Chinese leaders have been struggling to manage the delicate task of the country’s long-term economic restructuring. After witnessing plenty of market volatility last year during the “Year of the Goat,” MNCs now face an even more challenging “Year of the Monkey.” Here are a few key trends that multinational executives in China need to keep in mind for 2016:
Growth momentum in industrial production and retail sales will continue to diverge
As the Chinese economy continues to rebalance, the country is likely to see greater divergence between its industrial activity and services sector growth. While the retail market is growing at a relatively healthy rate, industrial production has been in contraction for multiple months. MNCs should expect intensified local competition in the booming retail sector as well as enhanced pricing pressure in the manufacturing and industrial space.
To prop up weakening industrial production, the People’s Bank of China (PBOC) is expected to adopt further expansionary monetary policy in 2016. The 50-basis-point cut in the reserve requirement ratios for major commercial banks this Monday was another attempt to inject liquidity into the market and encourage business activity in the short term. However, dwindling property market growth, heavy local government debts, and rampant shadow banking activity remain key imperatives to be addressed to correct China’s structural imbalance in the long run.
Critical market-oriented reforms are unlikely to see significant breakthroughs in 2016
Despite the government’s relatively successful urbanization efforts to develop China’s hinterland regions and alleviate overexpansion pressures in major coastal cities, Chinese leaders have failed to effectively implement key market-oriented reforms. These include restructuring the state sector, eliminating pricing control, and liberalizing financial markets, all of which would be hugely beneficial for China’s long-term growth trajectory.
While the 13th Five-Year Plan (2016-2020) calls for more market restructuring, the fact that the government has set relatively high growth targets (a GDP expansion floor of 6.5% YOY over the next five years) is a dangerous signal for increased focus on hitting short-term growth numbers and delaying the long-term reform agenda. In 2016, companies are likely to see slow market liberalization progress in China, which will harm the country’s economic transition and its attractiveness for foreign investors.
More market volatility is expected this year amidst murky policy communication
Market volatility will be inevitable as China’s industrial sector continues to weaken in 2016. Tight political and economic control by the Chinese Communist Party is a double-edged sword: while it protects the Chinese economy from external shocks, it is likely to lead to heightened turbulence under mishandled policy implementation and communication. This instability will be felt in the real estate market, stock exchanges, and foreign exchange market. The short-lived circuit-breaker mechanism in China’s equity market this January is a good example of an abrupt regulatory change that threw investors into a panic and further dampened consumer sentiment.
In addition, the Chinese government tends to avoid making clear commitments to reform timelines to allow for a longer grace period before critical economic restructuring takes place, which adds to the opacity of China’s policymaking process. For instance, the PBOC shifted its exchange rate policy from a dollar peg to a basket peg last December as a market liberalization step, but quickly changed it back to a quasi-dollar peg in early February to justify further devaluation of the yuan.
MNCs should also prepare for potential economic nationalism under China’s slowing economy
Heavy regulatory scrutiny and rising local competition sponsored by government support have long been major obstacles for MNCs in China. While the Chinese government promises to gradually open up its key sectors and relax restrictions to permit more foreign direct investment, increasing downward economic pressure could prompt Chinese leaders to rally around the flag and further crack down on foreign companies.
Having an effective government engagement strategy in China, which helps prevent MNCs from regulatory shocks and additional business barriers, will remain a critical strategic aspect for multinationals to consider in 2016. It will also be essential to re-evaluate the costs of operating in China, especially under growing risk of economic protectionism and intellectual property costs.
China’s economic growth in 2016 is going to be a bumpy ride. It will be necessary for MNCs to drive alignment internally: the Chinese economy will be slowing and market volatility will persist until the economic rebalancing act is accomplished, which could take another Five-Year Plan or more. However, the fact that China still adds another G20-sized economy to its GDP every year continues to offer abundant new market opportunities for MNCs.
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Photo Credit: AK Rockefeller