Walled In: China’s Great Dilemma Presentations by: Yansee Mata and Jarrod Van Doren

Overview China’s Economy: Slowing and Slowly Rebalancing Presented by Jarrod Short term, Intermediate term, and Long term expected results. Presented by Yansee

How and Why China’s Economy Matters China is the second-largest economy in the world, as measured by its GDP of $11.4 trillion. It is the most populous country in the world, with 1.375 billion people. 10% of global imports. Its demand accounts for 50–60% of the global production of iron ore, nickel, thermal coal and aluminum, and a significant share of copper, tin, zinc, steel, cotton and soybeans Two Examples: Between August 10 and August 27 of 2015, a 21.5% drop in local Chinese equities: triggered a 5.5% decline in US equities, an 8.1% drop in non-US developed equities, and an 8.4% decline in the MSCI Emerging Markets Index. In the first two weeks of 2016 a 16.4% drop in Chinese equities: 8.0% decline in the S&P 500 Index, 8.8% and 10.7% drop in the MSCI EAFE and MSCI EM indexes, respectively.

How and Why China’s Economy Matters cont.

How and Why China’s Economy Matters Cont. How China’s Economy Matters: Global economies are exposed to a slowdown in China through: Exports to China account for 2.3% of developed markets’ GDP, Their banking sectors’ loans to China, and through their corporate sectors. Examples Include: Australia’s exports to China are 5.1% of GDP 10.3% of South Korea’s total exports are to China Large multinational companies derive sales and profits from goods manufactured and sold in China and from services provided in China

How Foreign Banks are Connected to China As mentioned previously, global economies are exposed to a slowdown in China through their banking sectors’ loans to China. Exposure in the developed economies ranges from a low of 0.1% of bank assets in Italy to a high of 3.0% in the UK, with a modest 0.8% in the US.

Economic Growth in China Main reasons stated China's reported GDP data is unreliable: How quickly GDP data is released and the type of revisions that follow. The deviation between aggregated data and the sum of the underlying components. The very low volatility of China’s GDP.

Economic Growth in China cont.

GDP Reporting and Revisions China is one of the first countries to report its GDP, usually about two weeks after the end of each quarter. There is a lack of clarity regarding revisions and the are systematically upward while some are very significant. The National Bureau of Statistics (NBS) of China has revised upward the real level of 2004 GDP by 16.8% Real GDP growth in 2007 was also revised upward to 14.2% from an initial estimate of 11.9% Developed economies that collect smaller volumes of data more efficiently take between four and six weeks. The Bureau of Economic Analysis (BEA) publishes its advance estimate near the end of the month following the end of each quarter. Deviations in US reporting are both positive and negative and have averaged less than 0.1 percentage point in terms of their impact on US GDP growth rates

Data Discrepancy One of the most frequently used examples is the difference between local GDP data from China’s 31 provinces and the national GDP. Since 2003, the sum of the GDP levels reported by the provinces has been on average 6.1% higher than the national data; in 2012, the sum was nearly 8% higher. Many China observers believe that local province officials systematically exaggerate growth to secure promotions. A National Bureau of Economic Research (NBER) report found that higher city-level GDP growth has been highly correlated with CPC secretarial and mayoral promotions. As shown in Exhibit 2, the sum of provincial data has actually been lower than national GDP more often than it has been higher The Great Leap Forward era and the post- 2003 period are the exceptions. CPC = Communist Party of China Great Leap Forward - was an economic and social campaign by the CPC from 1958 to 1962 Chief changes in the lives of rural Chinese included the incremental introduction of mandatory agricultural collectivization. Private farming was prohibited, and those engaged in it were persecuted and labeled counter-revolutionaries.

How Fast is China’s GDP Actually Growing? One effort to combat the exaggerated reporting was the creation of the Li Keqiang Index It is composed of electricity consumption, rail freight volume and bank lending Li Keqiang Index - created by The Economist to measure China's economy using three indicators, as reportedly preferred by Li Keqiang, currently the Premier of the People's Republic of China

A Tale of Two Economies #1 - the older investment-oriented and export- driven economy. has dropped from a growth rate of 20–30% per year in the 2000s to a modest growth rate of about 7% (measured by industrial sales) has dropped sharply from peak growth rates of 15–20% to an actual contraction (measured by freight turnover) Electricity consumption in the secondary sector is actually declining on an absolute basis from double-digit growth rates just three years ago #2 - The consumer-oriented economy. has slowed more modestly from a growth rate in the high teens to about 9% (measured by retail sales) has decelerated from a peak growth rate of about 15% to around 7% (measured by passenger turnover). electricity consumption in the tertiary sector increased by 7.5% in 2015 secondary sector (comprising mining, manufacturing, construction and utilities) tertiary sector (comprising services such as hotels, real estate, financial services, transportation, storage and post, and other such services)

China’s Tipping Point? It is virtually impossible to identify a specific debt-to-GDP level or time period that will “tip” the Chinese economy into a financial crisis. The economy is evolving and factors that affect the tipping point are constantly changing.