China Reacts to Trade War

China Reacts to Trade War

China has announced sectors of the economy where it will ease foreign investment rules, with leaders stepping up efforts to portray the country as opening up as they prepare for a possible trade war with the United States.

The new “negative list” outlines key reforms in the financial sector while dropping restrictions in areas including the car industry, agriculture, infrastructure and mining.

The list released Thursday by the National Development and Reform Commission (NDRC), which will come into effect on July 28, will reduce the number of fields with limits from to 48, from 63 last year.

But it also notes some sensitive areas such as culture and national security will continue to be protected.

The announcement comes after the government unveiled changes earlier this year, which were seen as a nod to the United States and other western nations that have complained about lack of access to the world’s number two economy for years.

Among them are the cancellation of foreign shareholding caps for banks and allowing 51 percent control in some other financial fields for three years, after which restrictions will be scrapped.

However, critics say the policy comes with other limits that make only the largest foreign banks eligible for entry.

The list also removes curbs on petrol station ownership, cereal trading, and electricity infrastructure, while also easing restrictions in the auto, aircraft and ship-building industries.

The announcement comes as the world’s two largest economies prepare next week to slap the first batch of new border taxes on tens of billions of dollars in goods from both countries, fanning fears of a potentially damaging trade war.

Facing outside protectionism, China must “make greater efforts to promote openness, promote reform, promote development, promote innovation through openness, and promote the further development of economic globalisation”, the commission said in a statement.

“Investment cooperation between China and other countries and regions will be deepen further, with more extensive exchanges of capital, technology, management, and talents carried out.”

Beijing’s rhetoric is in sharp contrast to Washington, where officials have been considering ways to limit Chinese investment and even the flow of some Chinese nationals to US universities.

Beijing has been keen to portray itself as the wronged party, repeatedly saying it does not want a trade war but will hit back with equal strength if forced into a corner.

Officials also released a white paper Thursday mounting a full-throated defence of its pledged reforms and promises since joining the World Trade Organization in 2001.

“China has steadfastly carried out every promise made upon entering the World Trade Organization,” vice commerce minister Wang Shouwen said when introducing the report, and challenged countries that don’t agree to “sue us at the WTO”.

China’s government is facing a multi-front battle to defend its economy, fighting to reduce its debt mountain while the yuan and local stock markets tumble in the face of a US trade conflict.

With the Trump administration preparing to roll out tariffs on some $34 billion of Chinese imports next week, the Shanghai Stock Exchange is taking a nosedive — down some eight percent in the last two weeks before recovering on Friday.

The yuan has also come under pressure, falling to its lowest rate against the dollar since November 2017.

Louis Kuijs, head of Asia economics at Oxford Economics, said a trade war could slow China’s economy by 0.3 percentage points on average over 2019-2020.

“The increased uncertainty and risks will weigh on business confidence and investment, especially cross-border investment. There will be an impact on growth, in China, the US and elsewhere,” he added.

The tariffs expected to take effect July 6 are just a fraction of the total Trump has vowed to levy on China if it hits back with its own punitive measures.

As stocks fell recently, the governor of the People’s Bank of China (PBOC), Yi Gang, urged investors to “stay calm and rational”, assuring that the central bank would mitigate any “external shocks”.

– Reserve rate cut –

On Sunday the PBOC said it would reduce the reserve requirement rate (RRR) for most banks by 50 basis points in order to release some 700 billion yuan ($105 billion) of funds for loans for small businesses.

Lu Ting, chief China economist at Nomura International, said the move would provide “fresh liquidity for the real economy” and sent “a strong signal of policy easing”.

But he added a note of caution, saying that despite the RRR reduction, “we believe the Chinese economy is yet to bottom out, and the situation could get worse before getting better.”

The rate cut will come into effect on July 5 — on the eve of the day the first wave of US tariffs are due to bite — while the PBOC has beefed up its regular cash injections into the financial system.

But China has to be wary of pulling the easing lever too readily.

President Xi Jinping’s administration has been trying since last year to curb China’s significant indebtedness, tightening regulation of the banking sector and cracking down on rampant “shadow financing”.

That requires a delicate balance — if credit fully runs out of steam, companies will struggle to finance themselves.

Julian Evans-Pritchard, senior China economist at Capital Economics, said the RRR cut is “intended to support banks’ debt-to-equity swaps rather than mark a shift away from deleveraging and toward monetary easing.”

“But in practice, the RRR cut does seem likely to result in looser monetary conditions given signs that policymakers are becoming more concerned about the downside risks to economic activity from slowing credit growth,” he added.

Industrial production, retail sales and investment slowed in May, all signs of an ongoing slowdown in the world’s second largest economy.

– ‘Prevent panic’ –

Beijing has set a growth target of “around 6.5 percent” for 2018.

To reach this goal against “strong internal and external headwinds” expected in the second half, further easing is likely in the coming months, Nomura’s Lu Ting said.

The yuan, meanwhile, has been sliding.

A weaker currency might help Chinese exporters facing US tariffs, but the PBOC could step in if the depreciation goes too far.

Evans-Pritchard says Beijing is acutely aware of a similar slide in 2015-2016 that led to a painful capital flight.

China is therefore trying to carry out a deft balancing act: supporting the economy and business loans, while continuing to stem swelling debt and financial risks.

The debt mountain, corporate defaults and trade tensions prompted the National Institution for Finance and Development, an influential Chinese government-backed think-tank, to issue a stark warning.

“We think China is currently very likely to see a financial panic,” it said in a note quoted by Bloomberg. “Preventing its occurrence and spread should be the top priority for our financial and macroeconomic regulators over the next few years.”

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S. Jack Heffernan Ph.D. Funds Manager at HEFFX holds a Ph.D. in Economics and brings with him over 25 years of trading experience in Asia and hands on experience in Venture Capital, he has been involved in several start ups that have seen market capitalization over $500m and 1 that reach a peak market cap of $15b. He has managed and overseen start ups in Mining, Shipping, Technology and Financial Services.

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