Section divider CHINA OUTLOOK 2016 kpmg/globalchina 2016 Foreword At the beginning of 2016, the economic landscape in China is undoubtedly more challenging to decipher than when we prepared our 2015 report. Over the last year, there has been a lot of discussion about China’s transition to an era of slowing rates of economic growth. Continuing turmoil in the China stock market and weaker growth in several of the country’s most closely followed economic indicators have provided further cause for concern. A string of business climate surveys have all tended to portray the lower competition, higher margin glory days as relics of the past. These phenomena have led many pundits to argue that China’s economy may be in for a hard landing. Scanning global headlines, one is left with the impression that foreign investors’ eyes are pivoting towards untapped parts of Asia or India, or to opportunities closer to home. Increased outward investment by Chinese companies is cited as further evidence of structural problems at home. Yet, we believe these headlines do not tell the complete story. While 6.9 percent gross domestic product (GDP) growth in 2015 represents a 25-year low, it is still one of the highest among the world’s largest economies. In addition, the incremental economic output generated by China’s 6.9 percent growth today is much higher than in the years when China was experiencing double-digit growth. A nuanced analysis of economic data confrms our view that China is transitioning from an investment-intensive, export-led model of growth, to one driven by consumption and innovation, a shift that is being refected in patterns of inward foreign direct investment (FDI) and outward direct investment (ODI). This process has led to the emergence of a two-track economy. One track – in basic manufacturing and traditional industries – is experiencing signifcant headwinds; while a second track –in services, advanced manufacturing and consumer markets – is exhibiting strong growth potential. Of the record USD 126.3 billion that was invested into China last year, the services sector accounted for 61.1 percent; and while manufacturing’s share of total FDI decreased for the ffth consecutive year, investments into ‘high-tech manufacturing’ increased by 9.5 percent year-on-year (YoY). Foreign investors are recognising that opportunities are shifting rapidly to new industries, such as e-commerce, healthcare and automation. This shift supports what is perhaps the single constant of China’s 30-year economic transformation – the Chinese Government’s adept ability to mobilise foreign technology, know-how and capital towards the sectors with the most pressing needs for development assistance. In overseas markets, Chinese frms have increasingly invested in services, advanced manufacturing, technology and other high value- added and consumption-related sectors, as well as in assets providing high and stable returns. The latest data shows that China’s ODI reached a historic high of USD 118.02 billion in 2015, and though sector-specifc data for 2015 had not yet been released at the time of publication, fgures on outbound merger and acquisition (M&A) deals show that high value-added sectors such as electronics, fnancial services and healthcare present attractive investment opportunities for Chinese frms. Going forward, we expect the ‘two-track’ economy to continue characterising China’s growth, which will have a corresponding impact on inward and outward investment trends. While GDP is likely to continue on its slower growth trajectory, we see this as a positive development, as it is a necessary condition for China’s transition to a high value- added economy. Along the way, the demands of Chinese citizens and the priorities of the Chinese Government will become more complex, impacting the motivations and strategies of foreign frms investing in China, and Chinese frms investing abroad. As a fnal note, when we consider the outlook for 2016, we must remember that 2016 marks the start of the next Five-Year Plan period, from 2016 to 2020. The fnal plan is expected to be released in March 2016, but based on the ‘Proposal’ for the 13th Five-Year Plan released in late 2015, we expect that the plan will contain additional encouragement for Chinese companies to expand overseas in key sectors critical to the national priorities laid out in the plan. Similarly, we expect it to emphasise stepped-up FDI in areas such as pollution abatement, and to facilitate the introduction of foreign capital and innovation to address societal challenges under the ‘new normal’. Vaughn Barber Global Chair, KPMG Global China Practice * Figures are sourced from the National Bureau of Statistics of China (NBS) and Ministry of Commerce (MOFCOM). Full sources are provided in the document. Contents BUSINESS ENVIRONMENT OUTWARD DIRECT INVESTMENT (ODI) FOREIGN DIRECT INVESTMENT (FDI) 0238 China Outlook 2016/ 1 Business environment I n China Outlook 2015 – a fagship publication by KPMG’s Global China Practice (GCP) which was released last January – it was predicted that in light of the headwinds facing China’s economy, its GDP growth was “likely to slow down further in 2015, but not dramatically”. During the Third Session of the 12th National People’s Congress (NPC) a few months later, Chinese authorities lowered the offcial GDP target from 7.5 percent to “about” 7.0 percent. Looking back, the challenges in 2015 were actually more signifcant than anticipated. Several of the most closely followed economic indicators – such as the Purchasing Managers’ Index (PMI), exports, fxed asset investment (FAI), commodity prices and housing sales – displayed weaker performances. These factors, along with the Chinese stock market turmoil and currency depreciation in the second half of 2015, seemed to support the arguments of China’s bears, who believed the country’s economy was approaching a hard landing. Come 2016 and this still has not happened, and China’s economic growth has proved to be quite resilient. At 6.9 percent for the whole year, the country’s GDP growth rate for 2015 stayed very much in line with the offcial target (see chart below). While slower than previous years, this is still among the highest of the world’s major economies, and given the size of China’s economy today, the increase in economic output in 2015 was more than in previous years when the growth rate was higher. In comparison, the US would have to grow at 4 percent in order to produce the same amount of incremental economic output that China generated with 6.9 percent growth. Unsurprisingly, according to forecasts prepared by the International Monetary Fund (IMF), China is expected to continue being the largest contributor to world GDP – in purchasing power parity terms – and is expected to account for nearly 20 percent of world GDP by 2020, compared to 15.5 percent for the European Union and 14.9 percent for the US.1 Source: ‘Preliminary Accounting Results of GDP for the Fourth Quarter and the Whole Year of 2015’, National Bureau of Statistics of China (NBS), 21 January 2016, stats.gov/english/PressRelease/201601/ t20160121_1307717.html; KPMG analysis 1‘IMF Data Mapper: World Economic Outlook (October 2015)’, IMF, accessed on 19 February 2015, imf/external/datamapper/index.php. Importantly, the IMF’s most recent data revision to its World Economic Outlook did not modify the projections for China’s GDP growth; see ‘World Econo