February 5, 2016
U.S.-China Economic and Security Review Commission/1
Highlights of this Month’s Edition
Bilateral trade: At $365.7 billion, U.S. goods deficit with China hits new record; U.S. services exports
expanded to a record high in Q3 2015 driven by high Chinese travel to the United States.
Bilateral policy issues: U.S. firms rate Chinese interpretation of law as top concern and report lower
profitability and future growth in China’s economy in American Chamber of Commerce survey.
Quarterly review of China’s economy: GDP growth slows to 6.9 percent on manufacturing deceleration;
Beijing pursues new “supply-side” reforms; stock market volatility continues; the $500 billion surge in Chinese
capital outflows places the Chinese government on the horns of a dilemma.
Sector focus – Real estate: The slowdown in China’s real estate sector remains a drag on GDP growth;
government attempts to boost the sector have failed to halt the market’s decline.
Bilateral Goods Trade
U.S. Goods Trade Deficit in 2015 Sets a New Record
In 2015, the U.S. goods trade deficit with China increased by 6.7 percent year-on-year to $365.7 billion, a new
record (see Figure 1). U.S. exports to China declined 6.3 percent year-on-year, while imports increased 3.3 percent.
Figure 1: U.S.-China Goods Trade, 2005-2015
Source: U.S. Census Bureau. http://www.census.gov/foreign-trade/balance/c5700.html.
-500
-450
-400
-350
-300
-250
-200
-150
-100
-50
0
50
100
150
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
US$ billions
Exports Imports (negated) Balance
U.S.-China Economic and Security Review Commission 2
While the pace of U.S. export growth to China has never been very high (U.S. exports grew 1.9 percent in 2014),
the actually decline in exports this year makes for a disappointing new development. The only previous time this
happened was at the height of the global financial crisis, when exports fell from $69.7 billion in 2008 to an even
more tepid $69.5 in 2009, before staging a quick recovering in subsequent years.
China’s share of the U.S. goods deficit with the world also set a grim new record in 2015, hitting 50 percent (see
Figure 2). The overall goods deficit for 2015 was $736.2 billion. U.S. exports to China also remain flat for the third
year in a row at 8 percent of the total U.S. exports.
Figure 2: China’s Share of U.S. Goods Exports, Imports and Deficit
Source: U.S. Census Bureau. http://www.census.gov/foreign-trade/balance/c0015.html and http://www.census.gov/foreigntrade/balance/c5700.html.
Top Exports and Imports
In 2015, transportation equipment continued to lead U.S. exports to China, accounting for nearly 22.5 percent of all
exports (see Table 1). On the import side, computer and electronic products continue their perennial reign,
accounting for 35.3 percent of all U.S. purchases from China. Year-on-year, the value of top U.S. imports from
China increased marginally in 2015, with imports of computer and electrical products increasing 1.4 percent while
electrical equipment and appliances, the second-most imported product from China, increased 7.6 percent.1
0%
10%
20%
30%
40%
50%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Exports Imports Deficit
U.S.-China Economic and Security Review Commission 3
Table 1: U.S. Trade with China: Top Five Exports and Imports
(US$ millions)
Source: U.S. Census Bureau. http://censtats.census.gov/naic3_6/naics3_6.shtml.
Advanced Technology Products
The U.S. trade deficit with China in advanced technology products (ATP) reached $120.7 billion in 2015, a $3
billion decline form 2014 (see Table 2). An in the previous years, imports of information and communication
products (ICT) were the main contributor to the deficit. Excluding ICT, the United States ran a $13 billion ATP
surplus on the strength of aerospace exports.
Table 2: ATP Trade through December 2015
(US$ millions)
Source: U.S. Census Bureau. http://www.census.gov/foreign-trade/statistics/product/atp/2015/12/ctryatp/atp5700.html.
U.S.-China Trade in Services
In the third quarter of 2015, U.S. service exports to China grew 41 percent quarter-on-quarter (from $9.4 billion to
$13.3 billion), leading to a $9.35 billion surplus (a 72 percent increase over the second quarter) (Figure 3). Growth
U.S. Top-Five Exports to China U.S. Top-Five Imports from China
Exports
Share of
total
(%)
Change
over
Dec'14
(%) Imports
Share of
total
(%)
Change
over
Dec'14
(%)
Monthly (Dec'15)
Transportation Equipment 2,294,529 22.7% -18.2% Computer and Electronic Products 14,323,883 37.7% -12.4%
Agricultural Products 1,697,905 16.8% -39.0%
Electrical Equipment, Appliances,
and Component 3,107,840 8.2% -4.1%
Computer and Electronic Products 1,685,388 16.6% 8.6%
Miscellaneous Manufactured
Commodities 2,910,501 7.7% 0.5%
Chemicals 1,038,869 10.3% -10.5% Apparel and Accessories 2,330,199 6.1% 3.4%
Machinery, Except Electrical 734,986 7.3% -6.7% Machinery, Except Electrical 2,289,728 6.0% -3.5%
Other 2,675,730 26.4% - Other 13,053,180 34.3% -
Total 10,127,407 100.0% Total 38,015,331 100.0%
Year-to-date (thru Dec'15)
Transportation Equipment 26,113,734 22.5% Computer and Electronic Products 170,246,702 35.3%
Computer and Electronic Products 17,413,485 15.0%
Electrical Equipment, Appliances,
and Component 41,791,051 8.7%
Agricultural Products 14,885,588 12.8%
Miscellaneous Manufactured
Commodities 40,043,966 8.3%
Chemicals 13,515,112 11.6% Apparel and Accessories 33,443,829 6.9%
Machinery, Except Electrical 9,199,044 7.9% Machinery, Except Electrical 30,621,290 6.4%
Other 35,059,299 30.2% - Other 165,733,925 34.4% -
Total 116,186,262 100.0% Total 481,880,763 100.0%
Monthly (Dec'15)
Year-to-date (thru Dec'15)
Exports Imports
Balance
Dec'15 Exports Imports
Balance
2015
Balance
2014
TOTAL 3,376 13,111 -9,735 34,228 154,946 -120,718 -123,764
(01) Biotechnology 70 13 57 796 124 672 393
(02) Life Science 338 233 105 3,316 2,446 870 868
(03) Opto-Electronics 45 535 -490 465 7,058 -6,593 -6,570
(04) Information & Communications 490 11,835 -11,345 5,178 139,325 -134,147 -134,842
(05) Electronics 557 284 273 6,023 3,552 2,471 2,200
(06) Flexible Manufacturing 188 82 106 2,541 952 1,589 1,460
(07) Advanced Materials 23 27 - 4 211 407 -196 -94
(08) Aerospace 1,648 89 1,559 15,481 881 14,600 13,087
(09) Weapons 0 13 -13 2 156 -154 -144
(10) Nuclear Technology 18 0 18 215 45 170 -121
Monthly Cumulative year-to-date
U.S.-China Economic and Security Review Commission 4
in U.S. exports was driven primarily by an 86 percent quarter-on-quarter increase in Chinese travel*
to the United
States; expenditures by Chinese tourists grew from $4.3 billion to $8 billion. This upsurge in travel accounted for
95 percent of the quarter-on-quarter growth in U.S. service exports. As Figure 4 shows, the third quarter of 2015
saw the highest quarterly Chinese expenditures on U.S. travel to date. The cyclical increase in the first and third
quarters could be caused by travel and tuition payments of Chinese students which tend to fall in these quarters.
China is the largest source of international students and education spending to the United States—in 2013 (latest
available) Chinese students spent more than $8 billion in the United States.2 U.S. imports of services from China
remained largely flat in the third quarter of 2015, with a quarter-on-quarter decrease of 0.6 percent from $3.98
billion to $3.95 billion.
Figure 3: U.S.-China Trade in Services, 2014–2015 Q3
Source: U.S. Department of Commerce – Bureau of Economic Analysis, U.S. Trade in Goods and Services by Selected Countries and
Areas, 1999-Present, U.S. Department of Commerce, Foreign Trade Division, February 2016.
Figure 4: Quarterly Chinese Spending on Travel to the United States, 2010–2015 Q3
* Under U.S. statistics, travel service expenditures include travel for the purposes of education.
-$6
-$4
-$2
$0
$2
$4
$6
$8
$10
$12
$14
$16
Q1 Q2 Q3 Q4 Q1 Q2 Q3
2014 2015
$US billions
U.S. Exports to China U.S. Imports from China U.S. Surplus
$0
$1
$2
$3
$4
$5
$6
$7
$8
$9
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
2010 2011 2012 2013 2014 2015
US$ billions
U.S.-China Economic and Security Review Commission 5
Source: U.S. Department of Commerce – Bureau of Economic Analysis, U.S. Trade in Goods and Services by Selected Countries and
Areas, 1999-Present, U.S. Department of Commerce, Foreign Trade Division, February 2016.
Bilateral Policy Issues
U.S. Companies Report Inconsistent Interpretation of Chinese Laws, Less Welcome
Environment, and Decreased Profitability in China
The American Chamber of Commerce in China (AmCham) released its 2016 Business Climate Survey, which
highlighted growing concerns among U.S. businesses regarding inconsistent interpretation of Chinese laws by the
regulatory authorities. For the first time since 2010, surveyed U.S. firms reported that “inconsistent regulatory
interpretation and unclear laws” presented the greatest challenge to doing business in China.3 As Table 3 shows,
this year 57 percent of U.S. firms reported unclear laws and regulatory inconsistency as their top business challenge
in China.4 This issue has been consistently reported as a concern for U.S. business—from 2012 to 2015 it was the
second-most reported challenge in AmCham surveys.5 U.S. businesses have previously expressed concerns that
Chinese regulations are more frequently and severely applied to foreign firms. For example, in 2014 the U.S.
Chamber of Commerce stated that China’s antimonopoly law was enforced “disproportionately against foreign
companies to achieve industrial policy goals” and found that anticompetition fines were higher for foreign firms
than for Chinese businesses (on average 3.3 percent of the previous year’s sales for foreign firms versus 2.5 percent
for Chinese firms).6,* Alongside these regulatory concerns, difficulties in obtaining Chinese licenses rose to the third
most frequently cited challenge, with 29 percent of respondents identifying it as a top concern in 2016.7
Industry
overcapacity—a new addition to the survey in 2016—was the fifth most cited challenge for U.S. firms.8 This year
AmCham reported the results of 496 surveyed U.S. businesses operating in China.9
Table 3: Top Five Business Challenges in China for U.S. Firms, 2012–2016
2012 2013 2014 2015 2016
Shortage of
qualified
management:
43%
Labor costs:
44%
Labor costs:
61%
Labor costs:
61%
Inconsistent
regulatory
interpretation and
unclear laws:
57%
Inconsistent
regulatory
interpretation and
unclear laws:
37%
Inconsistent
regulatory
interpretation and
unclear laws:
38%
Inconsistent
regulatory
interpretation and
unclear laws:
39%
Inconsistent
regulatory
interpretation and
unclear laws:
47%
Labor costs:
54%
Shortage of
qualified
employees:
29%
Shortage of
qualified
employees:
35%
Shortage of
qualified
employees:
37%
Shortage of
qualified
employees:
42%
Obtaining required
licenses:
29%
Obtaining required
licenses:
26%
Corruption:
30%
Shortage of
qualified
management:
31%
Shortage of
qualified
management:
32%
Shortage of
qualified
employees:
29%
* For more analysis on business conditions in China, see U.S.-China Economic and Security Review Commission, Chapter 1, Section 2,
“Foreign Investment Climate in China,” in 2015 Annual Report to Congress, November 2015, 72–139. http://1.usa.gov/1Jcwf3h.
U.S.-China Economic and Security Review Commission 6
Corruption:
26%
Shortage of
qualified
management:
30%
Obtaining required
licenses:
31%
Increasing Chinese
protectionism:
30%
Industry
overcapacity:
29%
Source: American Chamber of Commerce in the People’s Republic of China, “2016 China Business Climate Survey Report.”
http://www.amchamchina.org/policy-advocacy/business-climate-survey/.
A majority of U.S. companies—71 percent—reported they felt foreign businesses are less welcome in China than
before (see Figure 5).10 The share is even higher in select industries. For example, 81 percent of tech, research and
development (R&D), industrial, and resource firms reported China to be less welcoming.11 This presents a dramatic
increase over survey results in previous years. In 2015 and 2014, 47 and 44 percent of U.S. businesses, respectively,
stated that China was less welcoming.12
Figure 5: Percent of U.S. Business Reporting China More or Less Welcoming to Foreign Business by
Sector, 2016
Source: American Chamber of Commerce in the People’s Republic of China, “2016 China Business Climate Survey Report.”
http://www.amchamchina.org/policy-advocacy/business-climate-survey/.
Despite concern over inconsistent interpretation of rules and perceptions of a less welcoming environment, this year
59 percent of U.S. businesses reported that changes in Chinese policies had improved business conditions (up from
55 percent in 2015), and 55 percent of businesses reported improvements to the business environment due to
Chinese enforcement of rules and regulations (see Figure 6).13 Strong progress in intellectual property rights
protection was reported, with 91 percent of U.S. businesses stating that China’s enforcement of intellectual property
rights had improved over the past five years (compared to 86 percent in 2015).14
0% 20% 40% 60% 80% 100%
All sectors
Industrial and resources
Technology and R&D intensive
Services
Consumer
Less welcome than before More welcome than before
U.S.-China Economic and Security Review Commission 7
Figure 6: Percentage of U.S. Businesses Reporting Improved Business Conditions due to Chinese Policy
Changes and Enforcement, 2015–2016
Source: American Chamber of Commerce in the People’s Republic of China, “2016 China Business Climate Survey Report.”
http://www.amchamchina.org/policy-advocacy/business-climate-survey/; American Chamber of Commerce in the People’s Republic of
China, “2015 China Business Climate Survey Report.” http://www.amchamchina.org/policy-advocacy/business-climate-survey/2015-
business-climate-survey.
A decreasing number of firms responded that they had a profitable year in 2015. Overall, a majority (64 percent) of
U.S. businesses reported that the past year was either profitable or very profitable.15 However, this was the lowest
share of firms reporting profitability in the past five years (Figure 7). The survey concluded that a mix of slower
economic growth and inconsistent application of laws are impacting U.S. companies. Eighty-three percent of U.S.
businesses predict that China’s growth in 2016 will be below 6.75 percent, with nearly half of survey respondents
anticipating Chinese growth below 6.25 percent.16
Figure 7: Was the Previous Year Profitable in China?, 2011–2015
Source: American Chamber of Commerce in the People’s Republic of China, “2016 China Business Climate Survey Report.”
http://www.amchamchina.org/policy-advocacy/business-climate-survey/.
44%
46%
48%
50%
52%
54%
56%
58%
60%
2015 2016
Changes in Policy Enforcement of Policy
9% 12% 10% 11%
20% 13%
16% 16%
23%
67% 68% 62% 67%
58%
9% 9% 9% 6% 6%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2011 2012 2013 2014 2015
Large loss Loss Break even Profitable Very profitable
U.S.-China Economic and Security Review Commission 8
Finally, there is widespread concern about the potential impact of the draft Foreign Nongovernmental Organization
(NGO) Management law on the ability of U.S. NGOs to operate in China. China is considering draft legislation that
gives Chinese security agencies broad powers to monitor, inspect, and terminate foreign NGOs operating in China.17
The law is written broadly enough to possibly include many business associations, foreign universities, and legal
and professional societies.18 Seventy-five percent of U.S. NGOs responding to the survey reported that the law
would limit the scope of their operations in China and 17 percent stated it would cause them to exit the country
(Figure 8). Only 25 percent foresee no negative consequences.19
Figure 8: How Draft NGO Law Would Affect U.S. NGOs
Source: American Chamber of Commerce in the People’s Republic of China, “2016 China Business Climate Survey Report.”
http://www.amchamchina.org/policy-advocacy/business-climate-survey/.
Quarterly Review of China’s Economy
Growth Hits 25-Year Low
According to official data released by China’s National Bureau of Statistics, China’s gross domestic product (GDP)
growth fell to 6.9 percent in 2015—a 25-year low—in line with the target of “around 7 percent” cited by Premier
Li Keqiang (see Figure 9).20 In the fourth quarter of 2015, China’s GDP grew 6.8 percent year-on-year, marking
the lowest quarterly performance of the year from a high of 7 percent in the first and second quarters.21 Doubts over
the accuracy and reliability of China’s official figures, however, have led some economists to look to other
indicators, including electricity, rail freight, supply of raw materials, and retail sales, as proxies for measuring
China’s GDP.22 Based on these indicators, which are less sensitive to political pressures, many estimate China’s
actual growth rate to range from 4 to 6 percent.23
0% 20% 40% 60% 80% 100%
Limit scope of operations in China
Limit ability for corporate partners to
support
Raise cost of operations
Limit ability to raise funds
No negative impact
Cause organization to exit China
U.S.-China Economic and Security Review Commission 9
Figure 9: China’s GDP Growth, 2010–2015
(year-on-year)
Source: Sina (China), “National Bureau of Statistics: China’s 2015 GDP Increased 6.9 Percent,” January 19, 2016. Staff translation.
http://finance.sina.com.cn/china/gncj/2016-01-19/doc-ifxnqriy3132067.shtml; CNN, “China’s Economy Grew 10.3 Percent in 2010,”
January 20, 2011. http://edition.cnn.com/2011/BUSINESS/01/19/china.gdp.growth/; Neil Gough, “China Lowers Official Economic
Growth Target,” New York Times, March 4, 2015. http://www.nytimes.com/2015/03/05/business/china-lowers-official-economic-growthtarget.html.
On February 3, 2016, the Chinese government announced the GDP growth goal for 2016 will be between 6.5 percent
and 7 percent, slightly lower than the 2015 target.
24 The International Monetary Fund’s (IMF) forecasts for China
were 6.3 percent for 2016 and 6 percent for 2017—below the Chinese government’s target.25 The IMF cut the global
growth outlook for 2016 by 0.2 percentage points to 3.4 percent in light of the economic turmoil in China and weak
performance in other emerging markets.26
Consumption, Services Rise as Manufacturing Slides
China’s growth appears to conform to the Chinese Communist Party (CCP) leadership’s pledge to rebalance the
economy away from its reliance on investment and exports and toward consumption-led growth. As seen in Figure
10, consumption’s contribution to GDP growth in 2015 has continued to increase, accounting for about two-thirds
of growth in 2015 compared with 51 percent in 2014. The investment’s share of GDP growth continued an overall
downward trend, falling from 47 percent of GDP growth in 2014 to 36 percent in 2015.27 China’s net exports were
a drag on the growth in 2015: official data show December exports fell 1.4 percent year-on-year, while imports fell
7.6 percent over the same period.28
10.3%
9.2%
7.8% 7.7%
7.4%
6.9%
6.0%
6.5%
7.0%
7.5%
8.0%
8.5%
9.0%
9.5%
10.0%
10.5%
11.0%
2010 2011 2012 2013 2014 2015
Official GDP Growth Rate Target
U.S.-China Economic and Security Review Commission 10
Figure 10: Share of GDP Growth, 2010–2015
Source: China’s National Bureau of Statistics via CEIC.
Though consumption appeared to be a main component of growth in 2015, retail sales growth data suggest
consumption played a smaller role than in 2014. Retail sales of consumer goods—a crude measure of total
consumption—grew 10.7 percent year-on-year in December 2015, compared with 11.5 percent in December 2014
(see Figure 11). Because China’s retail sales figure includes spending not just by households but also by government
departments and business-to-business sales, however, the household consumption component of GDP expenditure
can be a more accurate indicator of household spending.29 As shown in Figure 12, the 2015 decline in retail sales
could be due to the decline in the government component of GDP expenditure, given the household component’s
year-on-year increase in 2014 (official data for 2015 components of GDP expenditure were not available at the time
of writing).
Figure 11: Growth in Retail Sales of Consumer Goods, March 2014– December 2015
(monthly, year-on-year)
Source: China’s National Bureau of Statistics via CEIC.
46%
63%
56%
48% 51%
65% 66%
45% 42%
54%
47%
36%
-11% -8%
2%
-2%
2%
-3%
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
2010 2011 2012 2013 2014 2015
Consumption Investment Exports
10.8%
10.9%
10.7%
10.7%
10.5%
10.6%
10.8%
10.8%
11.2%
11.5%
10.2%
9.9%
10.2%
10.6%
10.4%
10.4%
10.8%
11.0% 11.0%
10.7%
9.5%
10.0%
10.5%
11.0%
11.5%
12.0%
U.S.-China Economic and Security Review Commission 11
Figure 12: Retail Sales versus Consumer Spending, 2005–2015
(year-on-year)
Source: China’s National Bureau of Statistics via CEIC.
Economic restructuring efforts appeared to accelerate in 2015. China’s tertiary sector—predominantly services—
grew nearly 12 percent year-on-year in the fourth quarter of 2015, outpacing secondary industries (mining, heavy
industry, manufacturing, and utilities)—China’s former growth engine—which nearly flat-lined (see Figure 13).
Primary industry (agriculture) grew 3.9 percent year-on-year.30 Official data show the services sector contributed
48.1 percent of China’s GDP in the fourth quarter, while construction and manufacturing contributed 40.4 percent
and agriculture contributed 11.6 percent. 31 Given the sizable contribution of the industrial sector to GDP, a
significant slowdown in heavy industry growth is a major contributor to the overall economic deceleration.
Figure 13: GDP Growth by Sector, 2012–2015
(quarterly, year-on-year)
Source: China’s National Bureau of Statistics, via CEIC.
0%
5%
10%
15%
20%
25%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Household Expenditure Government Expenditure
Retail Sales of Consumer Goods
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
2012 2013 2014 2015
Primary (Agricultural) Secondary (Industrial) Tertiary (Services)
U.S.-China Economic and Security Review Commission 12
Deterioration of conditions in China’s manufacturing sector—denoted by a Purchasing Managers’ Index (PMI)
reading below 50—continued through the end of 2015. The Caixin unofficial estimate of China’s manufacturing
PMI registered at 48.2 in December 2015, an improvement from the 2015 low of 47.2 in September but down from
49.6 in December 2014 (see Figure 14). Industrial value-added growth—viewed by markets as a proxy for overall
growth in China—has also slowed markedly, slumping from 7.9 percent year-on-year in December 2014 to 5.9
percent in December 2015.32 Both indicators show that industrial output—a main component of China’s GDP
growth—is continuing an overall downward trend.
Figure 14: China’s Declining Manufacturing Sector, March 2013–January 2016
Source: China’s National Bureau of Statistics via CEIC; “China Caixin Manufacturing PMI.”http://www.investing.com/economiccalendar/chinese-caixin-manufacturing-pmi-753.
Beijing Highlights “Supply-Side” Reforms
As rebalancing efforts take effect, policymakers in Beijing are having to modify the reform agenda to minimize
economic adjustment costs and reduce the risk of a debt-related disruption.33 According to explanations published
by Chinese state-run media outlets, Beijing is backing away from so-called “demand-side reforms”—including
measures like adjusting banking regulations and interest rates and exports—acknowledging these measures have
“not been very successful” in stimulating investment or consumption.34 Instead, the government announced it will
pursue “supply-side reforms,” which are aimed at boosting productivity and effective use of production factors
including resources, skilled workers, and technology.35 Michael Pettis, a Beijing-based economist and professor of
finance at Guanghua School of Management at Peking University, interpreted the new emphasis on supply-side
reforms to include the following key objectives:
1. Reducing overcapacity. This will involve encouraging mergers and acquisitions and allowing unproductive
firms to close without risking a level of unemployment that is destabilizing.
2. Reducing real estate inventory. The boom in real estate construction to promote Beijing’s massive
urbanization initiative has created an oversupply of inventory. Further liberalizing the household
registration system should help create demand for housing in lower-tier cities and reduce excess inventory.
3. Deleveraging and otherwise strengthening balance sheets. Zombie firms—heavily indebted, nonproductive
companies, often state-owned—are dragging down growth while banks are pressured to extend loans to
such firms so as not to cause a disruptive bankruptcy. Potential supply-side reforms would focus on making
debt-servicing costs more manageable for such firms and addressing the pressures to loan to them.
44.0
45.0
46.0
47.0
48.0
49.0
50.0
51.0
52.0
53.0
4%
5%
6%
7%
8%
9%
10%
11%
Industrial Value Added, YoY (LHS) Caixin Manufacturing PMI (RHS)
Neutral PMI
U.S.-China Economic and Security Review Commission 13
4. Fiscal expansion, including tax cuts. With the goal of boosting demand, tax cuts will be designed and
implemented to improve business efficiency.
5. Lowering corporate costs directly and by reducing government bureaucracy. This will involve reducing
institutional transaction costs for businesses to generate higher economic productivity and improve firms’
competitiveness.36
According to Mr. Pettis, the announcement of these supply-side reforms more or less constitutes leadership’s
recognition of the present danger of continued credit expansion and limitations of earlier reforms, but fails to address
the bigger risk to its economy—the quality and structure of Chinese debt. He argues China has two main options to
address ongoing deceleration and potential risk of future stagnation: one, to recognize the productivity growth will
not relieve its rising debt burden and liquidate assets to pay down debt; or two, to pursue the supply-side reforms
to unleash productivity strong enough to counter the debt burden.37 Mr. Pettis assesses that further avoidance of
reducing debt on the part of China’s economic policymakers risks a “near permanent state of economic
stagnation.”38 Columbia University professor and award-winning economist Joseph Stiglitz argues such supplyside
measures would ultimately be much more effective and tenable if Beijing embraces aggressive, better-designed
demand-side reforms, which would diffuse deflationary pressures resulting from China’s excess capacity problem.39
Because comprehensive demand-side reforms would reduce excess supply, he writes, the magnitude and scope of
supply-side reforms needed to prop up growth will be diminished.40
Stock Market Volatility Continues into 2016
Six months after its widely felt crash, the Chinese stock market experienced further declines in January, with the
Shanghai Composite Index (SCI), China’s main exchange, falling 22.6 percent.41 The slide was triggered in part by
the devaluation of the renminbi (RMB) against the U.S. dollar in early January, sparking concerns over the strength
of the Chinese economy.42 Since reaching its June 12 peak, the SCI has fallen 46.8 percent, while Shenzhen, the
smaller, technology-dominated exchange, has fallen 45 percent.43
Volatility continued despite a new circuit breaker mechanism implemented at the start of the year intended to
prevent dramatic falls in the market.* The mechanism was designed to suspend trading for 15 minutes when the
benchmark CSI300—an index that tracks the largest listed companies in Shanghai and Shenzhen—dropped 5
percent. If the index dropped an additional 2 percent, markets would close for the remainder of the day.44 However,
the system had the opposite of its intended effect, speeding up stock declines as investors scrambled to sell before
trading was suspended.45 On January 4, the first day the system was implemented, the CSI300 dropped 7 percent,
activating the circuit breaker and ending trading for the day 80 minutes early.46 On January 7, the market once again
fell 7 percent, this time after they had been open for less than 30 minutes.47 The same day, the China Securities
Regulatory Commission (CSRC) suspended the circuit breaker, citing its negative effects.48
Since the circuit breaker was suspended, markets have continued to decline, with the SCI dropping below the key
3,000 mark, an indicator of sentiment (see Figure 15). To limit further market volatility, the CSRC announced on
January 6 that large shareholders—defined as those holding 5 percent or more of shares in listed companies—will
be prohibited from selling over 1 percent of their total shares for the next three months.49 The CRSC also set a
requirement that large shareholders must disclose share reduction plans 15 trading sessions in advance of taking
action.50
* For more information on the recent stock market turmoil, see Nargiza Salidjanova, “China’s Stock Market Meltdown Shakes the World,
Again,” U.S.-China Economic and Security Review Commission, January 14, 2016. http://1.usa.gov/1SKu6Dh.
U.S.-China Economic and Security Review Commission 14
Figure 15: Shanghai Composite Index, June 2015–February 2016
Source: Shanghai Stock Exchange via CEIC database.
China Capital Outflows Surge amid Economic Slowdown
China’s calibrated opening of its capital accounts, expectations of an RMB depreciation, and rising concern over
its economic growth contributed to slower capital inflows and a surge of capital outflows in 2015.* While a number
of factors are fueling this shift, a major exodus of financial assets slows economic growth by reducing the
availability of domestic capital and generally signals a loss of confidence in a country’s economic strength. China’s
annual inflows of foreign capital dropped from an average of $387 billion during 2010–2014 to $110 billion in
2015.51 Net capital flows shifted from a surplus of inflows in 2013 to significant outflows in 2015. In the first three
quarters of 2015, capital outflows totaled $275 billion; total capital outflows (excluding foreign reserve loss)
reached $460 billion in 2015 based on calculations from the Institute of International Finance, a financial industry
trade group.52
This figure rises significantly with the inclusion of “errors and omissions,” a proxy for the amount of unofficial
capital flows by investors circumventing China’s tight capital controls.53 A review of recent trade figures between
China and Hong Kong revealed that Chinese citizens get money out of the country by over-invoicing imports and
under-invoicing exports.54 A comparison of China’s imports from Hong Kong and Hong Kong’s exports to China—
figures that should match—revealed that according to Chinese numbers, imports from Hong Kong were $142.5
billion higher than reported by the corresponding numbers from Hong Kong.
55 In December 2015, China’s General
Administration of Customs reported $164.1 billion (1.05 trillion RMB) worth of imported goods from Hong Kong,
while Hong Kong’s Census and Statistics Department reported $21.57 billion (HK$168.13 billion) in exports to
China.56
With the inclusion of errors and omissions, capital outflows totaled $436.8 billion in the first three quarters of 2015
(see Figure 16).57 Capital outflows accelerated in the last few months of 2015 based on unofficial estimates. The
Institute of International Finance calculated $676 billion in total capital outflows for 2015.58 Bloomberg Intelligence
measured nearly $1 trillion in outflows for 2015 compared with $134.3 billion in 2014.59
*
In closed capital accounts like China, balance of payments are a proxy to estimate net capital flows. Institute of International Finance,
“Capital Flows to Emerging Markets,” January 19, 2016, 14.
2,500
3,000
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5,500 June 12 - Stocks
Begin to Tumble Jan. 4 - Circuit
Breaker
Triggered
Jan. 7 - Circuit Breaker Suspended
U.S.-China Economic and Security Review Commission 15
Figure 16: China’s Capital Inflows and Outflows, 2005-Q3 2015
Note: Data incorporate errors and omissions.
Source: State Administration of Foreign Exchange via CEIC.
The significant rise in capital outflows reflects both anxiety about the Chinese market and pursuit of higher returns
abroad. Main drivers of China’s capital outflows include:
Loosening of Capital Controls: Over the last year, China has been gradually and selectively loosening its
controls on capital inflows and outflows—a key component of its financial reform agenda and broader goals
for the internationalization of the RMB.* As controls have been slowly relaxed, Chinese investors have
moved money abroad to take advantage of higher returns and diversify their portfolios.60 But an annual
$50,000 cap on the purchase of U.S. dollars for Chinese citizens remains in place, prompting illicit capital
outflows.61
Debt Repayment: Chinese firms borrowed heavily in U.S. dollar-denominated debt, taking advantage of the
appreciating value of the RMB and low U.S. interest rates following the global financial crisis. The sudden
devaluation of the RMB in August 2015 raised the cost of servicing their foreign debt by approximately
$15 billion.62 The U.S. Federal Reserve’s interest rate hikes in December 2015 strengthened the value of
the U.S. dollar and made borrowing more expensive, further incentivizing Chinese firms to reduce their
existing dollar-denominated debt.63
Depreciation of the RMB: Chinese citizens and global investors are seeking to move their assets abroad
before a depreciation of the RMB erodes the value of their assets. After years of steady appreciation,
investor expectations are shifting toward a weakening value of the RMB.
64 Goldman Sachs expects a 6
percent depreciation in the RMB in 2016. 65 Several other hedge funds, such as Hayman Capital
Management, Greenlight Capital Inc., and PointState Capital LP, are betting the RMB’s value will fall.66
Concern over the State of China’s Economy: In 2015, China’s economic growth slowed to its lowest pace
in a quarter of a century at 6.9 percent (for more information on the slowdown, see “Growth Hits 25-Year
Low” section).
67 In addition, the Chinese government’s muddled responses to the volatility of the stock
market and the sudden devaluation of the RMB in August 2015 have shaken investors’ confidence in the
ability of the Chinese government to run the economy.68
* For in-depth analysis on China’s efforts to internationalize the RMB, see: Eswar Prasad, “China’s Efforts to Expand the International Use
of the Renminbi” (prepared for the U.S.-China Economic and Security Review Commission, February 4, 2016).
http://1.usa.gov/1QeJEui.
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U.S.-China Economic and Security Review Commission 16
Surge in Outbound Mergers and Acquisitions: Based on data from the research consultancy Rhodium
Group, Chinese companies spent around $1 trillion on outbound mergers and acquisitions in 2015, a 16
percent increase from 2014.
69 Outbound acquisitions by Chinese firms are accelerating. According to
international financial software firm Dealogic, announced acquisitions in 2016 already total $12.5 billion,
the fastest start to a year on record.70
Increasing Numbers of Chinese Citizens Traveling and Studying Overseas: China has rapidly become the
world’s largest source of outbound international tourists and tourism-related expenditures. 71 Chinese
international travel grew from 10 million departures per year in 2000 to 98 million in 2013, and Chinese
spending abroad has also increased at a faster rate than any other country in the world, growing 28 percent
from 2013 to 2014.72 In addition, increasing numbers of Chinese students are studying abroad. In 2014
alone, more than 350,000 Chinese students traveled to the United States.73
“They [the Chinese government] have a clear choice: tightening the capital account or allowing the currency to
depreciate more quickly,” explained Kit Juckes, a global strategist at the French-based multinational banking and
financial firm Societe Generale.74 Continuing current policies runs in opposition to the “impossible trinity” that a
central bank cannot simultaneously maintain an independent monetary policy, a fixed exchange rate, and free capital
borders. If capital outflows continue to grow, it will place pressure on the RMB to depreciate, forcing the People’s
Bank of China (PBOC) to either allow the currency to depreciate or defend the currency with its reserves. Thus far,
the Chinese government has sought to maintain both the value of the RMB and last year’s incremental reforms to
loosen capital controls.
75
Foreign Reserves Fall
Rather than let the RMB devalue, the PBOC has been buying up RMB with its foreign reserves to artificially create
demand, contributing to a $483.1 peak decline of reserves in 2015 alone.76 China’s foreign reserves have fallen
$662.9 billion from their $3,993.2 billion height in June 2014 to $3.33 trillion in December 2015 (see Figure 17).77
Charles Collyns, chief economist for the Institute of International Finance, noted this fall “was unprecedented in
magnitude.”78 These holdings are expected to drop further in the coming year as economic growth slows.79
The PBOC has sought to stem the outflow of foreign reserves by increasing the cost of betting the RMB will
weaken.
80 Private equity and hedge funds have taken out loans in RMB that become easier to pay off as the RMB
devalues. To prevent such a devaluation, the PBOC is squeezing liquidity in Hong Kong—a major center for
onshore and offshore RMB trading. On January 25, the PBOC expanded reserve requirements on Hong Kong-based
RMB deposits from just mainland banks to all offshore banks, thus reducing the availability of RMB funds by
around $23 billion (150 billion RMB).81 The PBOC has pressured mainland banks to raise interest rates for Hong
Kong-based bank loans, effectively killing the offshore RMB-lending business with higher borrowing costs.
82 In
addition, the PBOC has prohibited foreign asset managers such as private equity and hedge funds from raising
RMB-based funds for overseas investments. 83 Beyond regulatory and administrative measures, the Chinese
government has signaled its unwillingness to allow the RMB to depreciate further. After billionaire investor George
Soros predicted “a hard landing” for China’s economy, China’s state-run media made veiled threats that “radical
speculators” would “suffer huge losses” from trying to bet against the RMB.84
U.S.-China Economic and Security Review Commission 17
Figure 17: China’s Official Foreign Reserves, 2005–2015
Source: People’s Bank of China via CEIC.
Sector Focus: Declining Real Estate Market Weighs on GDP
Growth
China’s Property Market Continues Weakening despite Rising Prices
The slowdown in China’s real estate sector remains a drag on GDP growth and has spurred government action to
restore confidence in the sector. China’s Real Estate Climate Index (RECI), a measure of the country’s business
activity in land sales and real estate, reveals that year-on-year real estate activity declined every month in 2014 and
2015, and dropped to 93 in December 2015, well below the 100 mark that distinguishes market growth from
contraction (see Figure 18).85 This decline has significant implications for China’s economic growth. Enam Ahmed,
a senior economist at the banking and financial services firm Standard Chartered, described China’s housing sector
as the “single most important sector in the world economy at present.”86 Mr. Ahmed’s emphasis on the property
market is supported by a recent Standard Chartered study calculating that China’s housing and related property
sectors—including demand for construction materials—contributed just 1.1 percent to the country’s GDP in 2015,
down from 3 percent in 2010.87 Analysts suggest that housing market declines were responsible for around half of
the slowdown in China’s economic growth, which decelerated from 10.6 percent to 6.9 percent during the same
period, highlighting the significant role the sector plays in China’s economy.
88 While growing housing prices could
signal a recovery in the country’s real estate market after a multiyear slump, stagnant investment, coupled with a
glut of available housing, have thus far derailed government efforts to support property sector growth.89
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U.S.-China Economic and Security Review Commission 18
Figure 18: Real Estate Climate Index, 2014–2015
Note: In the RECI index, figures below 100 indicate a slowdown in China’s real estate market.
Source: China’s National Bureau of Statistics via CEIC database.
New home prices and property sales began to trend positive in the final months of 2015 following a series of policy
changes aimed at supporting the real estate sector.90 To promote home buying, Beijing lowered the national firsthome
down payment requirement from 25 percent to 20 percent starting in February.91 This is the second cut to
down payment requirements since September 2015. In August 2015, Beijing relaxed restrictions on property sales
for foreign nationals, abolishing rules requiring foreigners to live in China for a year before investing in property
and removing limits on how many properties foreign buyers can purchase.92 Shortly after these policies took effect,
the property market began to show signs of improvement: average new home prices rose 1.6 percent year-on-year
in December, up from a 0.9 percent year-on-year increase in November (the third consecutive month of increasing
housing prices after over a year of steady declines).93 Of the 70 cities China’s National Bureau of Statistics monitors
for fluctuations in property prices, 39 saw new home prices increase in December 2015, compared to 33 a month
earlier.94 Property sales also increased in the final months of the year, reaching 14 billion square feet in December,
a 6.5 percent increase year-on-year and up 17.6 percent from November 2015.95 Additionally, annual home sales
reached a record high in 2015—exceeding $1 trillion—in large part because of rising prices in major cities like
Beijing and Shanghai.96
Despite recent increases in property prices and sales, Chinese real estate investment, which affects more than 40
sectors of the Chinese economy, remains sluggish.97 Although the central government has cut interest rates six times
over the past year and eliminated caps on deposit rates, property investment increased just 1.2 percent in 2015
compared to a 10.5 percent increase in 2014.98 In December 2015, real estate investment grew at its slowest monthly
rate since February 2009, increasing 1 percent.99 According to data from the real estate analytics firms CBRE
Research and Real Capital Analytics, China ranked just 13th globally in foreign investment for commercial real
estate in 2015, well behind its rankings from the previous years.100,* According to Liu Xuezhi, an analyst at Bank
of Communications Co. in Shanghai, “The biggest factor damping the momentum in [China’s] economic growth
now is the slowdown in [property] investment,” with government efforts to attract investors falling short.101
If the Chinese government successfully boosts property investment, however, it risks further increasing the
country’s growing housing glut. Unsold new homes in China occupied 4.9 billion square feet in 2015, an 11.2
percent increase year-on-year from 2014, despite government programs to buy unsold properties and convert them
* The same CBRE Research and Real Capital Analytics report ranked China the eighth-largest recipient of foreign real estate investment in
2013 and the tenth-largest recipient in 2014. Esther Fung, “Bargain Hunters Look to Shanghai amid Property Slowdown,” China Real
Time (Wall Street Journal blog), October 28, 2015. http://blogs.wsj.com/chinarealtime/2015/10/28/bargains-hunters-looks-in-shanghaiamid-property-slowdown/.
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U.S.-China Economic and Security Review Commission 19
into public housing.102 As a result of the massive oversupply, new housing construction projects fell by 14 percent
year-on-year in 2015.103 However, the floor space of commodity buildings*
still under construction has increased
by 32 percent since 2011, indicating construction completion rates will remain high even as the number of new
construction projects declines (see Figure 19).104 The Chinese government hopes urbanization, rising incomes, and
changes to the national housing registration system—known in China as hukou†—will result in increased demand
for housing, possibly by as much as 175 million new homes by 2030.105 The rate of inventory destocking, however,
will vary between provinces and cities, with urban areas taking two to three years to normalize, while oversupply
could exist in regional cities for over ten years.106 To successfully destock inventories while also increasing property
investment, China’s property sales must continue to rise; otherwise, Beijing risks increasing the housing glut as
construction rates rise relative to demand.
Figure 19: Property Construction of Commodity Buildings, 2005–2015
Source: China’s National Bureau of Statistics via CEIC database.
New Policies Needed to Address Market Declines
To increase property market growth, Beijing will have to reconcile major discrepancies between top-tier and lowertier
housing markets. Housing demand is focused disproportionately in China’s four first-tier cities—Beijing,
Shanghai, Shenzhen, and Guangzhou—leaving property prices in the second- and third-tier cities much lower.107
Lower-tier cities, which are categorized by their lower population, GDP, infrastructure, and cultural or historical
significance,‡
account for around 60 percent of national property sales, and thus are essential markets for improving
China’s national property sector. However, while property prices in Shenzhen increased nearly 50 percent year-onyear
in December, prices in Dandong—a third-tier city—dropped 5 percent year-on-year in the month.108 Since
February 2015, housing prices in second- and third-tier cities have increased only 2 to 3 percent, compared to around
15 percent in first-tier cities over the same period (see Figure 20).109 Investment in lower-tier cities is also declining:
according to a survey by the Asian Association for Investors in Non-Listed Real Estate Vehicles (ANREV), China’s
* Commodity buildings are housing properties that are sold in the private market. Leon Berkelmans and Hao Wang, “Chinese Urban
Residential Construction to 2040,” Reserve Bank of Australia, September 2012, 2.
http://www.rba.gov.au/publications/rdp/2012/pdf/rdp2012-04.pdf.
† For more on hukou reforms, see U.S.-China Economic and Security Review Commission, Economics and Trade Bulletin, January 6,
2016. http://origin.www.uscc.gov/sites/default/files/Research/Jan%202016%20Trade%20Bulletin.pdf.
‡ Second-tier cities are often defined as the provincial capitals and special administrative cities, while third-tier cities are generally
classified as prefecture level or county-level capitals. Alex Frew McMillan, “The Rise of China’s 2nd and 3rd Tier Cities,” CNBC,
February 10, 2011. http://www.cnbc.com/id/41420632.
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billion square meters
Floor Space Started Floor Space Completed
Floor Space under Construction
U.S.-China Economic and Security Review Commission 20
second-tier cities, which had been a top ten investment destination in 2014, attracted investments from 12.3 percent
fewer investors year-on-year in 2015.110
Figure 20: Newly Constructed Residential Sales Price, Year-on-Year Percent Change, 2011–2015
Source: Stratfor, “China: No Easy Cure for Local Governments’ Addiction to Real Estate Revenue,” October 16, 2015.
https://www.stratfor.com/analysis/china-no-easy-cure-local-governments-addiction-real-estate-revenue#.
As a result of the stagnant property prices and declining investment in China’s smaller cities, Chinese property
developers are quickly losing revenue: one-third of China’s property developers reported an operating loss in 2015,
and in January the Wanda Group, one of China’s largest property developers, cut its forecast for 2016 housing sales
by 37.5 percent from 2015.111 Foreign capital has provided temporary relief for property developers’ rising debt
levels, with currency devaluations in the second half of 2015 enabling China’s real estate developers to either swap
foreign currency debts for domestic ones or to pay them down.
112,*
If Beijing is unable to reverse market declines, however, local government debt, which increased to around 40
percent of GDP in 2015, will continue to rise.113 While the central government takes 48 percent of the country’s
total annual tax revenue, it is only responsible for 20 percent of the country’s annual fiscal expenditures, forcing
local governments to make up the difference.114 To bridge the budget gap, provinces and towns rely on loans from
state-owned banks as well as revenue generated from selling land use rights.115 As the property market becomes
increasingly unprofitable, local governments are struggling to pay off their loans and borrowing more from banks.116
If a local government becomes unable to pay off its debts, Beijing will have to bail out the losses of state-owned
banks, leading to entrenchment of moral hazard.117
Moving forward, China is reportedly considering a number of fiscal reforms to increase housing prices in lower tier
cities and rein in the nationwide property glut.
118 According to the state-run news outlet Xinhua, in August 2015
Beijing began laying out plans to introduce a real estate tax, which economists say would go a long way toward
reducing the oversupply of property.119 A Fitch report in August detailing the implications of a national property
tax also indicated the policy would provide local governments with “more stable, sustainable, and diverse revenue”
to reduce debt levels, though at a higher cost for property buyers.120 In early December, China’s Politburo also
vowed to reduce home inventory, although it did not offer specific plans to achieve this goal, which is intended to
spur investment in the sector.121 A working plan for 2016 laid out by China’s Ministry of Finance did not mention
*
In 2014, debt levels for China’s largest land developers rose 29 percent year-on-year. Neil Gough, “China’s Housing Market Shows Signs
of Hope,” New York Times, May 18, 2015. http://www.nytimes.com/2015/05/
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