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‘Two track’ economy for China: KPMG China Outlook 2016 Report

‘Two track’ economy for China: KPMG China Outlook 2016

While China's economic growth rate is slowing and there are major challenges to resolve in the traditional state owned sectors – with high levels of debt, overcapacity, low productivity and pollution issues – there are also many positives, according to KPMG’s China Outlook 2016 report released today.


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The detailed report from KPMG’s Global China Practice (GCP) finds that China’s transition from an investment and export-led growth model to one driven by consumption and innovation has led to the emergence of a two-track economy. The first track, in basic manufacturing and traditional industries, is experiencing significant headwinds, while the second, in services, advanced manufacturing and consumer markets is exhibiting strong growth potential.

“Properly understanding the objectives of China’s economic development, the policy settings which are being implemented to steer this transition, and the progress which has already been made are all key to understanding the drivers, trends and outlook for Chinese investment overseas, and for foreign investment in China,” said Vaughn Barber, Global Chair of KPMG’s Global China Practice.

The Chinese Government introduced a number of major policy initiatives in 2015 to facilitate the country’s economic transformation, tackle overcapacity issues, increase productivity, promote innovation and entrepreneurship, and enhance the international competitiveness of China’s traditional industries. Importantly, rather than focusing on the speed of growth, these initiatives place importance on the quality of growth in order to achieve a more balanced level of development that is conducive to long-term prosperity. This is expected to continue to be a feature of China’s policies over the next few years, especially following the release of the 13th Five-Year Plan in March 2016.

“There are some very encouraging stories here which auger well for Australia,” said Doug Ferguson, KPMG Australia’s National Leader Asia Business Group. “Notably, recent economic data shows the contribution from consumption as a percentage of GDP in China is rising and that means potential opportunity.”

He said the China Outlook 2016 report was timely as it not only addresses many of the fears circulating about China's economic growth but also highlights the robust growth for the services element of the Chinese economy – offsetting the impact of the industrial slowdown there.

Mr Ferguson was speaking from the Australia China Business Council meeting at Parliament House where the Prime Minister, the Hon Malcolm Turnbull MP, Foreign Minister the Hon Julie Bishop MP, and Australia’s new Trade & Investment Minister the Hon Steve Ciobo MP, are talking with Chinese and Australian business leaders.

“The Report shines a light on the sectors that Chinese companies will invest in overseas in the next 3 years – key information for Australia – and highlights which sectors the Chinese government wants foreign investors to focus on in China.”

e-commerce is one of these. According to the KPMG Report, Chinese consumers are reaching into their e-wallets following strengthening retail sales in 2015. The role of e-commerce has rapidly become a dominant feature in the Chinese consumer spending landscape – leading to the rise of industry disruptors and new entrants.

“e-commerce is the big standout. Online retail sales revenue totalled RMB 3.8 trillion in 2015 - an increase of 37 percent YOY and will double again by 2018. Australian exporters and importers need to understand this is the new superhighway for selling and distributing our consumer food and other products,” said Mr Ferguson.

“For Chinese outbound investment, it's all about the acquisition of technology, famous brands, healthcare services and financial services. Real estate also remains a dominant theme. Based on the report statistics, 82 percent of Chinese ODI now goes to developed countries like USA, Australia, Germany and 76 percent by private Chinese companies.”

He said that China, like Australia, was focusing on innovation as a means of transitioning into a high-value-added economy. With the ratification of the Free Trade Agreement between Australia and China, he pointed to the potential for the export of Australian goods and service, including know-how into China.

“The China Australia Free Trade Agreement (ChAFTA) will boost trade and investment between China and Australia: lower tariffs will help Chinese exporters’ competitiveness as well as reduce costs for consumers in China purchasing imported products from Australia,” he said.

The services, technology and advanced manufacturing sectors, led by private companies, have taken over the lead role in driving growth. KPMG says this will only continue - with strong government support and rising entrepreneurship and innovation cultures.

However, China's consumption contribution at 52 percent of GDP (vs USA at 68 percent) and urbanisation percentage at 52 percent vs 80 percent for most developed countries shows there is a long way to go for growth in all sectors.

Nevertheless, there will be ongoing opportunity for Australia says Doug Ferguson. The KPMG report highlights Australia’s position as one of the top five destinations for China’s overseas investment in 2014 – the most recent data year captured.

China became Australia’s seventh largest source of foreign investment in 2014 with its total investment stock here amounting to AUD 64.5 billion (about USD 58.2 billion) which was up 23.7 percent from 2013.

In addition to stimulating trade flows between both countries, we expect ChAFTA will continue to prompt Chinese countries to invest in Australia,” said Mr Ferguson. “This, coupled with the continued rise of a strong consumer market in China, suggests positive opportunity for both countries.”


Chinese Overseas Direct Investment (ODI)

Chinese non-financial outbound investment hit a record high of USD 118.02 billion in 2015, recording a 14.7 percent year-on-year increase. The value of announced deals recorded a 40 percent increase over the same period to reach USD 87.7 billion. Given this rapid growth, Chinese outbound M&A may be on track to surpass the USD 100 billion mark this year. Indeed, the first few weeks of 2016 showed no signs of this trend abating, with a staggering USD 74.8 billion of deals being announced in the period up to 18 February. Chinese outbound M&A activity continued to be focused on ‘quality growth’ with not only more, but also larger deals being announced in high value-added and consumption-related sectors. Consistent with this, more deals were done in developed markets, with many involving privately-owned enterprises (POEs).

KPMG’s GCP expects China’s ODI will continue to grow by more than 10 percent per annum, driven by factors including Chinese companies’ desire to acquire experience, technology, brands and human capital to become more competitive, and to access high-quality products and services that can be deployed in China to meet its evolving consumption trends. Agriculture and food, infrastructure, high-end manufacturing and real estate will continue to be important sectors in 2016, while ICT, healthcare and transportation are new 'hot' sectors to watch.

KPMG’s GCP also predicts more overseas investment by POEs and financial investors, as well as more win-win cooperation between Chinese and foreign companies. “A key feature of the ‘new normal’ for China’s relations with the rest of the world is ‘cooperation’ and ‘collaboration’, both in China and in markets outside China, to the mutual benefit of China, the partnering countries and the third-country markets,” said Vaughn Barber.

North America, Europe and other developed economies are expected to attract more investment as the availability of high-quality targets in those regions can help Chinese companies upgrade, transform and boost their competitiveness. More projects and investments will be undertaken along the 'Belt and Road', as the objectives come to be better understood and the mode of implementing this initiative continues to evolve over the coming year.

Careful attention should be paid to three positive drivers of Chinese ODI in 2016, namely China’s advancement of a new paradigm of international cooperation – through its ‘Belt and Road’ initiative for example, the emergence of new funding sources, and the implementation of the recent free trade agreements with Australia and South Korea.


Foreign Direct Investment (FDI)

China Outlook 2016 finds that non-financial FDI into China in 2015 increased by 6.4 percent year-on-year to reach an all-time high of USD 126.3 billion. There were fewer but larger inbound M&A deals, representing an increase in average deal size as higher value, more expensive Chinese companies were acquired.

In line with the emergence of a two-track economy in China, the service sector represented 61.1 percent of total FDI in 2015, while FDI into manufacturing accounted for 31.4 percent. As a comparison, 63.6 percent of China’s total FDI went into the manufacturing industry in 2006, while the service sector attracted 31.1 percent.

According to KPMG, the Chinese government has launched a number of policies and initiatives to encourage FDI in 2016 and beyond. These present significant opportunities for companies with targeted, well-positioned value propositions that deliver against emerging customer needs while simultaneously delivering a strong value proposition to the government’s development goals. Government spending will pivot to the ‘lean, clean and green’ categories that seek to improve healthcare coverage, reduce environmental impact, strengthen food safety and security, and ameliorate pollution conditions.

Recent policy publications indicate authorities are committed to opening up the service and manufacturing sectors to foreign capital, and loosening restrictions in the finance sector. China’s FTAs with Australia and South Korea, the establishment of new Free Trade Zones (FTZs) in Guangdong, Fujian and Tianjin, and the expansion of the Shanghai FTZ will assist in this process. Likewise, authorities are trying to leverage the latest advances in information communication technology, advanced manufacturing and automation technologies to increase the productivity of the country’s traditional industries, bringing opportunities to foreign companies with expertise in these fields. The deepening of China’s SOE reform should lead to more acquisition targets for, as well as wider market access to, foreign companies.

For further information, contact:

Kristin Silva

Head of Communications, KPMG Australia

Mobile: +61 411 110 953

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KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.

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