forecasts. We have upgraded our 2014
these effects over the coming quarters. Newfound reform momen-
real GDP growth forecast from 6.7% to 7.1% to reflect our view that
tum has the potential to help the economy grow out from under its
the recent pick-up in export growth will be sustained into early 2014.
credit excesses. However, several obstacles stand in the way of
We remain a long way below consensus estimates, however, as we
this, including the likelihood that reform efforts could exacerbate any
believe that reform measures are likely to be negative for headline
economic downturn. We are forecasting real GDP growth to come
real GDP growth.
in at 7.1% in 2014, before slowing further to average 6.1% growth

over the next five years.
Key Risks To Outlook

Notwithstanding the surge in credit in recent years, Chinas con-
The main downside risk to our economic outlook remains another
sumer price inflation (CPI) rate has remained remarkably benign,
collapse in external demand, such as the one that occurred at the
while producer price inflation (PPI) has been consistently negative.
height of the global financial crisis. This would seriously undermine
We believe that the flood of capital into the nations property market
growth in trade-dependent industries and hasten a fall in the property
helps to explain these trends. The outlook for real estate prices will
market, potentially leading to an outright recession. There is also
be crucial in determining the inflation picture in 2014 and beyond,
a risk that continued fiscal and monetary stimulus by government
and we believe that pressures will be caped despite the current
and the Peoples Bank of China could usher in stagflation.
inflationary market signals.

The major political risk comes from a rise in social unrest and a surge
The Chinese government is looking to control the burgeoning debt
in public demonstrations against government corruption, inflation and
load at the local government level, while at the same time promoting
housing affordability, which could be triggered by overseas events or
regional rebalancing, improving social welfare, and reducing the reli-
an economic slump. While we do not see the rule of the Communist
ance on unsustainable land sales. These goals seem incompatible
Party of China (CPC) as being at risk, such events would still have a
detrimental impact on the business environment and could see the

CPC strengthen its grip on the economy to the detriment of growth.
Chinas establishment of an Air Defence Identification Zone (ADIZ)

overlapping the disputed Senkaku/Diaoyu Islands will increase geopolitical risks in Asia, and potentially undermine Beijings standing
in the region, as it fuels a backlash. More Asian countries will turn
to the US to counterbalance Chinas influence.
Chapter 1:
Brief Methodology
Political Outlook
SWOT Analysis
BMI Political Risk Ratings

Chinas short-term political risk rating of 78.5 reflects the high degree of
Strengths
policy continuity and cohesion with regard to the policymaking process
The Communist Party of China (CPC), which has governed for over
associated with one-party rule. However, while this is a boon in the near
60 years, remains secure in its position as the sole political party in
term as reflected by the high score it acts as a drag on the countrys
China.
long-term political risk rating of 67.4. Indeed, the absence of a strong
Chinas expanding economy is giving it greater clout in international
constitutional framework and the tight control over political freedoms hurt
affairs, which will allow it to build politically important ties, especially
Chinas long-term rating particularly sharply, with the characteristics of
with the developing world.
policy subcomponent scoring a feeble 33.1 out of 100.
Weaknesses
As with any other one-party state, Chinas political system is inherently unstable and unable to respond to the wider changes taking
place in society.
Provincial governments often fail to enforce central government
directives.
Although bilateral ties have warmed in recent years, Chinas relationship with Taiwan remains problematic, with Beijing refusing to rule
out the threat of force in the event of a declaration of independence
by Taiwan.
Opportunities
China is actively expanding its political and economic ties with major
emerging markets in Latin America, Africa and the Middle East.
A new generation of leaders (the so-called fifth generation) took
power in 2012. This should ensure the continuation of reform and
modernisation.
Threats
Growing corruption, widening inequalities, increasing rural poverty
and environmental degradation have led to an increase in social
unrest in recent years.
The Communist Party is facing increasing factional rifts based on
ideology and regionalism. While greater political debate would be
welcomed by many, internal regime schisms could prove politically
destabilising.
S-T Political
Rank
Trend
Singapore
94.8
1
Brunei Darussalam
90.6
2
Hong Kong
84.8
3
Taiwan
83.3
4
Laos
80.4
5
Vietnam
79.0
6
South Korea
77.7
7
China
77.3
8
Sri Lanka
77.1
9
Malaysia
76.9
10
Philippines
71.2
11
Mongolia
70.4
12
North Korea
69.8
13
Indonesia
68.8
14
Cambodia
64.0
15
Thailand
62.5
16
India
62.3
17
Bangladesh
62.1
18
Bhutan
61.0
19
Myanmar
56.9
20
Pakistan
51.7
21
Papua New Guinea
45.2
22
Regional ave 72.3 / Global ave 64.9 / Emerging markets ave 62.3
=
=
=
=
=
=
=
=
=
=
=
=
=
=
=
=
=
South Korea
84.2
1
Singapore
80.6
2
Taiwan
75.4
3
Hong Kong
72.9
4
Mongolia
67.7
5
Malaysia
67.2
6
India
65.7
7
Brunei Darussalam
65.6
8
China
62.9
9
Philippines
62.8
10
Bangladesh
62.6
11
Thailand
61.8
12
Sri Lanka
60.2
13
Indonesia
60.0
14
Cambodia
59.3
15
Vietnam
57.7
16
North Korea
55.2
17
Papua New Guinea
54.8
18
Pakistan
53.7
19
Bhutan
51.0
20
Laos
46.9
21
Myanmar
40.9
22
=
=
=
=
=
=
=
=
=
=
=
=
=
=
+
=
=
=
=
=
=
=
L-T Political
Rank
Trend
china Q2 2014
Foreign Policy
China's New Air Defence Zone: Seven
Crucial Factors
BMI View
China's establishment of an Air Defence Identification Zone (ADIZ)
overlapping the disputed Senkaku/Diaoyu Islands will increase geopolitical risks in Asia, and potentially undermine Beijing's standing in the
region, as it fuels a backlash. More Asian countries will turn to the US
to counterbalance China's influence.
China's establishment of an Air Defense Identification Zone

(ADIZ) on November 23 2013, has significantly raised geopolitical tensions in the Asia-Pacific region, and risks creating a
major backlash against Beijing. China's new ADIZ appears to
be directed against Japan, since the zone covers the Japaneseadministered Senkaku Islands, which are also claimed by
China (which calls them the Diaoyu Islands) and by Taiwan.
By establishing the ADIZ, China appears to be challenging
Japanese sovereignty over the islands, as the zone requires all
aircraft entering it to identify themselves and report their flight
plans to the Chinese authorities. The Japanese government has
ordered its airlines not to comply with the ADIZ, after their initial
cooperation. The secondary 'target' of the ADIZ would appear

to be the US, which is the top ally of Japan, South Korea, and
the Philippines. China deeply resents the substantial American
military presence in Asia and Washington's stated commitment
to 'pivot' towards the Pacific, regarding these (correctly in our
view) as a means to counterbalance Beijing's rising influence.
Therefore, the Chinese ADIZ may be aimed at testing the US's
reaction to changes to the military status quo. The US's immediate response was to fly B-52 bombers through the zone without
notifying China, thus demonstrating that Chinese control of its
ADIZis hollow. On November 29, the US military revealed
that it had been sending daily flights through the disputed area.
Implications Of China's New ADIZ

1: China is becoming increasingly assertive in its territorial
dispute with Japan. The timing of the creation of the ADIZ has
raised questions, but there are several possible answers. Firstly,
the announcement came shortly after the Communist Party of
China (CPC) concluded the third plenum of the current Central Committee, in which President Xi Jinping outlined future
economic reforms and created a national security council. The
ADIZ may thus be designed to placate hardline nationalists and
the military establishment, and perhaps even distract public attention away from potentially painful economic restructuring.
Secondly, Japan also recently established a security council
Table: Political Overview

Head of State
President Xi Jinping (serving first of a maximum two five-year terms)
Head of Government
Prime Minister Li Keqiang (serving first of a maximum two five-year terms)
Last Election
Presidential and parliamentary March 2013
CPC congress November 2012
Composition of Current Government
Communist Party of China
Key Figures
The Politburo Standing Committee acts as the de facto highest decision-making body in China
and comprises the top leadership of the ruling party. Its members, in order of protocol, are: Xi
Jinping (concurrently general secretary of the Communist Party), Li Keqiang, Zhang Dejiang, Yu
Zhengsheng, Liu Yunshan, Wang Qishan, Zhang Gaoli
Other Key Posts
Finance Minister Lou Jiwei; Foreign Minister Wang Yi; Defence Minister Chang Wanquan;
Minister of Public Security Guo Shengkun; Central Bank Governor Zhou Xiaochuan
Main Political Parties (number of seats in parliament)
Communist Party of China (CPC): The founding and ruling political party of the Peoples Republic
of China, whose paramount position as the supreme political authority is guaranteed by Chinas
constitution and realised through control of all state apparatus. The CPC was founded in 1921 and
came to rule all of mainland China after defeating its rival, the Kuomintang (KMT), in the Chinese
Civil War.
Next Election
Presidential and parliamentary March 2018
CPC congress Autumn 2017
Ongoing Disputes
Ongoing dispute over Taiwanese sovereignty and Tibetan autonomy; some minor territory disputes
with Asian neighbours, including with Japan over the Senkaku Islands in the East China Sea and
with Taiwan, Malaysia, the Philippines and Vietnam over the Spratly Islands in the South China
Sea.
Key Relations/ Treaties
Close Link With ASEAN, WTO member, permanent seat on the UN Security Council, founding
member of the Shanghai Cooperation Organisation (SCO).
BMI Short-Term Political Risk Rating
77.3
BMI Structural Political Risk Rating
62.9
Source: BMI
political outlook
and is currently preparing new 10-year defence guidelines

for publication in December, and China may have wanted to
change the 'facts in the air' to pre-empt any new measures by
Tokyo. More broadly, the ADIZ is a practical way of increasing
pressure on Japan in the dispute. Earlier, in May 2013, Chinese
media carried articles questioning Japan's sovereignty over the
Ryukyu Islands, which were vassal states of China before being annexed by Japan in the 1870s (see May 13 2013, 'China's
Okinawa 'Claim' To Increase Regional Tensions'). The Ryukyu
archipelago includes Okinawa, an island of 1.5mn people and
host to most of the 50,000 American troops in Japan. Although
China was not formally claiming these islands, it was most
probably seeking to up the psychological pressure on Japan.
Political Tensions Weigh On Trade Relations
Chinas Exports To Japan, % of Total
20
18
16
14
12
10
8
6
Jan -14
Jul-12
Apr-13
Oct-11
Jan -11
Jul-09
Apr-10
Oct-08
Jan -08
Jul-06
Apr-07
Oct-05
Jan -05
Jul-03
Apr-04
Oct-02
Jan -02
Jul-00
Apr-01
Oct-99
Jan -99
Source: BMI, CGA
2. The risks of an 'incident' between Chinese and Japanese aircraft

or ships are rising. Both China and Japan have been increasing
their air and naval activities in the disputed region, and as a result,
we would not be surprised to see a collision between fighter jets
or naval vessels, or even some sort of skirmish between them
(see November 15 2013, 'Sino-Japanese Conflict Scenarios:
Geopolitical And Economic Implications'). An 'incident' could
take the form of a 'dogfight', or maritime stand-off. Tensions
would increase dramatically if fatalities occurred on either side.
The worst-case scenario would involve a civilian airliner getting
caught up in an incident in the ADIZ, resulting in a forced or
emergency landing, or even a shoot-down. There are precedents
for this: In 1978, a Korean Airlines flight made an emergency
landing in the USSR after being struck by Soviet fighter jets,
and in 1983 a separate Korean Airlines flight was downed with
the loss of 269 lives. Both flights violated Soviet airspace and
were apparently mistaken for military aircraft. Later, in 1988,
the US mistakenly shot down an Iranian airliner in the Persian
Gulf, with the loss of 290 lives. Given that Japanese and South
Korean airliners are not complying with China's ADIZ, a deadly
incident cannot be ruled out.
3: China's ADIZ will boost defence-focused nationalists in Japan.
Defence 'hawks' have been on a gradual ascendance since the
late 1990s, mainly because of the threat posed by North Korea,
but in more recent years due to Japanese concerns about the rise
of China. Japanese Prime Minister Shinzo Abe is one of his
country's leading defence-oriented politicians, and he favours
amending the country's constitution to reduce restrictions on the
use of the Self-Defence Forces (SDF, Japan's armed forces). So
far, Abe has chosen to prioritise his 'Abenomics' programme to
revive the economy through looser monetary and fiscal policies and structural reform, but the challenge posed by China's
assertiveness could encourage him to turn his focus back to
defence issues. This could detract political capital away from
the reform programme.
4: China has unintentionally raised tensions with South Korea,
too. China's ADIZ covers a submerged rock known internationally as Socotra Rock (not to be confused with Socotra Island,
Yemen), Iedo in Korean, and Suyan in Chinese, that is controlled
by Seoul but claimed by Beijing. South Korea has protested
against the Chinese ADIZ, but China has refused to redraw it to
exclude Korean claims. Therefore, South Korea is now planning
to expand its own ADIZ to cover its southernmost possessions.
The disagreement with Seoul is unfortunate for Beijing, because
it could tip South Korea closer to the US. China typically likes
to drive a wedge between the two countries, to undermine the
Washington-Tokyo-Seoul tripartite alliance. China also finds
it geopolitically useful to be on good terms with South Korea,
since both countries' populations have strong anti-Japanese
sentiment, due to atrocities committed against them by Imperial
Japan in the early 20th century.
5: China may be planning more ADIZs. There is speculation
that China may be planning additional ADIZs to cover areas it
disputes with Vietnam and the Philippines in the South China
Sea. Beijing claims most of the body of water as its own, and in
recent years has become more assertive on this front, thus raising
tensions with Hanoi and Manila. The result is that both governments have been strengthening their ties with Washington as a
potential counterbalance. Furthermore, China may be tempted
to expand its ADIZ to cover areas disputed with India in the
Himalayas. If all of these zones are set up, Beijing is certain to
strain relations with its neighbours, and encourage them to seek
closer ties with the US, which would be to China's disadvantage.
china Q2 2014
6: US support for Japan cannot be guaranteed. Although the US

is committed to Japan's defence, including the Senkaku Islands,
and although Washington has rejected China's new ADIZ, their
approach has differed slightly. Japan has ordered its airlines not
to comply with the ADIZ (as they had initially done), while
airlines from the US, Australia, Hong Kong, Singapore, and
Taiwan, are complying with the zone. The US has stated that its
actions do not signal acceptance of the zone, but Japan may be
uncomfortable with America's compliance with the ADIZ. More
broadly, if China were to seize the Senkaku/Diaoyu Islands by
force, then we doubt that the US would directly assist Japan in
retaking the archipelago. Washington would probably provide
diplomatic and logistical support, as it did for the UK in its successful war to recapture the Falkland Islands from Argentina
in 1982, but would not risk armed hostilities with China over
such small and uninhabited islands.
we reiterate that the risk of an 'incident' that leads to a limited

skirmish at sea or in the air is significant. Beyond the near term,
we expect both China and Japan to continue to vie for supremacy
in the Asia-Pacific region, with the US assisting Japan in this
regard, and most Asian countries relying on Washington as a
counterweight to Beijing (see October 21 2011, ' Sino-US Power
Struggle To Intensify Over The Coming Decade').
Long-Term Political Outlook

Major Challenges Over The Coming
Decades
BMI View
China faces myriad economic, social and environmental challenges
7: Most Asian states will continue to favour the US as a counterweight to China. China's new ADIZ is most probably aimed
at expanding its military reach in the Asia-Pacific region. More
broadly, Beijing wishes to project military power, which is why
it is developing aircraft carriers and has been cultivating the use
of port facilities in Bangladesh, Myanmar, Pakistan, and Sri
Lanka. This is not necessarily aggressive. As China's overseas
interests have increased in tandem with its economic expansion,
it is natural for Beijing to wish to develop the means to protect
its citizens and investments abroad. Nonetheless, it is evident
that Japan, Vietnam, the Philippines, and India, at the very least,
are very concerned about China's perceived military expansion,
and may increasingly cooperate with one another and the US
to counterbalance Beijing. The continued significance of the
US as an Asian power was evident in November 2013, when
an American aircraft carrier was dispatched to the Philippines
to assist in disaster relief operations after the latter country
suffered the devastating effects of Typhoon Haiyan. Japan,
too, sent a naval force and contributed aid. By contrast, China's
minimal assistance to the Philippines was believed to have been
constrained by their territorial dispute, and critics suggested that
Beijing is not always adept at exercising 'soft power'.
Conclusion: Asia-Pacific To See

Increased Tensions
Overall, the Sino-Japanese dispute over the Senkaku/Diaoyu
Islands represents one of the world's biggest geopolitical risks
at the present time, especially given that the West and Iran are
currently attempting a rapprochement, and the civil war in Syria
appears to have reached a manageable deadlock. Although we
do not expect to see a full-scale war between China and Japan,
10
over the coming decades that could seriously test the Communist Party
of China's ability to govern. The best-case scenario for any eventual
political transition would entail an elite-led liberalisation of the authoritarian system, while the worst-case scenario would involve a violent
change of regime.
Perhaps the biggest question concerning China's future is whether

the country will eventually move towards a democratic system
of government. This question has received greater attention
following the political upheaval in the Middle East and North
Africa in 2011. China is increasingly an anomaly in that it is
the only major emerging economy that has not yet experienced
a transition to democracy. Other countries as diverse as Russia, Poland, Mexico, Brazil, South Africa, South Korea and
Indonesia all moved away from one-party rule to democracy
once they attained a certain level of economic development,
suggesting that China will too. For now, the Communist Party
of China (CPC) derives its legitimacy from delivering rapid
rates of economic growth, which has lifted hundreds of millions
of people out of poverty over the past 30 years. Chinese state
planners widely regard an annual real GDP growth rate of 8.0%
to be the minimum necessary to create enough jobs to maintain
social stability. Thus, the weak global economy presents the
most immediate test of the CPC's governance. Even without
the anticipated slowdown, however, China will continue to
face many challenges.
Threats And Challenges To Stability

Rising Inequality: As China's economy surged during the 2000s,
inequality widened sharply. Although comparisons between different organisation's calculated gini coefficients are inexact, due
political outlook
to differing methodologies, most observers agree that inequality

is rising. In December 2012, the gini coefficient was estimated
at 0.61 in 2010, based on a survey of 8,438 households by the
Survey and Research Center for China Household Finance, a
body set up by the Finance Research Institute of the People's
Bank of China and Southwestern University of Finance and
Economics. This is an exceptionally high figure, far above a
government estimate of 0.41 in 2000, a World Bank estimate
of 0.42 in 2005, and a China Academy of Social Sciences figure
of 0.54 in 2008. Moreover, ongoing revelations that China's politically connected elites have accumulated vast wealth through
corrupt practices are bound to raise public anger.
Policy Continuity Scores Highly
Long-Term Political Risk Ratings
100
90
80
70
60
50
40
30
20
10
0
Characteristics
of polity
Characteristics
of society
Scope of state Policy continuity
Long Term
Political Rating
Source: BMI
Regional Economic Imbalances: The eastern seaboard has

benefited disproportionately from China's rapid expansion. In
particular, there is a relatively wealthy coastal belt consisting of Tianjin, Shandong, Jiangsu, Shanghai, Zhejiang, Fujian
and Guangdong provinces where urban household per capita
GDP was higher than CNY21,000 (the average for urban China)
in 2010. Unsurprisingly, these provinces are also where most
of China's industry and foreign direct investment (FDI) are
concentrated. By comparison, rural household per capita GDP
was roughly CNY8,100. Much of the western and interior parts
of China remain poor and underdeveloped. Consequently, the
eastern seaboard provinces are receiving migration inflows from
other parts of China, although these were temporarily reversed in
the 2008-2009 slowdown. Although the government has undertaken massive development plans to address these imbalances,
and new factories are gradually being built further inland, this
will be a long drawn-out process in a country of China's size.
has seen an increase in labour unrest. Job losses from economic

restructuring have generated some resentment towards the CPC,
which is officially a party of the workers. There is also rising
discontent over harsh working conditions, particularly in China's
coal mines, where deaths typically number thousands every year.
Environmental Issues: China's rapid economic growth has
come at the cost of environmental degradation. In 2005, officials acknowledged that more than 70% of rivers and lakes
were polluted. In July 2010, the Ministry of Environmental
Protection stated that 24% of China's surface water was unfit
for any purpose, including industrial use. Furthermore, many
parts of China experience water shortages, and these are likely
to increase as urbanisation rates rise. China's cities are also
notoriously polluted as a result of coal power plants. In addition, villagers have taken to violent protests against pollution or
forced land clearing for new projects. The issue of land seizure
has led to major unrest in the countryside. Chinese leaders are
well aware of the risks to economic growth and social stability
posed by pollution. However, the implementation of tougher
environmental laws is being subverted by vested interest groups
and corruption.
Religions And Ethnicity: Chinese leaders are fearful of the
possibility of religious- or ethnic-based rebellions, which convulsed the country in the 19th and 20th centuries. For example, the emergence of the Falun Gong sect in 1999 caught the
Chinese leadership by surprise; the popularity of the group was
seen as a threat to the CPC, prompting a harsh (and ultimately
successful) crackdown. Meanwhile, Christianity is reportedly
growing rapidly in China. The government recognises an official
state-sanctioned church, but underground churches and sects
are on the rise. While neither Falun Gong nor Christian groups
pose a direct threat to the government, any crackdown against
them risks creating a broader backlash against the authorities.
China has 18 nationalities with populations of more than 1.0mn,
out of 56 recognised in total. The most well-known minorities
are the Tibetans and the Muslim Uighurs of Xinjiang province.
The Tibetans staged a major uprising in 2008 and may rebel
again in the event of the Dalai Lama's death, as the younger
generation is considered more militant. The Uighurs clashed
with the Han Chinese in July 2009, leaving around 150 dead.
Aside from these two groups, violence has erupted between
minorities and the majority Han population from time to time.
The government plays down the ethnicity issue, yet it nonetheless has the ability to create instability.
Employment And Working Conditions: The past decade or so

11
china Q2 2014
Gender Imbalance: As a result of the one-child policy (adopted

in 1980) and a general bias in favour of sons, China has a pronounced gender imbalance, particularly in the under-30 age
bracket. The Chinese Academy of Social Sciences stated in
2009 that more than 24mn Chinese men of marrying age could
find themselves without spouses in 2020. A noteworthy book
('Bare Branches: The Security Implications of Asia's Surplus
Male Population') points out that such imbalances are potentially
destabilising for societies, since most crimes are committed by
single males under 30.
China scores a respective 85/100 and 90/100 in the 'scope of

state' and 'policy continuity' subcomponents (each with a 20%
weighting). Overall, the country's problems are by no means
unique to China. Rather, they are symptomatic of emerging
countries in general. However, they are on a scale never seen
before, which arguably gives them a qualitative dimension.
Furthermore, unlike citizens of other emerging nations, the
Chinese public do not have the opportunity to change their
government via the ballot box. This leaves open the possibility
of increased public unrest.
Financial Stresses: Although the banking sector has avoided a

long-predicted crisis, there are concerns that it remains opaque
and that lending is still largely policy-driven. In addition, the
surge in bank lending since early 2009 could yet create more
non-performing loans for banks.
Scenarios For Political Change
Internal Regime Fault Lines: Within the CPC, there are reportedly factional schisms. These reflect differences over ideology
(namely between those who favour more neoliberal reforms and
those who favour a more statist model), geographical regions
within China, the 'generations' within the party and the debate
over whether China should behave more assertively abroad.
All CPC factions favour a continuation of its rule, meaning that
they are unlikely to challenge the system outright. Nonetheless,
factional rivalry could complicate decision-making, thereby
leading to slower reforms.
Foreign Conflict: Although Chinese officials have emphasised
the country's 'peaceful rise', the People's Liberation Army (PLA)
has been sounding a more nationalistic tone. Beijing's increasing
assertiveness over its claims to the South China Sea and East
China Sea could lead to naval skirmishes or conflict with Vietnam, the Philippines, Japan or even the US. In addition, China
continues to claim Taiwan as a province, and has considerable
interests in neighbouring North Korea and Myanmar, which
may eventually necessitate intervention. Chinese military assertiveness could play well with nationalistic elements in society,
but could harm its international image and lead to intra-regime
tensions between 'hawks' and 'doves'.
BMI's long-term political risk rating for China stands at 62.9.
The weakest score, of 33/100, is in the 'characteristics of polity' subcomponent, which carries a 30% weighting. This score
reflects China's authoritarian one-party system of government,
which tolerates virtually no dissent. The 60/100 score in the
'characteristics of society' subcomponent (30% weighting) is
constrained by China's very high gini (inequality) coefficient.
12
Although China's former paramount leader, Deng Xiaoping,

stated in 1987 that elections would be possible in 50 years,
Chinese leaders continue to reject moves to adopt Western-style
democracy, fearing that this would lead to chaos. Indeed, in
2005, the CPC released its first white paper, 'The Building of
Political Democracy', which stated that 'democratic government
is the Chinese Communist Party governing on behalf of the
people while upholding and perfecting the people's dictatorship'. Rather than developing a Western-style liberal democracy,
the CPC believes that 'China's socialist political democracy has
vivid Chinese characteristics'. The Chinese leadership became
particularly worried about the possibility of revolution in China
following the upheaval that shook the Middle East in 2011, and
moved to suppress internet coverage of events there. China's
impressive economic achievements over the past 30 years have
given Chinese citizens less reason to resent their leadership
compared with Egyptians, Syrians, Yemenis, etc. Nevertheless,
we would expect to see greater calls for democratisation over
the next 10-20 years.
Best-Case Scenario: Elite-Led

Transition
Against this backdrop, the best-case scenario for political change
in China would be a stable, elite-led transition, under which a
reformist-minded CPC phases in free, multi-party elections at
city, provincial and national level over a period of several years.
Possible role models include South Korea and Taiwan, both of
which enacted democratic reforms in the late 1980s and early
1990s after decades of one-party rule. In both countries, the
governing party was able to hold on to the elective presidencies
for 10 and 12 years respectively and control the democratically
elected legislatures until the early 2000s. Should China follow
this pattern, the CPC could retain substantial political influence
even after a putative transition to democracy. An alternative
to the multi-party model would be a system whereby the CPC
remains the sole political party, but allows multiple candidates
political outlook
from its ranks to run for election to key administrative posts.

Under the best-case scenario, rapid economic growth would
remain on track and the liberalisation process should reassure
foreign investors that China is on the road to becoming a 'normal' country. However, South Korea (population 45mn) and
Taiwan (23mn) are far smaller and much more homogeneous
than China, and were considerably richer in the late 1980s than
China is today. As such, their experiences may not be easy to
emulate at the present time.
model that would allow greater autonomy for its provinces?

Furthermore, the political and economic culture resulting from
decades of one-party rule will linger in China, and issues such
as corruption and close links between business and government
will not go away quickly. Finally, in a democratic China, popular
pressures could force the government to go slow on economic
liberalisation, as has happened in many emerging economies.
Worst-Case Scenario: Indonesia-Style

Chaos
The worst-case scenario for Chinese politics would be an extended period during which the growing contradictions within
the economy foster more and more 'incidents of mass unrest'
especially organised unrest to the point that foreign investors
withdraw their capital and the government is forced to carry
out a harsh crackdown. The trigger for accelerated unrest could
come from a full-scale meltdown of the economy or a multiyear period of growth substantially below what China has been
accustomed to (for example, 5% or less annually). We feel that
both of these developments are unlikely at this stage, but they
cannot be ruled out entirely at the present time.
Were the economy to experience such stresses, the CPC could
find itself in a similar position to Indonesia's Suharto regime in
1997-1998, when civil unrest caused foreign investors to flee
and eventually toppled the government. Indonesia subsequently
democratised over a six-year period, but real GDP growth has yet
to return to pre-1997 levels and the economy is still considered a
somewhat risky investment destination (although it has received
renewed interest in recent years). An 'Indonesia scenario' in
China would set the latter's growth story back years and could
entail regional separatism or even a military coup. China has
experienced several periods in its history during which central
government authority has been reduced to only nominal control
over the provinces and warlords have held sway.
Democracy No Quick Fix

The above scenarios are not the only paths available to China,
and any transition could incorporate elements of both outcomes.
Overall, though, while a democratic government in China should
be more responsive to popular demands and allow greater political transparency, it would by no means provide a rapid panacea
for China's myriad problems. Beyond democratisation, there
would also be the issue of centre-periphery relations would
China remain a centralised state or would it adopt a federal
13
Chapter 2:
Economic Outlook
SWOT Analysis
BMI Economic Risk Ratings

China scores strongly across the board in our short-term economic
Strengths
China has a massive trade surplus and its huge foreign exchange
reserves serve as a major cushion against external shocks.
Chinas economic policymakers are committed to continuing their
gradual reform of the economy.
Weaknesses
Chinas economic growth boom has led to major imbalances and
environmental degradation.
The countrys dependency on investment to boost growth has made
it vulnerable to a slowdown in credit growth. Private consumption
remains weak at less than 40% of GDP.
The close relations between provincial leaders and local businesses
are fostering corruption, making it harder for the central government
to enforce its policies.
Opportunities
Chinas economic growth is slowly becoming more broad-based, with
domestic consumption likely to rise in importance vis--vis exports
and investment.
As China moves up the value chain, it will develop its own global
brand name companies, fostering innovation and growth.
Threats
We believe that we have witnessed a permanent end to Chinas
double-digit annual growth rate.
The economy will face difficulty in continuing to increase its share
of the global export market, and efforts to move up the value chain
will be fraught with problems.
risk ratings, securing an impressive overall score of 94.0, placing it at

number one in our global short-term ratings. The country also performs
well in our long-term economic risk ratings, securing a top 20 spot with
a score of 78.3, buoyed by Chinas strong growth prospects, low and
stable inflationary environment and a very secure external position.
However, an over-reliance on commodity imports and the manufacturing sector drag on Chinas long-term rating, as does the paltry amount
of government spending on health and education.
S-T Economy
Rank
Trend
Singapore
90.4
1
South Korea
89.4
2
Taiwan
86.9
3
China
86.0
4
Malaysia
77.9
5
Hong Kong
76.0
6
Philippines
73.5
7
Thailand
72.1
8
Vietnam
68.1
9
Indonesia
68.1
9
India
62.1
11
Bangladesh
57.5
12
Brunei Darussalam
56.9
13
Sri Lanka
51.5
14
Mongolia
48.5
15
Pakistan
48.3
16
Papua New Guinea
47.9
17
Cambodia
47.1
18
Myanmar
46.0
19
Laos
45.4
20
Bhutan
26.9
21
North Korea
L-T Economy
Rank
Trend
South Korea
81.5
1
Singapore
81.2
2
Malaysia
77.5
3
China
76.6
4
Hong Kong
74.3
5
Taiwan
74.1
6
Thailand
71.9
7
Philippines
65.8
8
Indonesia
63.4
9
Vietnam
62.3
10
Bangladesh
57.5
11
Brunei Darussalam
56.0
12
India
55.6
13
Sri Lanka
52.3
14
Pakistan
50.2
15
Laos
43.8
16
Mongolia
41.6
17
Papua New Guinea
41.4
18
Myanmar
40.9
19
Cambodia
40.1
20
Bhutan
33.8
21
North Korea
=
=
=
=
=
=
=
+
=
+
=
=
=
=
=
=
=
=
=
-
=
=
=
=
=
=
=
+
+
=
=
=
=
+
=
=
=
=
=
-
15
china Q2 2014
Economic Activity
Can Reforms Prevent The Credit
Hangover?
BMI View
We continue to believe that the hangover effects of China's economic
stimulus are yet to be felt, and cooling credit growth is likely to reveal
these effects over the coming quarters. Newfound reform momentum
has the potential to help the economy grow out from under its credit ex-
If history is anything to go by, as we believe it is, the unprecedented surge in China's credit relative to GDP could well lead
to a deep contraction in the economy and major property market
declines over the coming years. The prosperity that any credit
bubble brings is at risk of evaporating once the credit creation
comes to an end, as the wealth created during the boom turns
out to have been driven by asset appreciation and the associated
consumption of capital. This remains a key concern of ours as
we head into 2014. Continued evidence of wealthy Chinese
residents sending their assets (and often themselves) overseas
would seem to echo these concerns.
cesses. However, several obstacles stand in the way of this, including

the likelihood that reform efforts could exacerbate any economic down-
Credit Impulse Needs To Be Reversed
Total Credit, % of GDP And Annual Percentage Point Change
turn. We are forecasting real GDP growth to come in at 7.1% in 2014,

before slowing further to average 6.1% growth over the next five years.
Slowdown Is Inevitable With Or Without Reforms

Real & Nominal GDP Growth, %
35
30
25
20
15
10
5
0
Nominal GDP Grow th, US$
Real GDP Grow th
Long-Term Average
Long-Term Average
-5
Source: BMI, PBoC
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013e
2014f
2015f
2016f
2017f
2018f
-10
-15
Source: BMI, NBS
Hangover Yet To Fully Take Effect

We have written at length about how we believe that the economic
model underpinning China's recent economic boom leaves the
economy at risk of a severe downturn. In an all-out attempt to
generate 'headline growth', wealth creation has taken a back seat.
Current Momentum To Fade Early-2014

From a cyclical perspective, although the economy is once
again in an upswing, which looks set to continue over coming
months, we do not expect this to be sustained beyond early 2014.
Domestically, the upswing in new liquidity following the mini
credit crunch in mid-2013 is supporting investment activity in
the traditional sectors of the economy, but this should begin to
fade shortly as credit growth is beginning to slow once again.
On the export front, the rebound in US and European demand
TABLE: ECONOMIC ACTIVITY

2009
2010
2011
2012
2013e
2014f
2015f
2016f
2017f
2018f
Nominal GDP, CNYbn [1]
34,631.7
40,292.5
46,547.1
51,469.3
56,811.6
62,407.1
67,985.3
73,882.7
80,308.5
87,279.9
5,069.4
5,952.5
7,200.4
8,159.2
9,133.7
10,131.0
10,921.3
11,821.2
12,849.4
13,964.8
9.2
10.3
9.1
7.7
7.6
7.1
6.0
5.8
5.8
5.8

Population, mn [2]
Industrial production, % y-o-y, ave [1]
Unemployment, % of labour force, eop [3]
3,752
4,377
5,262
5,925
6,592
7,269
7,792
8,390
9,076
9,820
1,351.2
1,359.8
1,368.4
1,377.1
1,385.6
1,393.8
1,401.6
1,408.9
1,415.8
1,422.1
11.1
14.4
10.8
7.8
8.2
8.5
8.0
8.0
8.0
8.0
4.3
4.1
4.1
4.9
5.0
5.0
5.0
5.0
5.0
5.0
Notes: e BMI estimates. f BMI forecasts. Sources: 1 National Bureau of Statistics, BMI; 2 World Bank/UN/BMI; 3 National Bureau of Statistics.
16
economic outlook
is providing support for now, but we expect China's strengthening currency to begin to undermine exports as 2014 progresses.
Despite the excitement over reform momentum, measures to
increase transparency in the main sector in need of reform the
banking sector are likely to reveal the extent to which risk
has been concealed over recent years, potentially triggering a
more serious credit crunch. We are already seeing interest rate
swaps and interbank rates surge, which is likely to cut heavily
into the profit margins of small and medium-sized enterprises
that are the lifeblood of China's economy.
Reforms Could Help China Grow Its

Way Out Of Its Debts
At the same time, however, legitimate steps appear to be being
taken in order to reignite productivity gains in the economy,
and to move away from top-down growth generation in favour
of genuine wealth creation. While it is early days yet, since the
Third Plenum, it seems as though the government is taking some
vital steps on some key areas of economic liberalisation. Hukou
registration reform and rural land reform are two developments,
in particular, that we believe could unlock significant productivity growth, and other measures such as reducing overcapacity
at state-owned enterprises and liberalising the banking system
would also be huge steps in the right direction. Although details
are thin on the ground, should these reforms efforts be undertaken, they would provide a major tailwind to allowing China's
economy to grow its way out of its current credit excesses, and
set the stage for strong growth over the medium-to-long term.
Key Economic Priorities

During a two-day Communist Party session that ended on December 13, party leaders outlined their key economic priorities
for 2014:

Improving grain self-sufficiency
Addressing overcapacity
Tacking the growth of local government debt
Promoting regional rebalancing
Improving social welfare, including social housing
Increasing openness to international trade and investment
Land And Hukou Reforms Will Be Crucial
In addition to these priorities, there was also special emphasis

on urbanisation, which was the subject of its own, separate highlevel meeting on the sidelines of the main conference. Efforts to
improve rural land rights and reform the hukou system would
certainly go a long way towards increasing labour mobility,
which would likely lead to further urbanisation. At the same
time, as labour departs from the countryside it would also allow
agricultural land to be consolidated and farmed more efficiently,
raising productivity and income in rural areas, which is likely
to be a key pillar of the plan to boost grain self-sufficiency.
Tremendous economic efficiency gains could be realised from
the implementation of these policies.
Three Notes Of Caution On Reforms

There are three main misgivings we have with China's reform
drive. Firstly, we believe the idea of boosting urbanisation as a
way of achieving economic growth or greater consumption is
fundamentally flawed. In fact, promoting the rollout of infrastructure as a means of encouraging urbanisation has contributed to the shrinking share of consumption relative to overall
GDP, and also left the banking system very fragile. Continued
build-out of new towns and cities under the guise of promoting urbanisation would be a negative development for China's
medium term growth prospects.
Secondly, it is likely that reform efforts, particularly the likes of
freeing up the banking system and curbing overcapacity, could
seriously undermine real GDP growth, much more than China's
Communist Party (CCP) may be bargaining for. It is largely a
result of the excessive capacity, funded by a banking system
which suffers from serious moral hazard, and supported by the
huge build-up of local government debt, that China's growth has
been so strong since the global financial crisis. Take these pillars
of growth away, and the economy could easily come unstuck.
Thirdly, faced with a downturn in the economy, reform momentum could die out or even reverse. Furthermore, if any economic
weakness is deemed to have been caused by liberalisation measures (rather than being an inevitable consequence of the lack of
prior reforms) then this could seriously hurt reform momentum
over the medium term.
With these factors in mind, we remain China bears from a
growth perspective over the medium term, notwithstanding the
clear positive reform momentum that continues to build. We are
forecasting real GDP growth to come in at 7.1% in 2014, before
slowing further to average 6.1% growth over the next five years.
17
china Q2 2014
With local government debt sitting at anywhere between 30-60%

of GDP according to most estimates, the central government
will most likely have to play a dominant role. But even then,
reforms are needed at the local level to help address the existing debt burden and continued reliance on land sales. Despite
a large portion of government revenues heading to the central
government, local governments are responsible for supporting
strong economic growth, which usually requires expensive
infrastructure spending.
Fiscal Policy
Reforms May Fall Short Due To Lack Of
Funding
BMI View
The Chinese government is looking to control the burgeoning debt
load at the local government level, while at the same time promoting regional rebalancing, improving social welfare, and reducing the
Fiscally Stretched
reliance on unsustainable land sales. These goals seem incompatible
Assorted Fiscal Estimates
China's central government fiscal figures appear in solid shape,

but if we include local government investment vehicles (LGIVs,
which are set up to finance local government spending projects),
China's deficit looks similar to the likes of the US and eurozone.
If we strip out one-off land sales, meanwhile, the deficit is more
akin to that of Japan, with the IMF estimating that in 2012 the
total budget deficit was equivalent to 9.7 % of GDP.
Included in China's six top economic priorities for 2014 were
promoting regional rebalancing (which entails boosting urbanisation), improving social welfare (including boosting social
housing), while simultaneously reining in local government debt.
There is also talk of establishing a market system for rural land,
which would reduce the ability of local governments to sell land
to property developers and use the funds to support infrastructure
projects. Local government land sales account for an estimated
20-30% of total local government revenues, and removing this
would be a hammer blow to local budgets. These measures elicit
the question of where the funding will come from.
Source: BMI, IMF
Suggested plans so far have included allowing local governments

to issue bonds and levying property taxes. It is likely that the
country's first municipal bond will hit the market in the first half
of 2014 in an effort to reduce the need for covert borrowing via
LGIVs. This would increase transparency in the market, which
would certainly be positive, but it would still entail raising the
overall debt burden, which does not tackle the root of the problem.
table: FISCAL POLICY
2010
2011e
2012e
2013e
2014f
2015f
2016f
2017f
2018f
8,310.2
9,473.6
10,610.4
11,809.4
13,143.8
14,615.9
16,150.6
17,749.5
19,347.0
20.6
20.4
20.6
20.8
21.1
21.5
21.9
22.1
22.2
8,987.4
10,326.5
11,462.5
12,539.9
13,706.1
14,967.1
16,314.2
17,766.1
19,382.8
22.3
22.2
22.3
22.1
22.0
22.0
22.1
22.1
22.2
8,067.6
9,252.4
10,278.5
11,238.9
12,278.3
13,407.7
14,617.9
15,924.2
17,382.1
Current expenditure, % of total expenditure [1]
89.8
89.6
89.7
89.6
89.6
89.6
89.6
89.6
89.7
Current expenditure, % of GDP [1]
20.0
19.9
20.0
19.8
19.7
19.7
19.8
19.8
19.9
919.8
1,074.1
1,184.0
1,301.0
1,427.8
1,559.4
1,696.3
1,842.0
2,000.7
10.2
10.4
10.3
10.4
10.4
10.4
10.4
10.4
10.3
2.3
2.3
2.3
2.3
2.3
2.3
2.3
2.3
2.3
-677.3
-853.0
-852.1
-730.6
-562.3
-351.2
-163.5
-16.6
-35.8
-1.7
-1.8
-1.7
-1.3
-0.9
-0.5
-0.2
-0.0
-0.0
Fiscal revenue, CNYbn [1]

Revenue, % of GDP [1]
Fiscal expenditure, CNYbn [1]
Expenditure, % of GDP [1]
Current expenditure, CNYbn [1]
Capital expenditure, CNYbn [1]

Capital expenditure, % of total expenditure [1]
Capital expenditure, % of GDP [1]
Budget balance, CNYbn [1]
Budget balance, % of GDP [1]
Notes: e BMI estimates. f BMI forecasts. Sources: 1 National Bureau of Statistics, BMI.
18
economic outlook
Beijing has been weighing up the viability of property tax for

a number of years, and has tried various pilot schemes in the
likes of Shanghai and Chongqing on new residential units, but
revenues have been relatively low. China is thought to be developing a comprehensive registry for home ownership, which
would allow for a tax on all homes rather than just new units.
Rolling out such a scheme nationwide would be very a drawn
out affair.
y-o-y, while consumer price inflation (CPI) is just 3.0% y-o-y,

and producer price inflation (PPI) is negative to the tune of 1.4%
y-o-y. These data seem inherently incompatible, as they have for
most of the past two years. With new credit creation surging, it
is a surprise that inflation has not been more widespread. Also,
as corporate profits are determined largely by the difference
between input prices and output costs, the large and persistent
spread between CPI and PPI should have been associated with
an unprecedented economic boom. Instead, the economy has
posted its slowest growth rate in over a decade.
Monetary Policy
Real Estate Market Key To Inflation

Outlook
Inflationary Forces Evenly Balanced
Perhaps the missing link to these variables lies in the nation's

property market, which has diverted increasing amounts of capital away from more productive pursuits and masked the extent
of overall inflation. Total credit has tripled over the five years
since the global financial crisis, while nominal GDP has less
than doubled. We believe that the property market has been the
major beneficiary of this wave of new money supply, which will
pose deflationary risks going forward. Property prices continue
to hit new all-time highs, and while the debate rages on, we
firmly believe that the property market is in a bubble that will
burst. We have held this view for some time now, and even in
the face of successive government tightening measures, credit
continues to find its way into the market.
BMI View
Notwithstanding the surge in credit in recent years, China's consumer
price inflation rate has remained remarkably benign, while producer
price inflation has been consistently negative. We believe that the
flood of capital into the nation's property market helps to explain these
trends. The outlook for real estate prices will be crucial in determining
the inflation picture in 2014 and beyond, and we believe that pressures
will be caped despite the current inflationary market signals.
China's inflation dynamics continue to confound. Total social

financing (the broadest measure of liquidity) is growing by 18.7%
Table: MONETARY POLICY
2011
2012
2013
2014
2015
2016
2017
2018
Consumer price inflation, % y-o-y, eop [3]
4.1
2.5
3.0
2.6f
2.7f
2.8f
2.7f
2.7f
5.4
2.7
2.6
2.6f
2.8f
2.7f
2.7f
2.7f
Producer price inflation, % y-o-y, eop [3]
3.2
2.9
2.6
2.6f
2.6f
2.6f
2.6f
2.6f
Producer price inflation, % y-o-y, ave [3]
3.2
2.9
2.6
2.6f
2.6f
2.6f
2.6f
2.6f
Wholesale price inflation, % y-o-y, ave [3]
3.8
3.6
3.0
3.1f
2.9f
2.7f
2.7f
2.7f
Wholesale price inflation, % y-o-y, eop [3]
3.8
3.6
3.0
3.1f
2.7f
2.7f
2.7f
2.7f
28,985.0
31,883.5
35,071.9
38,579.0f
42,436.9f
46,680.6f
50,881.9f
54,952.4f
M1, CNYbn [4]

M1, % y-o-y [4]
8.7
10.0
10.0
10.0f
10.0f
10.0f
9.0f
8.0f
M2, CNYbn [4]
85,159.0
96,229.7
105,852.6
116,437.9f
128,081.7f
140,889.9f
153,569.9f
165,855.5f
M2, % y-o-y [4]
17.3
13.0
10.0
10.0f
10.0f
10.0f
9.0f
8.0f
Central Bank policy rate, % eop [1,5]
6.56
6.00
6.00
6.00f
5.75f
5.75f
5.75f
5.75f
3.5
3.0
3.0
3.0f
3.5f
3.5f
4.0f
4.0f
Lending rate, %, eop [4]

Lending rate, %, ave [4]
2.8
3.2
3.0
3.0f
3.2f
3.5f
3.7f
4.0f
Real lending rate, %, eop [2,4]
-0.6
0.5
-0.1
0.3f
0.8f
0.7f
1.3f
1.3f
Real lending rate, %, ave [2,4]
-2.6
0.5
0.4
0.3f
0.4f
0.8f
1.0f
1.3f
3-month money market rate, % eop [6]

Real 3-month money market rate, %, eop [2,6]
3-month money market rate, %, ave [6]
Real 3-month money market rate, %, ave [2,6]
3.1
-1.0
2.9
-2.5
Notes: e BMI estimates. f BMI forecasts. 1 One-Year Lending Rate; 2 Real rate strips out the effects of inflation. Sources: 3 National Bureau of Statistics,
BMI; 4 IMF, BMI; 5 Peoples Bank of China, BMI; 6 BMI.
19
china Q2 2014
China's inflation outlook seems to us to be evenly balanced

between the inflationary forces of continued liquidity growth
and the deflationary forces posed by an eventual unwinding of
the real estate and general credit bubble.
World-Beating Rise In Debt
Total Social Financing Versus GDP, CNYbn And %
Firstly, we believe that the rise in yields largely reflects hopes that
financial market reform will liberalise deposit rates, and market
participants are thus expecting higher deposit rates in the future.
Thus, it is not clear that higher inflation expectations are driving
these trends. It is clear, however, that higher interest rates, not
just on deposits and government bonds, but also on corporate
bonds as we have seen in recent months, should hurt interestrate sensitive sectors of the economy over the coming months.
The real estate sector is potentially the most at risk from this.
Record Low Coming Up
Total Social Financing, % chg y-o-y
Source: BMI, NBS
A Worrying Divergence
H-Shares Index Versus 1-Year Interest Rate Swap, %
Source: BMI
Source: BMI
Markets Signalling Inflationary

Pressures?
There are signs that inflationary pressures are on the rise. The
bond market for example has suffered from a huge sell-off over
recent months, with yields on 1-year interest rate swaps rising
aggressively in recent weeks. Similarly, the 10-year government bond is now yielding a multi-year high. This could well
be reflecting the fears of market participants that inflation and
policy rates will begin to rise in 2014. However, disinflationary
forces are also growing.
20
Secondly, credit growth is falling and looks set to continue to

do so. Over recent months, new total social financing (TSF)
has been relatively low as Beijing has sought to curb reckless
lending practices. In growth terms, owing to the exceedingly
high base of comparison, we are starting to see a sharp drop
in momentum. While still high at 18.7% y-o-y, this marks the
lowest level since August 2012, and on a month-on-month three
month moving average basis, the rate has dropped to a new low.
If new TSF continues on its current trend, the annual growth
rate of the total credit stock is likely to drop into single digits for
the first time on record, providing a significant disinflationary
force. We are forecasting CPI to average 2.6% in 2014 from an
estimated 2.7%% in 2013. We are also forecasting policy rates
to remain unchanged, with the 1-year lending rate ending the
year when it begins at 6.0%.
economic outlook
likely to grow by just 8.0% in nominal terms in 2014, versus

an expected 8.3% in 2013.
Balance Of Payments
Picking Up
Digging Deeper Into Export Trends
Export And Import Growth, % chg y-o-y
BMI View
China's exports are recovering and are likely to remain relatively
strong as we enter 2014. However, beyond this cyclical upswing, the
stronger yuan is likely to begin to bite, and we are forecasting exports
to grow by just 8.0% in 2014 in nominal terms, from an estimated
8.3% in 2013. Some interesting export trends are developing throughout the region, though, which are likely to reduce China's exposure to
external shocks, such as greater export diversification, with shipments
to the US, Europe, and Japan, continuing to decline in overall share.
China's export figures for November showed a 12.7% y-o-y

increase, taking the month's trade balance to US$33.8bn, a nearfive year high. As we argued recently (see '2014 Outlook: Less
Exposed, More Vulnerable', December 5), a recovery in the new
orders component of the US purchasing managers' index bodes
well for further Chinese export gains over the coming months,
given that the US is by far China's main export partner. As 2014
progresses, however, we believe that China's export strength will
begin to feel the effects of its strong currency, and exports are
Source: BMI, Customs General Administration (CGA)
Looking beyond these near term developments, we are noticing

some interesting developments in Chinese export trends since
the global financial crisis. Exports to the US and Europe have
declined substantially as a share of total exports. While they
have stabilised in recent months owing to recovering demand
Table: CURRENT ACCOUNT
Goods imports, US$bn [2]

Goods imports, % of GDP [2]
Goods exports, US$bn [2]
Goods exports, % of GDP [2]
2010
2011
2012
2013e
2014f
2015f
2016f
2017f
2018f
1,396.2
1,742.8
1,818.0
1,952.5
2,167.3
2,416.6
2,658.2
2,924.0
3,216.4
23.5
24.2
22.3
21.4
21.4
22.1
22.5
22.8
23.0
1,578.3
1,899.2
2,050.0
2,220.1
2,397.8
2,613.6
2,861.8
3,133.7
3,431.4
26.5
26.4
25.1
24.3
23.7
23.9
24.2
24.4
24.6
Goods exports, % of imports [2]
113.0
109.0
112.8
113.7
110.6
108.2
107.7
107.2
106.7
Balance of trade in goods, US$bn [2]
182.1
156.3
232.0
267.6
230.5
197.0
203.6
209.7
215.0
Balance of trade in goods, % of GDP [2]

Services imports, US$bn [2]
Services imports, % of GDP [2]
Services exports, US$bn [2]
Services exports, % of GDP [2]
Goods and services exports, US$bn [2]
Goods and services exports, % of GDP [2]
Balance of trade in goods and services, US$bn [2]
Balance of trade in goods and services, % of GDP [2]
3.1
2.2
2.8
2.9
2.3
1.8
1.7
1.6
1.5
194.0
238.9
258.8
288.3
331.5
382.9
436.5
497.6
567.3
3.3
3.3
3.2
3.2
3.3
3.5
3.7
3.9
4.1
171.5
184.8
206.8
232.3
260.1
294.0
333.6
378.7
429.8
2.9
2.6
2.5
2.5
2.6
2.7
2.8
2.9
3.1
1,749.8
2,083.9
2,256.8
2,452.4
2,657.9
2,907.5
3,195.5
3,512.4
3,861.2
29.4
28.9
27.7
26.9
26.2
26.6
27.0
27.3
27.6
159.6
102.2
180.1
211.6
159.1
108.1
100.8
90.8
77.5
2.7
1.4
2.2
2.3
1.6
1.0
0.9
0.7
0.6
-25.9
-11.9
-12.2
-15.7
-19.8
-24.6
-29.9
-33.2
-36.9
Income account balance, % of GDP [2]
-0.4
-0.2
-0.1
-0.2
-0.2
-0.2
-0.3
-0.3
-0.3
Net transfers, US$bn [2]
40.7
25.3
27.2
28.9
28.5
27.6
26.2
23.7
19.2
0.7
0.4
0.3
0.3
0.3
0.3
0.2
0.2
0.1
174.3
115.6
195.1
224.8
167.8
111.1
97.1
81.3
59.9
Income account balance, US$bn [2]
Net transfers, % of GDP [2]

Current account balance, US$bn [2]
2.9
1.6
2.4
2.5
1.7
1.0
0.8
0.6
0.4
Openness to international trade, % [1,3]
50.0
50.6
47.4
45.7
45.1
46.1
46.7
47.1
47.6
Notes: e BMI estimates. f BMI forecasts. 1 Imports plus exports, % of GDP. Sources: 2 National Bureau of Statistics, BMI; 3 BMI.
21
china Q2 2014
in these two areas, the decline appears to be structural in nature.

The reduced importance of the US and Europe in China's export
picture is a positive development, in our view. Despite the current
negative sentiment towards emerging markets, we firmly believe
that Asia (excluding Japan) and emerging markets in general
will experience much faster growth than the developed world
over the coming years. Additionally, the lower dependence on
any one country reduces China's exposure to external shocks.
Increasing Exposure To Asia And Reducing
Reliance On Developed Markets
Exports By Destination, % of Total, 12mma
from external shocks. We believe the increase in exports to

emerging Asia and the rest of the world reflect ashift in final
demand away from developed markets and towards emerging markets, rather than just an increase in openness to trade
within the region resulting in greater cross-border production
chains. Indeed, Chinese imports from the rest of Asia, including
ASEAN, have actually declined as a share of total. As a result,
China now runs a large trade surplus with the rest of Asia, and
ASEAN, after running deficits in recent years.
Surplus With Europe Collapsing As Surplus With
Asia Soars
Trade Surpluses By Geographic Area, US$bn
Source: CGA
Source: BMI, CGA
Chinese exports to Japan are declining rapidly in share. Despite

being the second largest export market (when we exclude shipments to Hong Kong, which are largely re-exported), Japan
now represents just 7% of total Chinese exports, down from
just 12% before the global financial crisis. It is likely that even
with Japan's economy witnessing a near-term revival, China's
exports to Japan will continue to decline as a share of total as
the Japanese economy weakens. The potential for trade tensions
to boil over once again between the two regional giants also
poses a downside risk.
Exports to the rest of Asia have surged in recent years, almost
entirely down to increased exports to the ASEAN region. Asia
ex-Japan (again, excluding exports to Hong Kong) now represents
27% of China's total exports, up from around 21% prior to the
GFC. The major driver of the increasing Asian share has been
ASEAN, which has risen from 7% to 11% since 2006 to today.
Exports to the rest of the world (Latin America, Africa, Canada
and Australasia) have also surged as a share of total , from 8%
prior to the global financial crisis, to around 14% at present.
Again this increased diversification should help insulate China
22
This brings us to the final point, that the strong yuan does not
appear to be undermining Chinese export competitiveness for
now. While China's overall trade surplus has declined sharply
as a share of GDP since its peak in 2007, this does not appear to
have been driven by a loss of competitiveness. China is running
large surpluses with the rest of Asia, and its trade surplus with
the US is as large as ever in nominal terms. China's adjustment
to a lower trade surplus as a share of GDP is almost entirely
due to stagnant import demand from Europe.
The gains in China's real effective exchange rate in recent years
have certainly made global manufacturers look elsewhere in Asia
to set up production plants in the low-end manufacturing space.
We have seen anecdotal evidence of companies seeking greater
geographic diversification by moving into the likes of Indonesia
and Vietnam. However, the data still show that China's low-end
manufacturing remains competitive, with shipments of electronics,
knitted equipment, and footwear still hitting new highs. Going
forward, we expect the strong yuan to gradually begin to bite as
it takes time for manufacturers to shift their production facilities
as a result of incremental increases in production costs.
Chapter 3:
10-Year Forecast
The Chinese Economy To 2023

6.0% Is The New 10.0%
BMI View
China's economic growth in the coming decade will be much slower
than in the previous one, as the savings rate declines, the economic
liberalisation process slows and population growth falls. These
Lower Investment Rate, Slower Growth

It is widely agreed that to encourage sustainable high rates of
growth in the coming years, China must lower its investment
rate and boost consumption. Looking at historical precedents,
it is clear that an investment share of GDP at 48.6% is too high.
However, it is this high savings and investment rate that has
allowed the economy to grow so fast over the past decade. A
lower rate of savings and investment will mean slower growth.
dynamics will result in real GDP growth averaging 6.2% over the
next decade as opposed to the 10.7% average of the past 10 years.
Private consumption will be a major outperformer, averaging growth
of 8.2% and rising in importance as a share of GDP.
The unprecedented growth boom in China over recent decades

has its foundations in the vast improvement made to productivity
through economic liberalisation. A major supportive tailwind
in the form of demographic trends provided additional support,
allowing savings to be accumulated at a rapid rate. Growth in
the coming decade will be much slower than during the last, as
the 'low hanging fruit' of liberalisation has already been undertaken and further reforms are likely to be slow and piecemeal
as the Communist Party of China (CPC) would be reluctant to
give up too much economic power for fear of losing its political dominance. A harshly deteriorating demographic situation
(slowing growth and an ageing population) will further weigh
on economic dynamism, resulting in real GDP growth of 6.2%
over the next decade compared with the 10.7% average of the
past 10 years. Consumption will rise as a share of GDP and, as
a result, services' share of GDP will rise, presenting significant
opportunities in consumer-related fields.
Regarding the domestic imbalances that have built up as a result

of the high investment ratio, the problem is not high investment
itself but the lack of viability of such investment projects in
theory, there is nothing wrong with a high investment rate if
all the investments make a profit. Excessive state involvement
has resulted in excessive unproductive investment in an all-out
attempt to boost headline growth. This has come at the expense
of private consumption, with the consequences likely to be a
sharp slowdown in growth over the coming years.
Policy Reaction To Coming Slowdown

Will Be Crucial
Policies to 'boost' consumption using subsidies, wage hikes
and consumer loans, or persuading consumers to reduce their
savings rate by providing a more comprehensive social security
net, target the symptoms rather than the causes. Broad-based
structural reforms will be needed to rebalance the economy
and avoid a hard landing and, so far, these reforms have been
lacking. We believe the government missed a key chance to
accelerate economic reforms during the global financial crisis,
with the stimulus policy of forcing banks to extend record
Table: Long-Term Macroeconomic Forecasts

Population, mn [2]
2016f
2017f
2018f
2019f
2020f
2021f
2022f
2023f
11,821.2
12,849.4
13,964.8
15,174.9
16,483.3
17,907.6
19,460.1
21,146.3
5.8
5.8
5.8
5.8
5.8
5.8
5.8
5.8
1,408.9
1,415.8
1,422.1
1,427.8
1,432.9
1,437.3
1,441.1
1,444.2
14,642
8,390
9,076
9,820
10,628
11,504
12,459
13,504
2.7
2.7
2.7
2.7
2.7
2.7
2.7
2.7
0.8
0.6
0.4
0.2
-0.0
-0.3
-0.6
-1.0
6.25
6.25
6.25
6.25
6.25
6.25
6.25
6.25
Exchange rate CNY/US$, ave [3]
Notes: f BMI forecasts. Sources: 1 National Bureau of Statistics, BMI; 2 World Bank/UN/BMI; 3 BMI.
23
china Q2 2014
loans to state-owned enterprises (SOEs) and local government

investment vehicles representing a step backwards in terms of
its long-term liberalisation drive. In doing so, these policies
have ignited a property and investment bubble that is likely to
burst, ushering in a sharp slowdown and undermining growth
potential in the early part of this decade. It is how Beijing deals
with the impending economic slowdown that will determine
whether China can continue sustaining 8%-plus growth, and
our baseline case argues that positive economic reforms will
be hard to come by.
Slowdown Is Structural In Nature
Real GDP Growth, %
productivity would be to liberalise the banking system, allowing

interest rates to reflect market forces and removing the political
nature of lending, which results in excessive capital going to
inefficient state-owned enterprises. The response to the 2008
crisis has made it clear that this will not be forthcoming any
time soon. From a political viewpoint, the CPC would not want
to give up its major lever of economic power and therefore risk
losing its political strength.
Closely related is the outlook for general capital market reform
opening up the capital account and allowing a flexible exchange
rate. We have seen some progress here, with greater currency
flexibility allowed over the past year and gradual liberalisation of
foreign financial investment (one of the many goals of the 12th
Five-Year Plan is to make it easier for local private investors to
buy into overseas markets, and in January the city of Wenzhou
publicised a trial policy that would allow individual investors
to make direct overseas speculation). We expect further gains
to be made, improving capital allocation. This is by no means
guaranteed, however, as the impending growth slowdown could
raise the potential for a political backlash against this kind of
reform among the party's elite.
SOE Liberalisation Has Run Its Course

Source: BMI, NBS, IMF
Efficiency Gains: Hard To Come By

Agricultural land reform and the deregulation of the hukou
household registration system provide potential for gains in
productivity by allowing more labour market flexibility and
further freeing up labour for urban migration. There has been
progress on this front, with the Chongqing government initiating
a pilot scheme giving migrant workers who have been working
in the city the right to non-agricultural status, with the aim to
turn 10mn farmers into urbanites by 2020. While progress has
been slow since then, we expect this policy to continue to spread
over the long term, supporting further urbanisation and growth.
The idea of urbanisation as a driver of growth, however, is valid
only insofar as entrepreneurs in cities can generate profits sufficient to warrant expanding their labour force. Over the long
term, this will depend on the government's willingness to allow
further economic freedom. In this regard, we believe that progress over the next decade will be much slower than in the past.
Financial Liberalisation Unlikely

Perhaps the most important reform the CPC could make to boost
24
As well as allowing price liberalisation and greater external trade,

opening up SOEs to private competition was a major factor in
boosting productivity. However, these particular reforms may
have hit a brick wall. Although the CPC relinquished a great deal
of power in removing itself from a large number of industries,
it remains the monopoly force in several key industries. As
with the banking sector, it will be difficult for the CPC to allow
further private-sector involvement into these sectors given the
risk this would pose to its grip on economic power.
Minimum Wage Hikes And Social

Security Will Hurt Growth Outlook
In the name of boosting consumption (as well as placating the
working classes), the CPC seems intent on hiking minimum
wages and increasing the size of the social welfare system (for
example, boosting healthcare and pension spending, and ramping
up social housing construction). While these may be desirable
from a social perspective, we do not believe they hold the key to
raising consumption spending; rather, these policies are likely to
reduce labour market flexibility and increase the already heavy
tax burden, reducing the ability of businesses to generate profits.
In terms of the composition of demand in the economy, these
policies will help to lower the savings ratio and, by extension,
increase the share of consumption in GDP although they will
10-YEAR forecast
do so at the cost of reduced growth potential.
Demographic Dividend Reversing

Over the past decade, the working population has risen at an
average rate of 1.26% per year, providing a supportive tailwind
for growth. Over the next decade, we expect this figure to fall
to just 0.71% per year, acting as a direct drag compared with
the previous decade, particularly towards the end of our forecast period when we see the working age population actually
shrinking slightly.
BMIs long-term macroeconomic forecasts are based on a variety of quantitative and qualitative factors. Our 10-year forecasts assume in most
cases that growth eventually converges to a long-term trend, with economic potential being determined by factors such as capital investment,
demographics and productivity growth. Because quantitative frameworks often fail to capture key dynamics behind long-term growth determinants,
our forecasts also reflect analysts in-depth knowledge of subjective factors such as institutional strength and political stability. We assess trends in
the composition of the economy on a GDP by expenditure basis in order to determine the degree to which private and government consumption,
fixed investment and the export sector will drive growth in the future. Taken together, these factors feed into our projections for exchange rates,
external account balances and interest rates.
25
Chapter 4:
Business Environment
SWOT Analysis
Strengths
China is continuing to open up various sectors of its economy to
foreign investment.
BMI Business Environment Risk

Ratings
While a vast supply of cheap labour and rapid economic growth ensure
that China remains the top destination for foreign direct investment in the
With its vast supply of cheap labour, the country remains the top
developing world, there still remains a number of crucial impediments for
destination for foreign direct investment in the developing world.
foreigners wishing to do business within the country. These shortcom-
Weaknesses
Foreign companies continue to complain about the poor protection
of intellectual property in China.
Chinese corporate governance is weak and non-transparent by
Western standards. There is a considerable risk for foreign companies
ings are underscored by our business environment ratings, which reveal

that bureaucracy and legal framework are the biggest drag on Chinas
overall score of 51.8, while the country also remains uncompetitive with
regard to its tax environment. While reforms are ongoing, we still expect
meaningful progress to remain gradual.
in choosing the right local partner.
Opportunities
Chinas ongoing urbanisation and infrastructure drive will provide
major opportunities for foreign investment in landlocked provinces
as well as the transfer of skills and know-how.
The Chinese government is giving more protection and encouragement to the private sector, which is the most dynamic in the economy
and accounts for most of the countrys job growth.
Threats
Chinas government will block attempts by foreign firms to take over
assets of national importance.
China is experiencing rising labour costs, prompting some investors
to turn to cheaper destinations such as Vietnam.
Rank
Trend
Singapore
80.0
1
Hong Kong
78.7
2
South Korea
71.1
3
Malaysia
68.6
4
Taiwan
61.9
5
Thailand
61.7
6
China
59.4
7
Brunei Darussalam
57.8
8
Vietnam
53.1
9
Sri Lanka
51.3
10
Philippines
48.5
11
Mongolia
47.9
12
India
46.0
13
Cambodia
40.4
14
Indonesia
40.2
15
Papua New Guinea
40.0
16
Bangladesh
38.3
17
Pakistan
37.2
18
Laos
34.4
19
Bhutan
33.7
20
North Korea
18.7
21
Myanmar
=
=
=
=
=
=
=
=
=
=
=
=
=
=
=
=
=
=
=
=
=
-
27
china Q2 2014
Business Environment Outlook

Introduction
While a major destination for foreign direct investment (FDI),
the attractiveness of China as a top FDI destination is being
threatened by rising wage demands and an uneven playing field
between local and foreign firms. Furthermore, the commanding
nature of China's economy means bureaucracy remains a key
obstacle to doing business within the country, while the legal
framework is still weak despite two decades of reform.
Institutions
Legal Framework
China operates a civil law system that includes some common
law elements, although relatively less emphasis is placed on legal
precedent. Two decades of reform have resulted in a number
of changes in institutions, laws and practices. A formal legal
system has resulted in a nationwide court system comprising
3,000 basic courts and some 200,000 judges. The courts are
divided into courts of general jurisdiction and the courts of

special jurisdiction.In 1979, economic courts were established
as part of China's Supreme People's Court and three levels of
provincial courts. The economic courts enjoy jurisdiction over:
contract and commercial disputes between Chinese parties; trade,
maritime, intellectual property and insurance; other business
disputes involving foreign parties; various economic crimes
including theft, bribery and tax evasion.
There is also an administrative legal system, which adjudicates
more minor criminal cases.
Judges are often vulnerable to corruption, political control and
the pressures of guanxi (connections based on family or local
ties). Their appointment, promotion and removal are all at the
discretion of local government and Communist Party of China
(CPC) leaders rather than the Supreme People's Court or provincial high courts. Both the judges and the litigants who appear
before them are subject to the influence of local protectionism.
Legislation is frequently inadequate, with numerous conflicts
between national and local norms; and a proliferation of regulations, interpretations and other edicts often producing incoher-
Table: BMI Business & Operation Risk Ratings

Infrastructure Rating
Institutions Rating
Market Orientation Rating
Afghanistan
21.8
20.1
17.9
19.9
Australia
80.3
85.8
68.1
78.0
Bangladesh
40.5
35.2
39.1
38.3
Bhutan
28.8
43.3
29.0
33.7
Cambodia
37.4
31.8
52.0
40.4
China
66.0
56.6
55.7
59.4
Hong Kong
71.1
84.2
80.7
78.7
India
47.4
41.8
48.8
46.0
Indonesia
37.1
31.2
52.3
40.2
Japan
76.4
77.1
49.8
67.8
Laos
39.2
28.7
35.3
34.4
Malaysia
60.1
74.9
70.9
68.6
Maldives
42.7
43.7
41.3
42.6
Nepal
29.4
29.9
30.8
30.0
New Zealand
69.3
92.7
65.3
75.7
Pakistan
33.4
37.0
41.1
37.2
Philippines
48.6
36.8
60.1
48.5
Singapore
71.1
84.2
80.7
80.0
South Korea
63.0
79.1
71.3
71.1
Sri Lanka
54.3
51.8
47.9
51.3
Taiwan
56.1
68.2
61.4
61.9
Thailand
61.0
56.8
67.2
61.7
Vietnam
58.2
39.0
62.2
53.1
Source: BMI. Scores out of 100, with 100 representing the best score available for each indicator
28
business environment
ence and inconsistency. Laws and regulations in China tend to

be far more general than in most OECD countries, and therefore
need more specific implementing rules and measures.
Even government arbitration, which many foreign businesses and
Chinese turn to in an effort to avoid the vagaries of the courts,
sometimes suffers from the same types of pressures that distort
judicial justice. Prosecutors, who are supposed to guard against
such illegal conduct, are usually too weak politically, and China's
current legal and regulatory system can be opaque, inconsistent
and often arbitrary. Implementation of the law is inconsistent.
Although China is a member of the International Centre for
the Settlement of Investment Disputes and has ratified the UN
Convention on the Recognition and Enforcement of Foreign
Arbitral Awards, it places strong emphasis on resolving disputes
through informal conciliation and mediation.
Property Rights
Chinese law states that all land is owned by 'the public'. Individuals are not permitted to own land. However, both Chinese
nationals and foreigners can hold long-term leases for land use.
They can also own buildings, apartments and other structures
on land, as well as personal property.
Intellectual Property Rights

China lacks effective protection for intellectual property rights
(IPR). In spite of some reforms under its WTO commitments
China has committed to full compliance with the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights
(TRIPS) enforcement is poor and penalties, in the rare cases
they are applied, are insufficient to act as proper deterrents.
Trademark and copyright violations are widespread. Lack of
coordination among public bodies undermines attempts at
enforcement. There is also wide variation in the application of
IPR protection.
Corruption
Corruption is prevalent, and anti-corruption efforts are obstructed
by weak or non-existent monitoring mechanisms. Embezzlement
and financial mismanagement have been identified by numerous audit reports. The use of guanxi is widespread in the upper
echelons of business. Many of those who come under investigation are able to deploy their connections to avoid prosecution.
However, anti-graft efforts have improved significantly under
Table: BMI Legal Framework Rating

Investor Protection Score
Rule Of Law Score
Contract Enforceability
Score
Corruption Score
1.9
20.1
17.9
19.9
Australia
78.9
85.8
68.1
78.0
Bangladesh
59.1
35.2
39.1
38.3
Bhutan
14.8
43.3
29.0
33.7
Cambodia
31.5
31.8
52.0
40.4
China
64.4
56.6
55.7
59.4
Hong Kong
93.7
84.2
80.7
78.7
India
61.5
41.8
48.8
46.0
Indonesia
53.9
38.7
64.7
50.8
Japan
80.7
77.1
49.8
67.8
Laos
14.0
28.7
35.3
34.4
Malaysia
80.1
74.9
70.9
68.6
Maldives
24.3
43.7
41.3
42.6
Nepal
41.8
29.9
30.8
30.0
New Zealand
94.6
92.7
65.3
75.7
Pakistan
46.4
37.0
41.1
37.2
Philippines
36.4
36.8
60.1
48.5
Singapore
96.2
87.1
81.2
80.0
South Korea
68.5
79.1
71.3
71.1
Sri Lanka
63.2
51.8
47.9
51.3
Taiwan
67.2
68.2
61.4
61.9
Thailand
53.7
56.8
67.2
61.7
Vietnam
24.4
39.0
62.2
53.1
Afghanistan
29
china Q2 2014
President Hu Jintao, who has made tackling rampant corruption

one of his top priorities. January 2008 saw sports magnate Yu
Zhifei jailed for embezzlement and the launch of an investigation
against the former head of oil giant Sinopec, Chen Tonghai, while
in 2007 there were two of China's most high-profile anti-graft
cases the sacking and arrest of Shanghai's former CPC boss
Chen Liangyu and the execution of Zheng Xiaoyu, the former
head of the food and drug watchdog. During a month-long
leniency offer, almost 1,800 officials confessed to corruption,
according to the CPC watchdog, the Central Commission for
Discipline Inspection.
Red tape is a major issue for investors. Given that many laws are
defined in very general terms, it is often left to the bureaucracy to
make decisions. With a lack of accountability, this process provides opportunities for corruption, while numerous bureaucratic
obstacles stymie the easy acquisition of licences. According to
World Bank data, 20 separate procedures are required to enforce
a contract, which takes an average of 180 days.
Infrastructure
Physical Infrastructure
As one of the fastest-developing economies in the world, China
has an insatiable appetite for infrastructural development. BMI
valued the country's construction industry at US$300.7bn in
2010, and expects the industry to be worth about US$488.0bn
by 2015, contributing 5.3% to the nation's GDP.
Much of the ongoing construction work in the country is at the
higher-value end of the industry (power plants, hydroelectric
schemes, high-speed rail links). Most of this will be funded
through private-sector involvement. However, public infrastructure spending will also need to increase substantially to
meet the government's targets.
However, site safety is a concern. The Ministry of Construction
put the industry death toll at 2,288 people in 2005; and, while this
represented an 11.4% y-o-y drop, the industry was still responsible for the highest number of deaths of any Chinese industrial
sector, including mining. As well as having to deal with these
social and structural problems, the industry is trying to reform
Table: Labour Force Quality

Afghanistan
Literacy Rate,%
Labour Market Rigidity Score
Female Labour Participation, %
28.0
20.0
33.1
Australia
99.0
0.0
58.4
Bangladesh
52.5
28.0
58.7
Bhutan
54.3
7.0
53.4
Cambodia
75.6
36.0
73.6
China
93.0
31.0
67.4
Hong Kong
93.5
0.0
52.2
India
65.2
30.0
32.8
Indonesia
91.0
40.0
52.0
Japan
99.0
16.0
47.9
Laos
72.5
20.0
77.7
Malaysia
91.5
10.0
44.4
Maldives
97.0
18.0
57.1
Nepal
55.2
46.0
63.3
New Zealand
99.0
7.0
61.8
Pakistan
54.2
43.0
21.7
Philippines
93.3
29.0
49.2
Singapore
94.2
0.0
53.7
South Korea
99.0
38.0
50.1
Sri Lanka
90.8
20.0
34.2
Taiwan
96.1
46.0
n/a
Thailand
93.9
11.0
65.5
Vietnam
90.3
21.0
68.0
Source: BMI,World Bank,ILO. Labour Market Rigidity score from Ease of Doing Business report, 1 = highest score
30
in other ways, such as improving environmental performance

and introducing a regulatory framework for building materials.
The major test for the Chinese government will be to eliminate
the physical and financial dangers from the industry. The action
it takes over the coming years to curb corruption and improve
working conditions will be crucial to the success of its ambitious
infrastructure building plans and, ultimately, to the country's
economic development.
The quality of roads in China is poor. In 2005, China had a total
road network of more than 3.3mn km, although approximately
1.47mn km of this network almost 45% are classified as 'village
roads'. Paved roads totalled 770,265km in 2004; the remainder
were gravel, improved earth standard or merely earth tracks.
Rail is the major mode of transport in China. The national
rail system the third largest in the world at approximately
76,000km is modernising and expanding rapidly, but still
possess a number of weaknesses, as highlighted by the January 2008 snow storms that brought the country's railways to a
virtual standstill.
Eight Chinese cities (Beijing, Tianjin, Shanghai, Guangzhou,
Wuhan, Shenzhen, Nanjing and Chongqing) currently have metro
systems, and at least seven more are planning them. Currently

proposed extensions and new networks amount to more than
2,000km, at a cost of at least CNY500bn (US$65bn). In Beijing
alone, which currently has around 114km of metro routes, there
are plans to expand the network to a total of 561km by 2020.
Some of this expansion was driven by the 2008 Olympic Games,
but most of it is aimed at relieving congestion and expanding the
city. Indeed, the World Bank urged China in June 2006 to do
more to improve public transport to ease traffic jams, rather than
build more highways to accommodate cars. Overall, with China
projected to have 125 cities with more than 1mn people each
by 2010, there is still huge scope for urban railway expansion.
As a result of the country's rapidly expanding civil aviation
industry, China had around 500 airports of all types and sizes
in operation by 2007, about 400 of which had paved runways.
China plans to build another 97 more airports by 2020.
China has more than 2,000 ports, 130 of which are open to foreign
ships and 16 'major' ports with a capacity of over 50mn tonnes
per year. China's total shipping capacity is in excess of 2,890mn
tonnes. By 2010, 35% of the world's shipping is expected to
originate from China. China also has more than 140,000km of
navigable rivers, streams, lakes and canals; and in 2003 these
inland waterways carried nearly 1.6trn tonnes of freight and
TABLE: ASIA ANNUAL FDI INFLOWS

2009
2010
2011
US$bn
Per Capita
US$bn
Per Capita
US$bn
Per Capita
1827.7
26.6
1212.4
35.6
1596.7
41.3
Bangladesh
Australia
0.7
4.8
0.9
6.1
1.1
7.6
Cambodia
0.5
38.6
0.8
55.4
0.9
62.3
China
95.0
71.2
114.7
85.5
124.0
92.0
Hong Kong
52.4
7497.7
71.1
10076.2
83.2
11675.6
India
35.6
29.5
24.2
19.7
31.6
25.4
4.9
20.5
13.8
57.4
18.9
78.0
11.9
94.3
-1.3
-9.9
-1.8
-13.9
Indonesia
Japan
Malaysia
1.5
52.0
9.1
320.5
12.0
414.6
Mongolia
0.6
233.4
1.7
626.0
4.7
1725.2
-0.8
-176.1
0.6
145.5
3.4
761.8
Pakistan
2.3
13.7
2.0
11.6
1.3
7.5
Philippines
2.0
21.4
1.3
13.9
1.3
13.3
Singapore
24.4
4937.2
48.6
9562.1
64.0
12336.9
South Korea
7.5
156.4
8.5
176.6
4.7
96.3
Sri Lanka
0.4
19.5
0.5
22.9
0.3
14.3
New Zealand
Taiwan
2.8
121.3
2.5
107.6
-2.0
-84.5
Thailand
4.9
71.6
9.7
142.8
9.6
139.7
Vietnam
7.6
87.5
8.0
91.1
7.4
83.7
Source: BMI, UNCTAD
31
china Q2 2014
6.3trn passenger/km to more than 5,100 inland ports.
able to satisfy the demand from non-agricultural sectors.
Labour Force
Education levels vary by region. English-speaking graduates

are most commonly found in Beijing or Shanghai. Companies
warn that technical skills or training in accounting and finance
are scarce. Skilled managers are also in short supply.
The Chinese labour force is expanding rapidly. Estimated in 2007

at 798mn, this represents a participation rate of around two-thirds.
The urban unemployment rate averages 4.2%. However, the
government admits that the statistics ignore many unemployed
workers, including those laid off by state-owned companies.
Although China has a reputation for having a bottomless well
of cheap labour, the Chinese economy has actually experienced
labour shortages in recent years. Minimum wages are rising as
the economy responds to the labour shortage, setting a new salary
floor for employers. For example, textile factories in Bangladesh
and India are undercutting China on price. The affluent Pearl
River cities are also drawing labour away from traditional industrial sectors, with workers able to command higher wages.
Shortages of rural workers are spreading from the nation's
coastal areas inland. Out of 2,794 villages investigated in a 2007
nationwide survey, 74.3% no longer have a surplus of young
labourers as all had left for work in cities. The survey projected
that, by 2010, the total rural labour force would no longer be
The labour market is heavily regulated. New labour rules state

that non-Chinese may be hired only where there is a demonstrable
need, and approval is required from local labour authorities. The
law provides for collective and individual contracts specifying
wage levels, working hours, conditions, insurance and welfare.
Since local CPC committees select union leaders, collective
agreements are usually not part of negotiations.
The Labour Law makes it more difficult to fire staff than previous regulations, which allowed foreign enterprises to dismiss
staff as a result of technical and production changes. Now, only
imminent bankruptcy and major production problems justify
redundancy. There is a minimum wage each province or municipality must set a minimum wage that must not be less than
half the local average wage. Furthermore, every month, foreign
companies have to contribute 2% of total wages (including those
Table: Trade & Investment Ratings

Openness To Investment Score
Openness To Trade Score
11.2
25.1
Afghanistan
Australia
71.1
39.1
Bangladesh
22.1
37.6
Bhutan
16.5
45.1
Cambodia
54.0
82.9
China
47.7
70.0
Hong Kong
49.5
98.9
India
53.8
42.0
Indonesia
56.8
58.3
Japan
7.8
40.1
Laos
69.0
19.8
Malaysia
50.6
98.7
Maldives
87.1
28.0
Nepal
New Zealand
4.8
59.5
40.9
52.6
Pakistan
31.8
51.7
Philippines
46.4
69.6
Singapore
47.7
99.2
South Korea
51.4
83.7
Sri Lanka
50.3
57.3
Taiwan
11.7
91.4
Thailand
61.6
89.5
Vietnam
79.7
96.5
32
payable to expatriate employees) to the trade union fund. This

contribution comes out of after-tax profits.
Foreign companies only rarely report strikes affecting their
Chinese operations. Workers have the right to organise and
participate in trade unions, but the law does not allow for the
creation of unions, which must be organised 'in accordance with
law'. The only permitted unions are state affiliates of the AllChina Federation of Trade Unions (ACFTU). The ACFTU is
more interested in maintaining relations between the government
and foreign companies than in seeking to promote industrial
strife. Although China does not allow independent trade unions,
it does tolerate some forms of activism.
Market Orientation
Foreign Investment Policy
As repeated surveys and foreign direct investment (FDI) flows
bear out, China remains the top emerging market destination
for foreign investors. Low labour costs, as well as better competitive and productivity rates, give China a leading edge in
the manufacturing and assembly sectors the dominant areas
for FDI inflows.
Since the early 1990s, China has substantially reformed its investment regime and foreign investors are now able to manufacture
and sell a wide variety of goods on the domestic market. In the
mid-1990s, China authorised the setting up of 100% foreignowned enterprises the preferred vehicle for FDI. This precipitated the rampant FDI performances of recent years. However,
there is concern that the government's concentration on luring
investment to the manufacturing sector has led to saturation
and overcapacity. UNCTAD figures show that China pulled in
US$108.3bn in FDI in 2008, setting yet another record.
The government wants to make the service sector a key area to
attract foreign investment. China is to channel FDI into research
and development centres, new high-tech industries, advanced
manufacturing and the energy conservation sectors.
Wholly owned foreign enterprises are now the most popular
entry route for investors. Since the 1990s, the authorities have
attempted to direct FDI towards 'encouraged' industries and
regions, bringing in new incentive schemes for investments in
high-tech industries as well as in the central and western parts
of the country. A revised list came into effect in April 2002,
outlining areas and sectors where foreign investment would

be encouraged, restricted or prohibited. The raft of investment
incentives developed over the past two decades centre on the
special economic zones. The list is partly intended to abide by
the promised sectoral openings that were part of Beijing's WTO
accession agreements: opening up banking, insurance, petroleum
extraction and distribution. For example, the upper limit is 20%
for a single foreign investor in one Chinese bank, and combined
foreign shareholding in banks is not allowed to exceed 25%.
Regulations issued in November 2002 have eased foreign investment intended for the acquisition of stakes in Chinese companies.
Non-Chinese investors can now purchase traded and non-traded
(state-held) shares of Chinese companies. However, foreign
investors have been put off by the requirement to undergo an
extensive approvals process with trade unions.
China allows for full profit repatriation, and since the mid1990s foreign investors have broadly had free access to foreign
exchange. Since WTO accession, an overhaul of regulations
has been implemented to improve IPR. China has committed
to full compliance with the WTO TRIPS as well as with other
TRIPS-related commitments. However, enforcement remains
negligible, with penalties frequently failing to be imposed.
Most FDI remains focused on the export-oriented manufacturing
and assembly sectors. But services mainly tourism, telecoms
and finance form a growing proportion of the FDI stock in
China. The top sectors in terms of attracting FDI are chemicals,
machinery and industrial goods as well as IT, including software.
The main sources of investment are Japan, the US and Germany.
Foreign Trade Regime

In line with its WTO accession requirements, China has lowered
its import tariffs. In 2006, the general tariff level on imports
was 9.9%, a decline of more than 40% on the early 1990s level.
The commitment to lower tariffs has been borne out by thriving
import levels, which have surged faster than China's exports in
recent years. China is now the world's third-biggest importer.
The government has pursued multilateral agreements as a priority,
with a series of regional and bilateral free trade negotiations under
way as part of its wider commitments under the Doha Development Round. China's formal accession to the WTO in December
2001 cemented its integration into the global economy. The two
key bilateral deals were the EU-China agreement signed in May
2000 and the US-China agreement signed in November 1999.
Beijing is actively pursuing regional trade deals, with recent
33
china Q2 2014
progress towards a free trade agreement (FTA) between China

and the 10-member Association of South East Asian Nations
(ASEAN). It has also initiated FTA talks with the Southern
African Customs Union and the Gulf Co-operation Council.
In January 2002, China implemented tariff cuts required as part
of its WTO accession agreement and beefed up access to trading
rights. This was followed one year later by a further lowering
of tariffs, again dictated by the WTO. China has substantially
reduced the number of goods subject to import quotas, and is
committed to phasing out remaining quotas. Licensing procedures
have been streamlined to comply with transparency requirements.
Some WTO commitments have been met ahead of schedule, and
there are ongoing plans to liberalise trading rights further. China
may apply tariff rates significantly lower than the published most
favoured nation (MFN) rate in the case of the goods industry.
Import tariff rates are divided into three categories: general
rates, MFN rates and Bangkok Agreement rates, applying to
ASEAN members.
Non-tariff barriers remain in force. China has agreed to drop all
agriculture export subsidies as part of the WTO agreement. But
there has been criticism over its lack of adherence to trade agreements, particularly when discretionary elements are involved
specifically the absence of implementation on IPR protection.
US officials have also accused Beijing of intervening to keep
the yuan artificially low, thereby boosting its exports to the
US and creating a debilitating trade surplus. But the Chinese
government appears likely to resist pressure to adjust its currency regime solely to suit the US. Concerns also remain over
inconsistencies in the legal system, as well as over government
attempts to control trade flows through the deployment of import
and export licences. The government retains regulatory controls
through commodity inspections and a plethora of registration
requirements.
to its arm's length borrowing capacity, leading to the possibility

of excessive interest deductions) and foreign tax credits.
Corporate Tax
The standard rate is 33%, comprising a 30% national tax and a
3% local tax. Foreign investment enterprises (FIEs) generally
pay tax at concessional rates depending on the location and type
of business. The state tax rate of 30% may be reduced to 15%
or 24% if the FIE is located in one of the specially designated
zones. Qualified FIEs are entitled to a tax exemption or reduction
during a tax holiday period. The local tax of 3% may be waived
or reduced by the local government. A unified tax for Chinese
and foreign enterprises, involving the removal of concessional
rates and exemptions, is anticipated.
Income Tax
Income tax is levied on Chinese and foreign individuals at progressive rates ranging up to a 45% limit. Non-residents who are
resident for less than a year are subject to personal tax only on
income sourced in China. Individuals resident for one to five
years are subject to personal tax on income sourced in China,
plus foreign income actually remitted to China. Those resident
for more than five years are taxed on their worldwide income.
Indirect Tax
China is obliged by WTO rules to offer identical tax treatment
for domestic and imported products. VAT is levied at two rates: a
standard 17% rate and a lower 13% rate. A 6% VAT rate applies
to small enterprises. VAT is applied to most products, with the
lower 13% rate pertaining to grain and edible oil, books, water
and agricultural times. Exports are zero-rated and exporters can
obtain VAT refunds. The business tax rates are 3-5% for most
services, but a 20% rate applies to entertainment.
Withholding Tax
There is no withholding tax on dividends, but a 10% rate is
applied to interest and 10% on royalties.
Tax Regime
China is pushing ahead with reform, with the emphasis on reducing taxes and unifying income tax rates for domestic and foreign
companies. China's dual-tier tax system offers separate rates for
domestic and foreign enterprises. A new tax reform will unify
the income tax treatment of domestic and foreign enterprises.
As of January 1 2008, both domestic and foreign-funded enterprises have been subject to a 25% statutory rate. The reform also
includes rules relating to controlled foreign corporations, thin
capitalisation (when a company has excessive debt in relation
34
Operational Risk
Security Risk
Overall, China is a relatively safe country with a low albeit
growing crime rate. While violence against foreigners is fairly
rare, it does occur and severe injuries have occasionally been
the result.
The threat of political violence against foreigners in China is

low. However, the potential for violent outbreaks exists, and
foreigners operating businesses on Chinese soil should remain
aware of the political situation. It should also be noted that
violent incidents have taken place between members of various
ethnic groups in China.
There is a low threat from terrorism in China. However, the
British Foreign and Commonwealth Office advocates that
people should remain aware of the global risk of indiscriminate
terrorist attacks.
35
Chapter 5:
Key Sectors
Autos
Executive Summary
Sales: According to the China Association of Automobile
Manufacturers (CAAM), vehicle sales in September 2013
surged 19.7% y-o-y, to 1,935,800 units, bringing sales for the
first nine months of the year to 15,882,449 units, an increase
of 12.7% y-o-y.
While we had originally said that auto sales will suffer a slowdown in H213, as a slowing economy would hurt consumer
sentiment, we now believe the slowdown in the car market will
come in 2014 when the current economic bounce gives way.
This is because as our Country Risk team crucially points out,
this latest surge in credit through the informal channels in the
system will not be positive for economic growth in 2014, not
least as it delays the painful but necessary rebalancing away
from stimulus driven growth.
brands would take a while, due to the deep rooted cultural underpinnings of the dispute. True enough, consumer misgivings
towards Japanese brands have started to abate 12 months later,
and these carmakers are now enjoying surging growth rates
from a low base (see 'Weakening Yen Possible Trump Card
For Japanese Autos', January 17 2013).
Shanghai FTZ Could Be Positive For Exports: We believe
the Shanghai FTZ could go on to boost China's auto parts exports. While exact details on the economic incentives within
the zone still remain sketchy and it is likely that the FTZ's full
potential will take years to materialise, its set up is a step in the
right direction. According to CAAM, the gross value of auto
parts exports rose 4.6% y-o-y in H113. If regulators manage to
attract more suppliers to set up shop within the FTZ and take
advantage of its preferential tariffs, component exports can be
further boosted.
Industry Forecast
Passenger Car Segment Will Outperform: As the Chinese
economy rebalances over the coming years to one where consumption makes up a larger share, the outperformance of the
passenger car segment vis-a-vis the CV segment will persist.
Over our 2013-2017 forecast period, we expect car sales to grow
8.4% a year on average versus 4.8% a year average growth for
the CV segment. Therefore, we believe there is greater value
in passenger car brands, which are industry leaders, rather than
pure play CV manufacturers.
Comeback Of Japanese Brands Aids Monthly Performance:
The strong print in passenger car sales figures is attributable to
broad-based strength in the sector. Besides the continued outperformance of the SUV and MPV segments, which is in line
with BMI's long-held view, the recovery in Japanese automakers'
sales also contributed to the surge.
Indeed, anti-Japanese sentiment generated by the Sino-Japanese
dispute was at its peak during September and October 2012,
leading to sharp sales declines for Japanese carmakers in those
months (see 'Escalating China-Japan Tensions Spell Trouble',
September 18 2012). We warned that the comeback for Japanese
Production: As Chinese wages have continued rising over the

years, China's attractiveness as a manufacturing and export
hub, on the back of cheap labour, is diminishing (see 'Rise Of
Robots As Industry Moves Up Value Chain', December 4 2012).
Our long-term auto production forecasts take that into account
and we see them growing in line with our auto sales forecasts,
mostly to satisfy domestic demand.
Sales: According to the CAAM, vehicle sales in September 2013
surged 19.7% y-o-y, to 1,935,800 units, bringing sales for the
first nine months of the year to 15,882,449 units, an increase
of 12.7% y-o-y.
Slowdown View Still There, Just Delayed: While we had
originally said that auto sales will suffer a slowdown in H213,
as a slowing economy would hurt consumer sentiment, we now
believe the slowdown in the car market will come in 2014 when
the current economic bounce gives way. This is because as our
Country Risk team crucially points out, this latest surge in credit
through the informal channels in the system will not be positive
for economic growth in 2014, not least as it delays the painful
but necessary rebalancing away from stimulus driven growth.
37
china Q2 2014
Passenger Car Segment Will Outperform: As the Chinese

economy rebalances over the coming years to one where consumption makes up a larger share, the outperformance of the
passenger car segment vis-a-vis the CV segment will persist.
Over our 2013-2017 forecast period, we expect car sales to grow
8.4% a year on average versus 4.8% a year average growth for
the CV segment. Therefore, we believe there is greater value
in passenger car brands, which are industry leaders, rather than
pure play CV manufacturers.
On the other hand, the current picture for Chinese vehicle exports
is not as bright. BMI has long held the view that export oriented
auto manufacturing is becoming increasingly uncompetitive in
China due to the rising cost of production. Adding weight to our
view is the sharp y-o-y declines in vehicle exports over the past
few months. While some of the contraction can be attributed
to cooling demand in some of the regional markets, Thailand
and Indonesia, two prominent regional exporters, have not experienced such drastic falls in the same period. Therefore, we
conclude that other factors such as China's rising manufacturing
wages are to be blamed for lacklustre export volumes.
Shanghai FTZ A Positive For Auto Exports: SAIC Motor

Corp recently launched a subsidiary based in China's first free
trade zone (FTZ) located in Shanghai. The subsidiary will be a
trading company and use its 100,000 square metre warehouse to
source auto parts worth CNY20bn (US$3.3bn) annually within
five years. The Shanghai FTZ offers lower duties and faster
custom clearance for trade activities.
Lastly, while it is still too early to tell, we speculate that it is

possible that automakers may be attracted to export vehicles
from the FTZ in the future. For example, General Motors
Company (GM) plans to boost its Chinese vehicle exports by
70.0% in 2013, to 130,000 units, on the back of demand from
emerging markets for low-cost Chinese cars. If the Chinese
authorities put together investor friendly incentives for example, just requiring a representative office in the FTZ to enjoy
its benefits as opposed to an actual manufacturing plant and
follow up with the provision of world-class port infrastructure
within the zone, more carmakers could follow in GM's footsteps
and look to export from China.
We see this development as a positive for the automaker. SAIC

is China's largest carmaker and has been looking to diversify its
sales out of the country for some time. Furthermore, the firm
has been setting up production bases in overseas markets such
as Thailand (see 'Thai Base Will Be SAIC's Asian Springboard',
July 5 2013), and plans to establish sales ventures in the Middle
East and Latin America in the near future. This new trading
company will be able to leverage the FTZ's preferential trade
tariffs and source the most competitive component prices for
the carmaker's global operations.
Rise In Funding Cost Poses Risks To Auto Sector Players: The recent turbulence in the Chinese banking system saw
overnight interbank borrowing rates soaring beyond 30% (see
'Beijing's Credit Crunch Conundrum', June 20 2013). While
rates have fallen since then as the central bank stepped in to
ease the credit crunch in the banking system, they still remain
elevated compared with the more benign environment before
the liquidity squeeze. The accompanying chart highlights the
rise in interest rates, showcasing the upward shift of the swap
curve from May 1 2013 (before the banking sector crunch) and
July 8 2013.
FTZ Has Potential To Boost Exports: We believe the Shanghai

FTZ could go on to boost China's auto parts exports. While exact
details on the economic incentives within the zone still remain
sketchy and it is likely that the FTZ's full potential will take
years to materialise, its set up is a step in the right direction.
According to CAAM, the gross value of auto parts exports rose
4.6% y-o-y in H113. If regulators manage to attract more suppliers to set up shop within the FTZ and take advantage of its
preferential tariffs, component exports can be further boosted.
Moreover, the risk of a further flare-up remains ever-present

given the precarious health of the banking system. In this sec-
Table: Autos Sector Production And Sales
Total Production (CBUs, mn)
2010
2011
2012
2013f
2014f
2015f
2016f
2017f
18.103
18.255
19.272
21.204
22.781
24.477
26.348
28.146
Motorcycle Production (CBUs, mn)
26.690
27.005
23.630
23.039
23.500
23.970
24.689
25.430
Total Sales (CBUs, mn)
18.060
18.530
19.306
21.201
22.737
24.473
26.299
28.001
Motorcycle Sales (CBUs, mn)
26.590
26.928
23.651
23.059
23.521
23.991
24.771
25.452
f= BMI forecast. Source: CAAM, Organisation Internationale des Constructeurs dAutomobiles (OICA)
38
key sectors
tion, we look at such a scenario and examine the impact to the

auto sector supply chain.
With 86% of all receivables in the Chinese auto industry funded
by bankers' acceptance bills (usually ranging from 30-180
days), short-term financing costs would inevitably rise should
we see another round of financial markets volatility. Discount
bills remain an important lubricant for transactions, allowing
automakers to extend generous payment terms to dealers, and
suppliers to extend credit to carmakers.
Dealerships Will Bear The Brunt Of Higher Interest Rates:
Small dealerships have tight cash flows and depend on bankers' acceptance bills to pay carmakers for inventory purchases.
Furthermore, they do not enjoy access to long-term financing
and are unable to borrow funds at attractive low interest rates,
a privilege which state-owned enterprises enjoy. This makes
this mode of funding even more vital to them.
The rise in note yields would mean that dealerships which cannot afford the higher interest rates would cut their inventory
levels. This could, in turn, impinge upon potential car sales if
the requisite stocks were not on hand to meet demand.
In the worst case scenario, we see already struggling dealerships
being dealt a fatal blow in an elevated interest rate environment . With inventory costs rising and our view for auto sales
to experience slower growth in H213, smaller dealers will be
forced out of business.
But Surge In Carmakers' Accounts Receivables Is Worrying: We acknowledge that carmakers remain diversified as they
supply vehicles to different dealers and have balance sheets
which are generally well-capitalised. Their cash balances are
healthy and average long-term debt/equity ratios are below 15%.
However, we have observed a trend of a surge in accounts/note
receivables for many of the private Chinese automakers and
this becomes a source of concern with a rise in financing costs.
Since it is not easy to extract data on total vehicle sales made
on credit, we find it reasonable to look at accounts receivables
as a percentage of total revenues to get an idea of dependency
on deferred payments among carmakers.
As the accompanying chart shows, the rise in accounts receivables in the past few years for China's largest SUV maker, Great
Wall Motors , is not commensurate with a similar increase in
revenues (in millions of CNY). The percentage of revenues as
account receivables at the firm surged from 10.5% in 2006, to
37.2% in 2012. For Geely, since its takeover of Volvo in 2008,

its account receivables have formed a big percentage of total
revenues, with average receivable days hitting 172 in 2012.
While state-run automakers have lower average receivable days
which are more in line with global norms (around 30 days), the
rise in yields of short-term discount bills puts every carmaker
on the hook for sales made on credit. With small dealers potentially going bust, a significant share of these account receivables
could go bad, with private carmakers being the most vulnerable.
Although firms such as Great Wall have the cash on their balance sheet to take the necessary write-downs, we caution the
negative impact to the bottom line of carmakers in the coming
quarters should this trend continue.
Suppliers May Shorten Duration Of Credit Terms: Meanwhile, should the hike in short-term borrowing costs persist,
suppliers to car manufacturers may no longer find it worthwhile
to extend long payment terms, which is currently the case.
This would then have the effect of increasing the working
capital requirements of automakers in an already tighter credit
environment.
Higher Yields Will Hurt Investment: Companies have reportedly cancelled bond issuances amid the volatile market. Big auto
dealerships rely on the bond market to fund their investments
for new dealerships. While demand for cars remains robust,
should more auto dealerships shelve capital-raising plans, we
could see a slowdown in the inland expansion of automakers.
This detrimental impact on the supply side of the industry will
then indirectly hurt auto sales.
Food & Drink

Executive Summary
While we are bullish on the long-term prospects for the Chinese
consumer sector, the country's domestic demand rebalancing
is likely to be a long, drawn-out process. An acceleration of
household spending driven by sizeable personal savings and
rising wages would compensate for a reduction in capital outlay,
helping to keep the economy motoring along at its current rate
of expansion. Indeed, the vast size of China's consumer base,
the undeveloped nature of organised retail, the relatively low
penetration of services, and the strong scope for premiumisation
are all structural positives and underpin our view that private
consumption will slowly rise as a share of nominal GDP over
39
china Q2 2014
the next decade.

Headline Industry Data

2013 food consumption = +13.3%; compound annual growth

rate (CAGR) forecast to 2017 = +9.4%.
2013 beer volume sales = +8.3%; CAGR forecast to 2017

= +8.7%.
2013 soft drinks volume sales = +7.5%; CAGR forecast

to 2017 = +6.9%.
2013 mass grocery retail sales = +8.8%; CAGR forecast

to 2017 = +9.1%.
have grown at a five-year average rate of 23%, led largely by

its faster growing beverages arm, which accounts for more than
half of its business. Noodles have lost quite a bit of their lustre
as a driver of growth and, as a result, have become progressively
less important to overall sales despite having contributed 53%
of total revenues back in 2005.
Fonterra Hit As Contamination Fears Unfold: The Chinese
government's decision to recall milk imported from New Zealand in July 2013 over contamination fears marked the latest
blow to the latter's dynamic infant formula segment in recent
weeks. New Zealand-based dairy major Fonterra is likely to be
most severely impacted by the scandal: around 90% of China's
imported milk comes from New Zealand, and the company is
China's largest single supplier of infant nutritional products.
Key Company Trends
Food
A Year To Forget for Yum? Brands: Yum? Brands reported

a 68% decline in global profit for Q313 (to September 2013)
to US$152mn, leading to a 5.2% decline in its share price on
October 9 2012. This has all but wiped out gains in the stock
since the beginning of the 2013. The company, which owns
KFC, Taco Bell and Pizza Hut, can attribute its poor performance over the last year to depressed sales from its KFC brand,
particularly within China. While this has been a year to forget
for Yum? Brands, its position in China, with the potential that
the country holds, should see the company return to growth in
the near future.
Food Consumption
Instant Noodles Sales Slowing: Shareholders are asking

about the growth stage of China's noodle industry. According
to Nomura (FT), China consumes about 3 kilograms of instant
noodles on a per capita basis annually, which incidentally compares with about 5 kilograms in Hong Kong. There could be
room for the mainland to catch up with the more affluent Hong
Kong, yet rising health consciousness could cap, to a degree,
how much more mainlanders can consume per annum. More
volume growth is possible as people work longer hours and the
country's favourite convenience food could continue to grow as
the population becomes more time-poor.
The idea that the sector is slowing down was backed up by the
first half 2013 results announcement by Tingyi , the leading
noodle company in China, with more than half of the market for
instant noodles, according to the Financial Times. Noodle sales,
which accounted for 43% of Tingyi's business in 2012, grew
by 6.4% in the first half of the period, well below the 10% or
so they averaged over the past few years. Tingyi's overall sales
40
Food consumption in China is forecast to expand at a

compound annual average growth rate of 9.4% to 2017.
Per capita food consumption is also forecast to increase at

a robust rate; it is expected to increase at a compound annual average growth rate of 8.8% between 2013and 2017.
Over our five-year forecast period, we are bullish on the growth

prospects of the Chinese food sector. Supported by an ongoing
spread of mass grocery retail (MGR) and increasing incomes,
we are forecasting a massive compound annual average increase
of 9.4% in headline food consumption between 2013 and 2017,
at which point we expect it to reach CNY7.4trn (US$1.06trn).
Smaller cities in China are increasingly capturing the attention
of mass grocery retailers, as the major urban centres become
overcrowded and suffer from overpriced real estate. This is
helping to drive the rise in food consumption as a wider range of
packaged food products become available to a greater number of
Chinese consumers. Increasing disposable incomes will translate
into a greater discretionary appetite and drive food consumption
growth. A sizeable proportion of the country's rural population
falls within a relatively low-income bracket and does not yet
have strong spending power to fund purchases of higher-value
food products. Food consumption remains centred on essential,
staple food and beverage items. However, income levels are set
to increase steadily over the coming years, buoyed by China's
dynamic economic expansion, and this is likely to prompt an
increasing number of Chinese consumers to turn towards the
key sectors
Confectionery
vast availability of high-value, non-essential food and beverage

items to sate their changing consumption habits.

Canned Food

Canned food value sales are forecast to outperform canned

food volume sales; canned food value sales are forecast
to increase at a compound annual average rate of 8.3%,
compared with volume growth of 5.4% to 2017.
Confectionery value sales are forecast to increase at a

compound annual average growth rate of 10.5% to 2017.
Confectionery volume sales are forecast to grow at a compound annual average rate of 7% between 2013and 2017.
Growing incomes and rising health awareness are major trends

dictating the development of the Chinese confectionery sector.
In line with these dynamics, Chinese consumers are developing
increasingly sophisticated tastes with a particular penchant for
healthier confectionery products such as dark chocolate and
functional gum. As confectionery such as dark chocolate typically
carries higher price tags, growing demand for these products
will be very likely to give a bigger impetus to confectionery
value sales over the coming years.
We continue to forecast moderately strong growth in China's

canned food sector, in line with the growing popularity of
processed foods and rising disposable incomes. Between 2013
and 2017, we are forecasting compound annual average growth
of 8.3% in canned food value sales to reach CNY249bn, while
volume sales are forecast to grow at a compound annual growth
rate of 5.4%. Unsurprisingly, the bulk of this growth will be
accounted for by consumers in urban, affluent areas with increasingly busy lifestyles and long working hours fuelling the
demand for convenience and processed food items.
Sugar confectionery dominates the Chinese confectionery market

in terms of volume sales. While sugar confectionery such as cakes
and biscuits are largely perceived as mainstream indulgences
in urban areas, there is a growing demand for higher-value,
healthier alternatives of confectionery such as dark chocolate.
It should be noted that the drivers in China are slightly different

from those in other markets in the Asia-Pacific region, where
lifestyles have become more hectic and consumers have the
disposable incomes to support changing consumption habits.
In China, while these factors certainly are at play, there is a
greater interest in healthy and fresh produce. Therefore, the
canned foods and other pre-packaged items that do sell well
are likely to be those that combine the demands of health and
convenience and which, accordingly, rate as premium items
and can be sold at a much higher price.
Dark chocolate is particularly well received among women

given its relatively lower fat content and antioxidant properties.
Supported by rising incomes and growing health awareness,
we forecast chocolate confectionery sales in volume terms to
increase at a compound annual average rate of 8.9% between
2013 and 2017, representing the highest-growth sub-sector.
More notable is that value sales growth is expected to outpace
volume sales growth over our five-year forecast period, reflecting the accelerating premiumisation momentum in the chocolate
confectionery sector.
Heightened food safety concerns surrounding domestically

produced products due to the recent spate of food safety and
hygiene scandals in the country will also keep the demand for
canned foods propped up over our five-year forecast period, with
consumers opting for the perceived safety of packaged items.
While the gum sector remains a growth laggard among the Chinese confectionery sub-sectors, our growth forecast of 5.0% in
gum volume sales to 2017 on compound annual average terms
is nonetheless respectable given the relative maturity of the
Table: Food Consumption Indicators Historical Data & Forecasts, 2010-2017
Food consumption (US$bn)

Total food consumption growth, %, CNY (y-o-y)
Food consumption (CNYbn)
2010
2011
2012e
2013f
2014f
2015f
2016f
2017f
3,033.4
3,827.4
4,287.4
4,857.2
5,349.6
5,834.6
6,356.3
6,955.8
11.4
26.2
12.0
13.3
10.1
9.1
8.9
9.4
4,913.1
2,230.7
2,796.9
3,113.4
3,505.6
3,838.2
4,162.9
4,511.5
Per capita food consumption (US$)
10.7
25.4
11.3
12.6
9.5
8.5
8.4
8.9
Per capita food consumption (CNY)
448.1
592.1
679.7
783.4
852.5
918.8
985.5
1,062.0
e/f = BMI estimate/forecast.Source: National Bureau of Statistics, BMI
41
china Q2 2014
sector. Similarly, the gum sector is witnessing stronger demand

for healthier alternatives such as functional gum and sugar-free
gum compared with traditional gum and bubble gum.
The trend of innovation is particularly evident in the Chinese
gum sub-sector. Due to the massive array of gum confectionery
in terms of both domestic and foreign brands, gum producers
have turned towards branding and product innovation in terms of
packaging design and flavours to develop their unique competitive differentiation. As gum manufacturers continue to engage
in the aforementioned initiatives to keep up with the rapidly
changing tastes of the younger population, this will certainly
instil greater dynamism in the sector.
Drink
Coffee industry players such as China Resources Enterprise,

Starbucks and Gourmet Master are already geared for aggressive expansion in the hopes of capitalising on the growing
caf culture in China, and their expansionary plans are likely
to imbue the sector with considerable dynamism.
China Resources is currently opening 50-100 Pacific Coffee shops
per year, while Gourmet Master has unveiled plans to increase
its Chinese outlets more than six-fold to 1,000 by 2015. Market
leader Starbucks has also upped its game recently by signing a
deal with the Chinese provincial government of Yunnan to set
up a coffee bean farm as it looks to secure a sustainable supply
of coffee beans to cater for the growing domestic demand for
coffee. Starbucks is also planning to stretch its presence beyond
the major cities of China into third-tier and fourth-tier cities.
Hot Drinks
Alcoholic Drink

Coffee sales are forecast to experience slightly stronger

growth than tea sales to 2017; coffee value sales are forecast
to increase at a compound annual average growth rate of
12.8%, while tea sales are forecast to grow at a compound
annual rate of 10.7%.
Between 2013 and 2017, we are forecasting that tea sales will
experience value growth of 10.7% on a compound annual average
basis to reach CNY25.6bn in 2017. Coffee sales in value terms
are forecast to experience stronger growth of 13.6% over the
same period to reach CNY20.3bn. The slightly weaker growth
forecast for tea sales can be attributed to the relatively saturated
and mature nature of the market.
That said, we expect competition between hot drinks players
to remain intense as the sector delivers long-term susta inable
and reasonably high growth over our five-year forecast period.
The expansionary activities of coffee industry players continue
to bear out the scope for growth in China.
Alcoholic drink sales in value terms are forecast to grow at

a compound annual average rate of 10.5% to 2017.
Alcoholic drink sales in volume terms are forecast to increase at a compound annual average rate of 8.6% to 2017.
China's alcoholic drinks market holds vast potential and continues

to attract major investments from global and local players alike
as they vie for a greater share of this highly attractive market.
These investments will continue to be the main driver behind
our bullish forecast figures. China's alcoholic drinks sector is
forecast to grow by a compound annual average of 10.9% between 2013and 2017 to reach CNY3.9trn in 2017.
Beer sales will continue to experience the strongest volume
growth, at 8.6% on a compound annual average basis to 2017.
This sub-sector in particular is attracting major investments
from the world's leading players, who are prepared to pay over
the odds just to gain a foothold in what is considered to be one
Table: Hot Drinks Value/Volume Sales Historical Data & Forecasts, 2010-2017
2010
2011
2012e
2013f
2014f
2015f
Coffee sales (000 tonnes)
250,823.1
273,980.0
295,213.5
325,688.4
360,652.7
393,533.4
433,544.3
472,719.8
Tea sales (000 tonnes)
603,585.0
674,430.0
745,403.5
803,118.6
869,198.9
937,194.8
1,006,844.2
1,081,137.0
Coffee sales (CNYmn)
2016f
2017f
8,873.5
9,624.8
10,713.0
12,480.8
14,235.3
15,937.0
18,066.4
20,250.5
11,478.5
13,544.1
15,418.5
17,044.2
18,981.5
21,039.5
23,213.4
25,599.2
Coffee sales (US$mn)
1,310.9
1,488.9
1,689.7
1,950.1
2,173.3
2,414.7
2,737.3
3,068.3
Tea sales (US$mn)
1,695.7
2,095.1
2,431.9
2,663.2
2,897.9
3,187.8
3,517.2
3,878.7
Tea sales (CNYmn)
e/f = BMI estimate/forecast.Source: National Bureau of Statistics, Trade press, Company information, BMI
42
key sectors
of the best growth opportunities in the world.

The attractiveness of the Chinese beer sector can be largely
linked to a growing premiumisation momentum in the sector.
Rising affluence will encourage consumer up-trading over the
coming years, and this premiumisation opportunity is already
firmly within the sights of regional brewers. UK alcohol giant
SABMiller plans to trial its international premium beer brand
Miller Genuine Draft in China through its local joint venture
CR Snow Breweries as it seeks to ride on the country's growing
premiumisation trend. Although CR Snow does not yet possess
a nationwide presence across China, we believe that its previous efforts to expand its distribution and strengthen its market
position have put it in a favourable position to pursue growth
in the premium beer market segment. Similarly, Dutch brewer
Heineken is to concentrate on promoting its premium beer in
China in order to maximise its profits.
While volume growth for the Chinese spirits sub-sector remains
fairly modest BMI is expecting 5.9% compound annual average growth in spirits volume sales over our five-year forecast
period the market is expected to expand dynamically in value
terms, buoyed by sustained multinational investment and the
increasing affluence of the country's vast middle class. The
country's rapid middle-class expansion and the accordant rise
in per capita incomes should continue to stimulate substantial
value growth in the spirits sector over the medium-to-long term
as consumers gradually trade up to these higher-value alcoholic
beverages.
Although the spirits sector lacks comparable dynamism in
volume sales growth when compared with the wine and beer
segments, an ongoing barrage of multinational investment and
the increasing affluence of Chinese consumers should keep the
sector's expansion on a strong footing.
China is also developing a greater appetite for wine, particularly
French wine brands. According to a recent report released by
International Wine and Spirit Research, China is set to overtake
the UK in terms of still, light wine consumption within the next
12 months. By overtaking the UK, China would be ranked
among the top five wine-consuming countries across the globe,
according to the report.
Rising consumer affluence, growing health awareness and
increasing dynamism among domestic wine producers are positives underpinning our bullish growth outlook for the Chinese
wine sector. A growing thirst for premium wines is testament to
consumer up-trading in China. As middle-class consumers enjoy

higher incomes, they are developing increasingly sophisticated
tastes and are already opting for imported prestige brands over
their domestic brands. In fact, wine is increasingly perceived
as a status symbol among the emerging middle class in China.
Growing consumer perceptions of the health benefits of red wine
have given another fillip to domestic wine demand.
Meanwhile, domestic wine producers will continue to increase
their wine production, which is likely to bolster wine demand
growth. However, with a stable market unlikely to emerge until local buyers can distinguish between good and indifferent
wines and between imports and locally produced imitations,
Chinese wineries will continue to look to overseas acquisitions
of vineyards to leverage on the brand appeal of international
wines as well as to increase their production capacities. For
example, China Foods, formerly China National Cereals, Oils
and Foodstuffs Corporation (COFCO), a state-owned agribusiness conglomerate, purchased Chteau Viaud, a 20-hectare
Lalande-de-Pomerol estate in the wine region of Bordeaux,
France. Other domestic wineries such as Dynasty Fine Wines
Group and China Great Wall Wine Company are also looking to acquire Old World winery assets. Our forecast of 7.6%
compound annual average growth in wine sales in volume
terms to 2017 underlines the tremendous potential on offer in
the Chinese wine market.
Soft Drinks

Soft drinks sales in value terms are forecast to increase at

a compound annual average rate of 10% to 2017.
The carbonates sub-sector is forecast to witness the slowest growth in the soft drinks segment, with volume sales
expected to increase at a compound annual average rate
of 5.9% to 2017.
Despite its relatively fragmented nature, the Chinese soft drinks

market continues to attract major investments from global and
regional soft drinks manufacturers, which translates into a rapid
emergence of competition in the sector. While carbonates will
continue to account for the bulk of overall soft drink sales in
China, growth opportunities in the carbonates sector certainly
do not compare favourably with the other sub-sectors such as
juices and energy drinks. Investments in the health-oriented soft
drinks categories will only intensify over the coming years as
consumers' purchasing power grows and they develop increasingly sophisticated tastes.
43
china Q2 2014
Despite its relative maturity, China's carbonated soft drinks

sector continues to display strong growth potential within the
Chinese soft drinks market, with production capacity investments by industry majors such as The Coca-Cola Company and
PepsiCo helping to fuel this growth.
Carbonates Dominate: While Coca-Cola continues to dominate the carbonated soft drinks landscape in China, domestic
soft drinks manufacturers are aggressively ramping up their
expansions in terms of product lines and production capacities
as they seek to expand their domestic scale. A recent case in
point is Tingyi-Asahi Beverages Holdings acquisition of
PepsiCo's bottling operations in China. Tingyi-Asahi is a soft
drinks joint venture between Asahi and Ting Hsin (Cayman
Islands). As part of the deal, PepsiCo will receive a 5% stake
in Tingyi-Asahi and will have an option to increase the stake
to 20%. For Tingyi, it could reap the benefits of stronger brand
appeal, greater expansionary capacity and improved expertise
in the carbonated drinks market by bottling and distributing
Pepsi in China. Although Tingyi-Asahi has a reasonably wellestablished portfolio of non-carbonated soft drinks, its reach
in the carbonated soft drinks segment is less impressive, and it
could leverage on PepsiCo's expertise in this segment to achieve
a better-rounded portfolio in soft drinks.
Exciting Prospects In Non-Carbonates: Looking to the longer
term scenario, it is the opportunities in the non-carbonates subsectors that really catch the eye. Increasing consumer purchasing
power is creating a whole new breed of consumers with money
to spend on non-essential purchases and eventually the money
to upgrade to premium products, such as added-value energy
drinks and juices, in line with the growing trend of health
consciousness.
A growing consumer appetite for functional beverages will
continue to attract investments from global and regional soft
drinks manufacturers, which should imbue the sector with
greater dynamism over the coming years. Swiss food giant
Nestl recently acquired a 60% stake in Xiamen Yinlu Group,
a Chinese producer of peanut milk and instant canned porridge,
to strengthen its reach across the Chinese functional drinks market. The likes of Coca-Cola and PepsiCo will also sharpen their
focus on the non-carbonates segment by increasing promotional
expenditures and expanding their product ranges (such as the
Glaceau Vitamin-water energy drink for Coca-Cola and the
Tropicana juice range for PepsiCo).
44
Specifically, the bottled water segment will remain a major

contributor to non-carbonated soft drinks demand and is forecast
to expand by a compound annual average growth rate of 7.8%
to 2017 in volume terms. The low quality of tap water and the
relatively low prices of bottled water largely explain the rapid
uptake of bottled water consumption over the past decade. While
these demand drivers will continue to fuel bottled water sales in
the coming years, continued sector investments from Nestl and
Danone will provide a greater impetus to bottled water demand.
Mass Grocery Retail

Overall mass grocery retail sales (local currency) are

forecast to increase at a compound annual average rate of
9.0% to 2017.
The discount sub-sector is set to outperform, with sales

forecast to increase at a compound annual average rate of
11.4% between 2013 and 2017.
In our view, China represents one of the Asia-Pacific region's

most dynamic long-term growth opportunities. Given China's
rapid pace of urbanisation and continued expansionary investments from the world's leading mass grocery retail players,
there are considerable opportunities on offer in the country. We
highlight the outperformance of the discount store sub-format
over our five-year forecast period, which is expected to grow on
the back of ongoing retailer expansion and growing consumer
interest in these formats.
Rapid urbanisation in China will remain a major driving force
behind the continued spread of modern retail in the country.
As the rural areas of China enjoy the fruits of the country's
rapid economic development, and with the help of government
programmes to boost rural development, rural incomes should
experience a considerable boost, representing a burgeoning
consumer base for modern retailers.
Moreover, given that China has already opened its retail doors
to foreign operators (for example, allowing international
companies to hold 100% equity in local firms), the country is
likely to remain a favoured investment destination for foreign
retailers. Global retail giants have continued to commit vast
sums towards expansions in China, with Carrefour pledging
some 25 hypermarket openings annually and Tesco planning to
double its hypermarket store count to more than 200 and open
500 Lifespace shopping malls in the medium term. Further organic expansion is also on the agenda for Walmart as it looks
to acquire more land in China to establish a greater number of
key sectors
Sam's Club cash-and-carry stores. Meanwhile, Lawson currently has about 355 stores in China and aims to set up around
10,000 stores by 2020.
Perhaps more noteworthy is mass grocery retailers' expansion
focus. We believe that operators in China are likely to shift their
focus to the under-retailed secondary and tertiary towns and
cities. This is due to the prospect of stiffer enforcement of retail
regulations in major cities, which aim to restrict the growth of
modern retail and protect smaller independent retailers.
Chinese soft drinks company is another example of this trend.
In order to secure better control over the distribution of its soft
drinks products, Wahaha is planning to gradually build up its
retail footprint in the less urbanised and less crowded areas of
China before introducing its retail brands to the urban classes.
Although Wahaha's expansion focus can be linked to the intense competition in the urban cities of China, which makes it
challenging to make any significant headway, the company's
expansion plan is nonetheless a strong testimony to the massive
rewards on offer in the rural regions.
The discount store format remains a fledgling concept in China,
which explains its outperformance. Most retailers are already
well entrenched in the supermarket and hypermarket sub-sectors
and are likely to turn to the discount store sub-sector in a bid to
secure additional avenues of growth.
size (compared with hypermarkets) and the format's higher

profitability levels (compared with convenience and discount
stores), thereby encouraging players to continue committing
their resources to the sector.
The other mass grocery retail sub-sectors are also forecast to
expand impressively over our forecast period. Convenience
store sales are expected to increase by a compound annual average growth of 9.7% to 2017, driven by increasing consumer
interest in the convenience store sub-format and the ability of
the format to cater to the increasingly urbanised needs of the
Chinese population. In line with an increase in the number of
dual-income families in the country, demand for convenient and
packaged foods should also increase accordingly.
While we expect strong hypermarket sales growth, we note
the possibility of legislation on large store openings in the sort
of major towns and cities in which large-scale retailers would
wish to invest. We are currently forecasting a compound annual
growth of 8.9% in China's hypermarket sales to reach CNY527bn
by 2017. Plenty of opportunities for growth remain prior to
legislation coming into play and in specific areas once it is
introduced hence the still impressive growth forecast.
With the majority of retailers' expertise lying in the supermarket format, continued expansionary investments will lend
considerable upward support to sales growth in the medium
term. Another supportive factor behind the continued strength
in the supermarket sector is the format's relatively small format
Table: Mass Grocery Retail Sales Historical Data & Forecasts, 2010-2017
2010
2011
2012e
2013f
2014f
2015f
2016f
2017f
Supermarkets (CNYbn)
276.9
320.3
349.9
381.4
417.8
456.4
497.1
541.4
Hypermarkets (CNYbn)
291.9
320.8
345.8
375.0
409.0
445.4
484.3
527.2
3.6
4.0
4.3
4.7
5.2
5.8
6.4
7.2
Discount stores (CNYbn)

Convenience stores (CNYbn)
24.7
30.9
33.8
37.0
40.7
44.7
49.0
53.8
597.1
676.0
733.8
798.1
872.7
952.2
1,036.9
1,129.6
Total mass grocery retail sector growth, %, CNY, (y-o-y)
12.2
13.2
8.6
8.8
9.3
9.1
8.9
8.9
Supermarkets (US$bn)
40.9
49.5
55.2
59.6
63.8
69.2
75.3
82.0
Hypermarkets (US$bn)
43.1
49.6
54.5
58.6
62.4
67.5
73.4
79.9
0.5
0.6
0.7
0.7
0.8
0.9
1.0
1.1
Total mass grocery retail sector (CNYbn)
Discount stores (US$bn)

Convenience stores (US$bn)
Total mass grocery retail sector growth, %, (US$bn)
3.6
4.8
5.3
5.8
6.2
6.8
7.4
8.2
88.2
104.6
115.7
124.7
133.2
144.3
157.1
171.1
e/f = BMI estimate/forecast. Source: China Statistical Yearbook, Trade Press, BMI
45
key sectors
Other Key Sectors

Latest Forecast Data
Below are the latest forecast tables for our other core key sectors:
Table: Freight Key Indicators

Port of Shanghai container throughput, TEU
2013
2014
2015
2016
2017
2018
33,770,220.8
35,705,326.0
37,950,674.9
40,422,118.8
43,097,808.4
45,995,305.7
3.8
5.7
6.3
6.5
6.6
6.7
5,551.4
5,755.1
6,031.4
6,369.1
6,792.9
7,241.2
2.5
3.7
4.8
5.6
6.7
6.6
3,806,400.0
3,859,689.6
3,921,444.6
3,999,873.5
4,095,870.5
4,210,554.9
Port of Shanghai container throughput, TEU, % y-o-y

Air Freight Tonnes (000)
Air Freight Tonnes % Change y-o-y
Rail Freight Tonnes (000)
Rail Freight Tonnes % Change y-o-y
Road Freight Tonnes (000)
-2.5
1.4
1.6
2.0
2.4
2.8
35,595,365.0
39,475,259.8
43,422,785.8
47,591,373.2
51,731,822.7
55,766,904.8
10.5
10.9
10.0
9.6
8.7
7.8
Road Freight Tonnes % Change y-o-y

Source: BMI
Table: Oil and Gas Sector Key Indicators

Oil Proved Reserves, mn barrels
Oil Production, 000b/d
2013e
2014f
2015f
2016f
2017f
2018f
25,584.7
24,001.4
22,410.2
20,804.6
19,199.1
17,601.6
4,540.0
4,625.1
4,646.8
4,686.0
4,686.0
4,664.0
Oil Consumption, 000b/d
10,687.9
11,115.4
11,448.8
11,792.3
12,146.1
12,510.5
Oil Refinery Capacity, 000b/d
10,826.0
11,086.2
11,434.4
11,634.4
11,919.4
11,919.4
Oil Net Exports, 000b/d
-6,147.8
-6,490.3
-6,802.1
-7,106.3
-7,460.1
-7,846.4
105.9
101.8
100.0
99.0
97.0
96.0
Value of Net Oil Exports, US$bn (BMI base case)
Oil Price, US$/bbl, OPEC Basket
-247.4
-252.0
-259.5
-268.2
-275.7
-286.0
Value of Net Hydrocarbons Exports, US$bn (BMI base case)
-273.1
-281.8
-293.7
-306.6
-317.2
-331.2
Value of Net Oil Exports at constant US$50/bbl US$bn
-116.4
-123.3
-129.3
-135.0
-141.6
-148.0
Value of Net Oil Exports at constant US$100/bbl US$mn
-232.8
-246.6
-258.7
-270.0
-283.2
-296.0
Value of Net Hydrocarbons Exports constant US$50/bbl US$mn
-128.5
-137.9
-146.4
-154.4
-163.0
-171.6
Value of Net Hydrocarbons Exports constant US$100/bbl US$mn
-257.0
-275.8
-292.9
-308.8
-325.9
-343.2
-6,988.2
-7,503.5
-7,987.3
-8,449.9
-8,942.3
-9,479.2
Total Net Hydrocarbons Exports, 000boe/d
3.5
3.5
3.6
3.6
3.6
4.0
Gas Production, bcm
Gas Proved reserves, tcm
112.7
117.2
123.1
129.3
135.7
142.5
Gas Consumption, bcm
161.5
176.0
191.9
207.2
221.7
237.3
LNG Price, US$/mn btu
15.7
15.1
14.9
14.7
14.4
14.3
5.6
5.2
4.8
4.4
4.1
3.8
2013e
2014f
2015f
2016f
2017f
2018f
85.6
98.8
111.4
124.4
137.7
151.2
Reserves/Production Ratio
Source: National Statistics, Industry Sources, BMI
Table Pharma Sector Key Indicators

Pharmaceutical sales, US$bn
Pharmaceutical sales, US$bn, % chg y-o-y
Pharmaceutical sales, CNYbn
Pharmaceutical sales, CNYbn % change y-o-y
Health expenditure, US$bn
Health expenditure, US$bn % change y-o-y
Health expenditure, CNYbn
Health expenditure, CNYbn % change y-o-y
Communicable, maternal, perinatal and nutritional conditions, DALY
19.2
15.4
12.7
11.7
10.7
9.8
532.4
608.7
693.2
777.6
860.7
944.8
17.5
14.3
13.9
12.2
10.7
9.8
526.6
611.0
690.8
779.8
882.2
996.4
16.7
16.0
13.1
12.9
13.1
12.9
3,275.2
3,763.7
4,300.2
4,873.6
5,513.5
6,227.4
15.1
14.9
14.3
13.3
13.1
12.9
21,582,865
21,107,358
20,660,102
20,241,124
19,850,453
19,488,117
47
china Q2 2014
Table: Telecoms Sector Key Indicators

Number of Main Telephone Lines in Service ('000)
2013e
2014f
2015f
2016f
2017f
2018f
242,635.0
268,974.0
263,056.5
257,795.4
252,639.5
247,586.7
Number of Main Telephone Lines in Service, % change y-o-y
-3.3
-2.2
-2.0
-2.0
-2.0
-2.0
Number of Main Telephone Lines/100 Inhabitants
19.4
18.9
18.4
17.9
17.5
17.1
Number of Cellular Mobile Phone Subscribers ('000)
1,231,245
1,329,745
1,422,827
1,508,196
1,583,606
1,646,950
Number of Cellular Mobile Phone Subscribers, % change y-o-y
10.9
8.0
7.0
6.0
5.0
4.0
Number of Mobile Phone Subscribers/100 Inhabitants
88.9
95.4
101.5
107.0
111.9
115.8
Number of Mobile Phone Subscribers/100 Inhabitants, % change y-o-y
10.2
7.4
6.4
5.4
4.5
3.5
592,200.0
609,966.0
628,265.0
647,112.9
666,526.3
686,522.1
Number of Internet Users ('000)

Number of Internet Users, % change y-o-y
5.0
3.0
3.0
3.0
3.0
3.0
Number of Internet Users/100 Inhabitants
42.7
43.8
44.8
45.9
47.1
48.3
4.4
2.4
2.4
2.5
2.5
2.5
201,460.5
251,825.6
302,190.7
332,409.7
345,706.1
338,792.0
15.0
25.0
20.0
10.0
4.0
-2.0
Number of Internet Users/100 Inhabitants, % change y-o-y

Number of Broadband Internet Subscribers ('000)
Number of Broadband Internet Subscribers, % change y-o-y
Table: Defence and Security Sector Key Indicators

Defence expenditure, CNYmn
2013e
2014f
2015f
2016f
2017f
2018f
1,745,597.7
1,136,231.1
1,248,143.0
1,359,706.3
1,477,653.0
1,606,169.3
Defence expenditure, CNYmn % change y-o-y
8.3
9.8
8.9
8.7
8.7
8.7
Defence expenditure, % of GDP
2.0
2.0
2.0
2.0
2.0
2.0
820.0
895.5
970.1
1,048.8
1,134.5
1,227.5
168,398.4
182,408.0
191,712.4
202,236.8
214,365.6
227,186.4
Defence expenditure, CNY per capita of population

Defence expenditure, CNY per serviceman
Defence expenditure, US$mn, constant prices
Defence expenditure, US$mn, constant prices % change y-o-y
Defence expenditure, constant US$ per capita of population
6.8
8.3
5.1
5.5
6.0
6.0
121.5
130.9
136.8
143.5
151.4
159.8
Defence expenditure, constant US$ per serviceman

Table: Infrastructure Sector Key Indicators

2010
2011
2012e
2013f
2014f
2015f
2016f
2017f
Construction industry value, CNYbn
3,194.0
3,439.9
3,756.4
4,043.8
4,348.3
4,648.2
4,968.5
5,310.6
Construction industry value, US$bn
494.1
545.3
603.9
656.5
698.5
743.7
795.0
849.7
25.4
10.4
10.7
8.7
6.4
6.5
6.9
6.9
6.9
6.7
6.6
6.5
6.4
6.3
6.2
6.1
Construction industry, real growth, % y-o-y

Construction industry value, % GDP
This report is abstracted from BMIs industry report series, which covers 22 sectors across global markets. Every quarter, we will provide tables
showing the latest five-year forecasts for key industries as well as a forecast scenario for a key sector. If you would like to order a full report, or find
out about BMIs other 1,113 industry reports, please contact subs@businessmonitor.com
48
Chapter 6:
BMI Global Assumptions
Global Outlook
Momentum To Continue In H114
The latter half of 2013 saw an improvement in growth in most
corners of the globe, and we believe this momentum will continue through H114 at least. Overall, we are forecasting 3.2%
global real GDP growth in 2014, up from 2.6% in 2013. This
will be driven by significant acceleration in developed state
growth, to 2.0% in 2014, from 1.2% in 2013, and in contrast to
the modest improvement in emerging markets real GDP growth
to 4.9% from 4.6%.
Leading indicators, from US import demand to global purchasing managers indices, suggest that with the pickup in activity
in China, the US, Europe and even Japan, the global economic
engine is set to have its major pistons firing simultaneously
for the first time since 2010 in the aftermath of the 2008-2009
financial crisis. Europes economic revival appeared to have
faded somewhat towards the end of 2013, but we still believe
that regional growth will gain momentum in 2014, and the US
retains the potential to really surprise to the upside. At the very
least, the drags on growth from the US and Europe are likely
to be behind us. Emerging markets will see varying economic
fortunes depending on their individual situations, but outright
recession looks unlikely apart from a handful of countries.
While China is likely to disappoint on the growth front, its
economy is still feeling the upswing from stimulus efforts
introduced in the wake of the mid-2013 credit crunch, and this
momentum will very likely continue to spill over into early 2014.
Indeed, we have revised up our forecast for Chinese real GDP
growth for 2014 from 6.7% to 7.1%. Despite the upward revi-
Table: Global Assumptions

2012
2013e
2014f
2015f
2016f
2017f
2018f
Real GDP Growth (%)

US
2.8
1.8
2.8
2.6
2.4
2.4
2.4
Eurozone
-0.7
-0.5
1.0
1.3
1.3
1.5
1.5
Japan
1.9
2.4
1.3
1.1
0.9
1.0
0.9
China
7.7
7.6
7.1
6.0
5.8
5.8
5.8
World
2.9
2.6
3.2
3.3
3.3
3.4
3.4
US
2.1
1.7
2.1
2.1
2.1
2.1
2.1
Eurozone
2.6
1.7
1.5
1.6
1.8
1.9
1.9
Japan
0.0
0.3
0.9
1.3
1.8
2.3
2.7
Consumer Inflation (ave)
China
2.7
2.8
2.9
2.8
2.7
2.7
2.7
World
3.4
3.2
3.2
3.1
3.1
3.1
3.1
Fed Funds Rate
0.00
0.00
0.00
0.75
2.00
3.00
3.50
ECB Refinancing Rate
0.75
0.25
0.25
0.50
1.00
1.50
2.00
Japan Overnight Call Rate
0.10
0.10
0.10
0.10
0.25
0.50
0.75
Interest Rates (eop)
Exchange Rates (ave)

US$/EUR
1.27
1.32
1.27
1.23
1.20
1.20
1.20
JPY/US$
79.85
98.00
102.00
102.00
102.00
102.00
102.00
CNY/US$
6.31
6.22
6.16
6.23
6.25
6.25
6.25
OPEC Basket (US$/bbl)
109.50
105.03
101.75
100.00
99.00
97.00
96.00
Brent Crude (US$/bbl)
111.70
107.63
102.75
102.00
101.00
99.00
99.00
Oil Prices (ave)
e/f = estimate/forecast. Source: BMI
49
china Q2 2014
sion, we remain considerably below the Bloomberg consensus

estimate of 7.5%.
down from 1.1% previously) and 1.5% in 2015, following an

estimated -1.0% out-turn for 2013.
Developed States
Elsewhere in Europe, we have lowered our 2013 real GDP

growth estimate for Sweden to 0.8% from 1.1% due to poor
Q313 real GDP data. Survey data and other leading indicators
suggest that the outlook for household consumption and business investment is brightening alongside a recovery in European
demand, and we are forecasting an acceleration in Swedish
growth to 2.4% in 2014.
Our developed states real GDP growth estimate for 2013 is

1.2%, and we forecast this to rise to 2.0% and 2.1% in 2014
and 2015 respectively. We have lowered our real GDP growth
estimate for the eurozone in 2013 to -0.5% from -0.4% previously, owing mainly to a downgrade for the Netherlands. We
forecast the Dutch economy to expand by 0.5% in 2014 (revised
Table: Developed States, Real GDP GrowtH, %
2012
2013e
2014f
Developed States Aggregate Growth
1.4
1.2
2.0
2015f
2.1
G7
1.7
1.4
2.1
2.0
Eurozone
-0.7
-0.5
1.0
1.3
EU-27
-0.4
0.0
1.3
1.6
3.7
2.4
2.0
2.5
Selected Developed States

Australia
Austria
0.8
0.5
1.5
1.9
Belgium
-0.3
0.3
1.2
1.9
Canada
1.7
1.7
2.3
2.5
Czech Republic
-1.3
-0.9
1.3
2.7
Denmark
-0.4
0.4
1.4
1.6
Finland
-0.8
-1.7
1.6
1.9
France
0.1
0.0
0.5
0.9
Germany
0.7
0.5
1.9
1.5
Hong Kong
1.4
2.4
3.0
3.7
Ireland
0.2
0.6
2.1
2.3
-2.6
-1.8
0.4
0.7
Italy
Japan
1.9
2.4
1.3
1.1
-1.1
-1.0
0.5
1.5
Norway
3.1
0.9
1.9
2.7
Portugal
-4.7
-3.0
-0.5
0.9
1.3
3.6
3.2
3.2
Netherlands
Singapore
South Korea
Spain
Sweden
2.1
2.5
3.0
4.1
-1.6
-1.2
0.7
1.1
0.7
0.8
2.4
2.8
Switzerland
1.0
1.9
2.0
1.7
Taiwan
1.3
2.1
3.0
4.1
United Kingdom
0.0
1.5
1.8
2.2
United States of America
2.8
1.8
2.8
2.6
e/f = estimate/forecast. Source: BMI
Table: BMI VERSUS BLOOMBERG CONSENSUS REAL GDP GROWTH FORECASTS, %

US
Eurozone
Japan
Brazil
China
Russia
India
1.7
-0.4
1.8
2.5
7.6
1.5
5.0
BMI
1.8
-0.5
2.4
2.3
7.6
1.4
5.0
Bloomberg Consensus
2.6
1.0
1.6
2.5
7.5
2.5
4.8
2.8
1.0
1.3
2.4
7.1
2.1
5.6
2013
Bloomberg Consensus
2014
BMI
Source: BMI, Bloomberg
50
bmi Global Assumptions
Emerging Markets
Our emerging markets aggregate forecasts are unchanged,
with projected growth of 4.6% in 2013, and 4.9% in 2014 and
2015, which reflects our view that emerging market growth will
improve but not return to the heights of the 2001-2008 period.
In Latin America, stronger economic growth in the first half of
2013 has prompted us to revise up our real GDP growth estimate
for Argentina from 2.9% to 3.2%. We are maintaining our 2.9%
growth forecast for 2014, but risks remain to the upside. In
Brazil, we forecast real GDP growth of 2.4% in 2014, a slight
downward adjustment from our previous 2.5% forecast. This
downgrade, combined with an upgrade of our 2013 forecast to
2.3% from 2.0% previously, mean that we see growth remaining
almost flat over the next 12 months.
In Asia, apart from the downgrade to our 2014 growth forecast

for China, we have revised down our 2013 real GDP growth
estimate for Thailand from 4.0% to 3.6% owing to weak Q313
data, and we expect growth to remain subdued at 3.8% in 2014.
In emerging Europe, weak Q313 data has led us to revise down
our already below-consensus outlook for Russian economic
activity, and we have lowered our 2013 headline growth estimate to 1.4% and our 2014 forecast to 2.1% (from 2.0% and
2.5% previously).
We are well below consensus for Chinese, Japanese and Russian real GDP growth in 2014, while above consensus for India
and the US.
Table: Emerging Markets, Real GDP Growth, %
Emerging Markets Aggregate Growth
2012
2013e
2014f
2015f
5.1
4.6
4.9
4.9
Latin America
2.9
2.7
3.1
3.5
Argentina
1.9
3.2
2.9
3.5
Brazil
1.0
2.3
2.4
3.1
Mexico
3.8
1.6
3.3
3.7
Middle East And North Africa
3.5
3.4
4.1
4.4
Saudi Arabia
5.1
3.6
4.3
3.3
UAE
6.2
4.1
3.4
3.6
Egypt
2.2
1.9
2.7
4.2
Sub-Saharan Africa
4.3
5.1
5.7
5.7
South Africa
2.5
1.9
2.5
3.0
Nigeria
6.5
6.7
7.3
7.4
Emerging Asia
6.9
6.8
6.5
5.9
China
7.7
7.6
7.1
6.0
India*
5.0
5.0
5.6
6.2
Indonesia
6.2
5.7
5.4
6.5
Malaysia
5.6
4.6
4.4
4.2
Philippines
6.8
6.9
6.0
5.4
Thailand
6.4
3.6
3.8
4.4
Emerging Europe
2.7
2.1
2.5
3.2
Russia
3.4
1.4
2.1
2.9
Turkey
2.2
3.3
2.6
3.4
Hungary
-1.7
0.8
1.7
1.9
Romania
0.7
2.6
2.8
3.3
Poland
2.0
1.4
2.6
2.8
e/f = estimate/forecast; *fiscal years ending March 31 (2012 =2011/12). Source: BMI
51
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BMI China Business Forecast Report Q2 2014

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IMPORTANT NOTICE:

Business Forecast Report

Reforms No Silver Bullet

GDP per capita, US$ [7]

GDP per capita, EUR [7]

Import cover, months [10]

Foreign reserves ex gold, US$bn [10]

Current account balance, % of GDP [7]

Current account balance, US$bn [7]

Balance of trade in goods and services, % of GDP [7]

Goods and services imports, US$bn [7]

Balance of trade in goods and services, US$bn [7]

Goods and services exports, US$bn [7]

Budget balance, % of GDP [7]

Exchange rate CNY/EUR, ave [12]

Budget balance, US$bn [7]

Lending rate, %, ave [10]

Exchange rate CNY/US$, ave [12]

Consumer price inflation, % y-o-y, ave [7]

Unemployment, % of labour force, eop [9]

Fixed capital formation, real growth % y-o-y [7]

Fixed capital formation, % of GDP [7]

Government final consumption, real growth % y-o-y [7]

Government final consumption, % of GDP [7]

Private final consumption, real growth % y-o-y [7]

Private final consumption, % of GDP [7]

Nominal GDP, EURbn [7]

Real GDP growth, % y-o-y [7]

Nominal GDP, CNYbn [7]

Nominal GDP, US$bn [7]

Central Bank policy rate, % eop [1,11]

CHINA MACROECONOMIC INDICATORS

Business Monitor International Ltd

Chapter 1: Political Outlook..................................................................................................................... 7

Long-Term Political Outlook................................................................................................................................... 10

Chapter 2: Economic Outlook................................................................................................................ 15

Fiscal Policy ............................................................................................................................................................. 18

Business Monitor International Ltd

Chapter 3: 10-Year Forecast................................................................................................................... 23

Chapter 4: Business Environment......................................................................................................... 27

Chapter 5: Key Sectors........................................................................................................................... 37

Food & Drink ............................................................................................................................................................ 39

Other Key Sectors.................................................................................................................................................... 47

Chapter 6: BMI Global Assumptions..................................................................................................... 49

Business Monitor International Ltd

Major Forecast Changes

We continue to believe that the hangover effects of Chinas economic

changes to Chinas economic forecasts. We have upgraded our 2014

these effects over the coming quarters. Newfound reform momen-

credit excesses. However, several obstacles stand in the way of

We remain a long way below consensus estimates, however, as we

believe that reform measures are likely to be negative for headline

economic downturn. We are forecasting real GDP growth to come

real GDP growth.

in at 7.1% in 2014, before slowing further to average 6.1% growth

Key Risks To Outlook

The main downside risk to our economic outlook remains another

sumer price inflation (CPI) rate has remained remarkably benign,

collapse in external demand, such as the one that occurred at the

while producer price inflation (PPI) has been consistently negative.

height of the global financial crisis. This would seriously undermine

growth in trade-dependent industries and hasten a fall in the property

market, potentially leading to an outright recession. There is also

be crucial in determining the inflation picture in 2014 and beyond,