Abstract China launched its economic reforms and open door policy in 1978. A country having largest population, it attracts a pool of foreign investors towards its economy. Since then the economy went through a series of regulatory and political changes, global and domestic factors surrounded the economy, and it emerged as the second largest economy in the world registering a positive growth in its GDP consecutively for almost two decades.
The economic situation prevailing globally requires the investors today to assess the opportunities across the globe and China looks to have favourable macroeconomic factors towards being a good investment opportunity. Background of China’s Phenomenal Growth Though China was proclaimed communist right after the 1949 revolution, it wasn’t until Deng Xiaoping came into power in 1976 that central planning was infused with capitalist thoughts and ideals.
China’s modern growth truly began with Deng Xiaoping’s policies, which though way short of the Shock Therapy being advocated by Jeffery Sachs to the South American economies, was still a step towards a new form of communism – heavy state sponsored industrialization coupled with Foreign Direct Investments with a minimum of red tape. China’s vast resources along with the above policies have made it the fastest growing major economy in the world. The skewed distribution of resources has also meant that development has been concentrated along the coastal areas.
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China’s GDP, inflation, foreign direct investment, Currency Exchange rate, Balance of Payment (BOP) and unemployment rate are some of the macroeconomic factors that we will look into in this paper. Foreign Direct Investment (FDI) After the first wave of invasions by the Mongols in the 13th century, China has predominantly been a closed economy. Although its wealth surpassed that of the European cities of the Renaissance period like Venice and Vienna, it remained hidden from the rest of the world. This trend continued after Mao Zedong took power in 1949.
FDIs into China in its current form began after Deng Xiaoping gradually eased FDI regulations, resulting in a large amount of money flowing into Chinese development projects. During this period American and Japanese companies began using China as their hub of manufacturing and most of the investments were made by them. Macroeconomic Factors Affecting Investments in China Page 1 [SAPM TERM PAPER] September 28, 2011 FOREIGN DIRECT INVESTMENT IN CHINA (1984-2004) 180 160 140 120 100 80 60 40 Contracted Utilized 20 0 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 Source of data: Ministry of Commerce of the People’s Republic of China.
For the purposes of this paper, taking a look at the more recent trends in FDI inflows might be more useful. FOREIGN DIRECT INVESTMENT IN CHINA (1984-2004) 100 90 80 70 60 50 40 30 20 10 0 2005 2006 2007 2008 FDI Source of data: Ministry of Commerce of the People’s Republic of China . As we can see, Chinese use of FDI peaked in the year 2008, at US$ 92. 4 billion. Such remarkable progress was soon scuttled because of the 2008 recession and there has been a continuous exodus of funds from the Chinese economy. A single year has seen the largest exodus of capital in percentage terms since the Tiananmen Square massacre in the late 1980’s.
Macroeconomic Factors Affecting Investments in China Page 2 [SAPM TERM PAPER] September 28, 2011 Source: http://www. chinability. com/FDI. htm In 2010, FDI surpassed US$ 100 billion and it stood at US$ 105. 74 billion at the end of the year. A few of the factors that have positively affected this flow of FDI into China are: ? ? Thriving global economy and capital markets China’s attractiveness as a place for parking funds is directly related to its infrastructural development, resource availability, productivity etc. The level of maturation of these elements has made China an attractive option for investments.
Also, availability of labour at low cost has made it very attractive The size of the Chinese local market is very huge and hence growth opportunities are ample for industries here. The sizable local market makes China very attractive for FDIs. ? We have looked at FDI as the first major in our paper because FDI inflows point to a lot of factors that are right (or wrong) with the economy. In our opinion China remains an attractive FDI destination based purely on the fact that the extent of development possible is still large and the development thus far has been highly skewed, both in terms of demography and geography.
Thus China’s capacity to absorb funds remains as high as ever, despite questions being raised about the undervalued currency. Gross Domestic Product (GDP) The GDP of the country stands at $US 5. 9 trillion contributing to 9. 84 % of the world’s economy. China being the second largest economy in the world and growing at a whopping rate of 9. 5 percent appears to be the safest investment option for the investors today. The GDP has been increasing for the past two decades justifying the growth potential the country enjoys because of its natural resources and human capital.
Macroeconomic Factors Affecting Investments in China Page 3 [SAPM TERM PAPER] September 28, 2011 The GDP is expected to grow in the range of 6-8 percent for the next few years to come, and is expected to cross that of US by 2018. Inflation Traditional thinking would lead us to believe that China’s breathtaking pace of development would also lead to a phenomenal increase in the demand for goods and services and thereby translate into higher inflation rates, than what one would expect in the developed economies.
Whilst Chinese inflation rates have been consistently, year on year, been higher than those of the developed nations, they have been lower than what most experts opined. This has possible, in part, because of more and more goods being available for domestic consumption as well. While China has recently become the largest exporter in the world, it has also become the world’s second largest importer. It is this balance, which has enabled China to succeed where India has failed to tame inflation.
Macroeconomic Factors Affecting Investments in China Page 4 [SAPM TERM PAPER] September 28, 2011 From 1994-2010, average inflation has been 4. 25% with a high of 27. 70% in October, 1994 and a low of 2. 2% in March, 1999. Recent trends in China point to the government trying to reduce the inflation rate, which has consistently been hovering around 6% for the past 20 months. China succeeded in finally bringing down the inflation to 6. 2% in August this year. The government thus managed to successfully decouple growth and inflation.
Fears that stricter monetary regulations would stifle growth have thus been unfounded. Source: TradingEconomics. com, China Economic Information Net Unemployment The unemployment rate in the country stands at around 4. 1 percent today, which in reality is understated by a few percentage points because of the reason that the figure does not include workers laid off by the state-owned firms and also it only includes the registered urban people leaving aside a large population that has shifted base from the sub-urban areas to the cities in the recent times.
If all the facts get incorporated and the numbers are reworked, the unemployment figure is poised to go up by notches. Macroeconomic Factors Affecting Investments in China Page 5 [SAPM TERM PAPER] September 28, 2011 China is experiencing a healthy growth in its GDP year on year, thanks to the capital projects and huge exports out of the country. World Bank reports that China has a GDP growth potential of 9. 5%, and with the expected GDP growth of ~ 8 percent there’s still a substantial gap to be bridged. Over the past decade China could only add 0. percent of new employment opportunities for every 1 percent of growth in GDP, which goes on to say that the economy needs to fair well on this front and should open up for newer investments in the country. China so far has majorly encouraged capitalintensive projects, e. g. Steel, machineries. It largely banks on its exports to provide strength to its economy. It’s high time that the country look for big investments in different avenues like service industry and hospitality which will create many employment opportunities.
This certainly opens up attracting investment options in China. Trade and Investment Policies Last year’s Trade Policy Review (TPR) of China by the TPR body of World Trade Organisation brought out some encouraging highlights regarding the transformational developments China is eying for its economy after the global crisis. The Chinese government is pursuing policies to get the service sector growing in the country and focus has shifted towards meeting the domestic demand.
Liberalization of trade policies coupled with reduction in the regulations will attract newer investments eventually leading to healthy competition and efficient resource allocation in the country. The graph vindicates the fact that there have not been enough movements on the capital market arena and the sector throws up huge investment options for the domestic as well as the outside players. Domestic Demand and High Infrastructural Growth in the Country Chinese economy is growing at around 10% every year while the country has a very low base of about US$3,400 per capita income.
Additionally most of the working population in China save 35% of their income leaving a huge domestic consumption market yet to be explored, in fact in recent times Macroeconomic Factors Affecting Investments in China Page 6 [SAPM TERM PAPER] September 28, 2011 Chinese people are looking at quality products to improve their lifestyle, which is a great sign when you look at the size of the market in China. We can see the retail sale surging in the last few years by almost 100 percent. Capital market in the country is largely under-developed and immense investment opportunities lie there as well.
Going by the projected numbers of high economic growth and the huge unexplored domestic market, it looks like one will have a competitive disadvantage if investments opportunities in China are not used well. After the 2008 financial crisis, China is sitting on a huge cash deposit and is now spending most of its cash on infrastructural projects in the country. As a wise investor one should carefully follow the government policies and avail any investment opportunity the government opens up. Measures to contain housing prices (a policy focus) have boosted real estate investment.
China is the second last importer of goods in the world. Let’s take a look at the country’s consumption of capital goods and prospective demands in the next few years? ? ? ? It consumes about 55% of the world’s cement. China takes up 40% of the world’s steel. China uses 30% of the coal that’s consumed in the world. China oil demand has soared more than 400% last 10 years and announced to build up its oil reserve at the end of 2008 China consumes 20% of the world’s copper and 19% of the world’s Aluminium. China has 50,000 miles of highway exceeding the current length of US. ? Macroeconomic Factors Affecting Investments in China Page 7 [SAPM TERM PAPER] September 28, 2011 ? China plans to build 27 new nuclear power plants before 2020. The facts and the prospects give us an outlook of the various capital investment opportunities the country will be throwing up in coming years, making the country a hot spot for the capital inflows. With China getting liberal on the FDI front and showing signs of making its trade policy more transparent in future, the odds of making good investments in China look to be in favour.
Currency Exchange Rate China is on a path to making its currency, Yuan, a global currency. To achieve this, it has loosened several of the restrictions placed on the currency. One of the steps in this direction is to allow overseas investment in Yuan. But, as the currency is not fully convertible outside the country, those providing foreign investments in Yuan would have to invest this Yuan that they have received. Thus, this would also increase investment in China. It has also taken steps toward making its local currency, the Yuan, fully convertible.
Also, it has given rights for foreigners to hold deposits in Yuan, and to use it to buy and sell goods. Due to all the steps taken by the Chinese administrators, the Yuan is supposed to start appreciating at a faster clip than over the last few years as soon as the global economy starts regulating itself. If the Yuan appreciates in dollar terms, dollar investors stand to gain. Also, a strong and increasing currency means that foreign investors will include this expected appreciation in their expected returns outlook.
Due to this positive outlook, investments would flood the Chinese market. Balance of Payments Balance of payments is divided into two broad categories current account and capital account Current Account ? ? Goods Services o Transportation Page 8 Macroeconomic Factors Affecting Investments in China [SAPM TERM PAPER] September 28, 2011 o o ? ? ? ? ? ? Travel Other services Investment income Current transfers Capital and financial Account Direct investment Portfolio investment(FII) Other investment Reserve Asset China being an export led growth economy keeps its currency undervalued.
Its exchange rate policy is deeply linked with its long term goal of high exports growth, generating large foreign holdings and current account surplus. Due to this inflow there is less need of opening of its financial markets and thus restrictive policies. Exports led growth demands operating efficiencies, heavy capital investment in technology and research and development, etc. Thus, there is a large potential of investments and FDI inflows. As stated earlier development of China has a lot of scope which could influence FDI in the economy.
Macroeconomic Factors Affecting Investments in China Page 9 [SAPM TERM PAPER] September 28, 2011 Interest rates also have a role to play to attract hot capital in the economy. As economies like America and Europe are facing a downturn and their interest rates are low (1% in US) compared to china (3. 5%) the hot capital flows in with an expectation of better returns. Also it is believed that Chinese currency is undervalued and would appreciate in the coming years with respect to USD and so if an investor invests in China than in US he/she is expected to get higher returns.
Conclusion China being the world’s second largest economy and most populous nation has its long term story intact. But for the short term they may face a lot of issues sustainablity and inflation being the two most important ones. Due to the downturn seen in the global economies exports have seen a slowside which is picking up now, also what is interesting to see is its imports and retail sales increasing which increases its aggregate demand further and hence growth in GDP.
Strong labour market is another key driver of China’s growth. Expectation of currency appreciation, comparative higher interest rates and development scope helps inflow of money into china. Also relaxation in investment and trade policies is an added advantage for global investors. Looking at all the favourable macroeconomic factors China is one of the favourite destinations for investments and growth in the long run. Macroeconomic Factors Affecting Investments in China Page 10