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World economy: The China cycle
By Geoff Dyer
Published: September 12 2010 20:03 | Last updated: September 12 2010
20:03

Allied by alloys: a steel market in the Chinese privince of Hubei. As
well as investing in fellow emerging nations' commodities, such as
Brazilian iron ore, Beijing is increasingly investing in their
infrastructure
Deep in the Amazon jungle, huge chunks of red earth are torn out of
the ground at Carajás, the biggest iron ore mine in the world, to be
transported halfway round the globe to the steel mills on China’s
eastern seaboard. There they are turned into the backbone for millions
of tower blocks in hundreds of booming Chinese cities.

Last year, China overtook the US to become Brazil’s biggest trading
partner. The two large developing countries may be on opposite sides
of the planet but their growing economic ties over the past decade
have become among the enduring symbols of shifts in the global economy.

The duo could also be forging a path for one of the potential biggest
realignments in the global economy over the next decade. With little
fanfare, China is likely to emerge as the biggest direct investor in
Brazil this year, following a string of deals announced in mining,
steel, construction equipment and electricity transmission.

Such investments are part of a slow-burning but hugely important
trend. Newly crowned the second-largest economy, eclipsing Japan,
China is becoming the anchor for a new cycle of self-sustaining
economic development between Asia and the rest of the developing world
– one that is bypassing the economies of Europe and the US.

China is not only sucking in raw materials from other developing
economies, just as it has during the past decade. It has also begun
making investments in infrastructure and industry in those countries,
some of which are made possible by its cut-price and increasingly
sophisticated manufacturing companies or by the attractive financing
terms it can offer. Beijing has for some years been investing in this
way in parts of Africa: now such deals are being rolled out around the
world. For many developing countries, the impact of the China boom is
coming full circle.

“It is the start of a new cycle,” says Ben Simpfendorfer, an
economist at RBS and author of The New Silk Road, a book on the
surging economic ties between China and the Middle East, central Asia
and south Asia. “China has companies that are willing to invest, they
have products that are good enough, and they are backed by abundant
liquidity in the country’s financial system.”

BEIJING MEETS BRAZIL
●Direct investment overseas by Chinese companies has increased from
just $5.5bn in 2004 to $56.5bn last year. Chinese officials predicted
last week that it would reach $100bn by 2013.

●About 70 per cent of the money invested last year went to other
parts of Asia. Latin America came in second place with 15 per cent.

●Chinese companies have so far invested only very modestly in Brazil
but Brazilian officials estimate that investment will exceed $10bn
this year.

●Chinese banks have lent $10bn to Petrobras, the Brazilian oil
company, and $1.23bn to Vale, the iron ore miner.

Ian Bremmer, president of the Eurasia consultancy and author of the
recent book, The End of The Free Market, says there is no accident to
this China-led process of decoupling from the west. It is, he says, a
strategy to reduce economic – and to some extent political –
dependence on the US.

“It is a very conscious policy, on the top of the agenda for the
entire Chinese leadership,” he says. “They are looking for a
hedging strategy because they feel uncertain about the long-term
economic prospects of the developed world.”

Promoting innovation and stimulating domestic consumption are also
part of that strategy, he argues, but pushing stronger economic
integration with the rest of the developing world is the “one
strategy that can be done quite quickly”.

Nowhere is the impact of this process being felt more keenly than in
Brazil.

As trade has boomed with China during the past decade, Brazilians have
sometimes complained of being relegated once again to their 20th-
century role of providing commodities to the industrial powers. In the
past year, however, the long-awaited wave of Chinese investment in the
country appears finally to have reached Brazil’s shores. While it
reached only $92m in 2009, the country’s officials estimate that it
will exceed $10bn this year.

Wuhan Iron and Steel, for instance, paid $400m for a stake in a mining
company owned by Brazilian industrialist Eike Batista, and is planning
to build a huge steel mill beside the port near Rio de Janeiro that
another of Mr Batista’s companies is constructing. Lifan, one of
China’s biggest manufacturers of motorcycles and cars, already
exports heavily to Brazil. Now the company’s founder, Yin Mingshan,
says it is considering opening a plant to build cars in the country.
“Brazil is a very promising market, with a vast territory and a big
domestic market,” he says. “Some Chinese businessmen are foolish
enough to ignore doing business in Brazil but I am not that stupid.”


If investment in Brazil is one symbol of this new stage of economic
Chinese engagement with the developing world, another is the flurry of
new rail networks taking shape globally. Chinese railway construction
companies are some of the most efficient anywhere, and have for
several years been operating in neighbouring countries in central and
south-east Asia. But in the past year they have also signed contracts
in such diverse places as Ukraine, Turkey and Argentina.


Chinese companies in the sector have not restricted their activities
to the manual task of laying rail lines. They are hoping to start
signing overseas deals to sell high-speed rail equipment, including
locomotives and signalling systems. The first customer could be the
planned high-speed line between São Paulo and Rio de Janeiro.

There are two factors that have made these new links possible. The
first is that China has produced a generation of companies making
capital goods that are now internationally competitive. They can offer
developing countries new trains, power stations, mining machinery and
telecommunications equipment of sufficient quality at prices that are
often well below those of their multinational competitors.

GLOBAL RENMINBI USE
‘It’s like a Formula One starting race, everyone jostling for
position’
Although China is both the second- largest economy and the biggest
exporter in the world, the renminbi is virtually unseen outside the
country. For global transactions, China depends on foreign currencies
– in particular the US dollar.
The perils of this arrangement became clear during the financial
crisis, when China’s mighty export machine was hit by a freeze in
dollar-denominated trade credit. So in recent months Beijing has
unveiled measures to facilitate the use of the renminbi and reshape
the global monetary system. “We’re at the beginning of something
huge,” says Dariusz Kowalczyk, a Hong Kong-based strategist at
Crédit Agricole. “Intermediation through the dollar will be
gradually eliminated.”
In June, Beijing expanded the scope of a year-old pilot scheme for
settling cross-border trades in renminbi, opening it up to the world.
Global banks such as HSBC, Deutsche Bank and Citigroup have since been
encouraging companies from London to Tokyo to use the Chinese currency
rather than the dollar. Some even offer discounted transaction fees as
an incentive. “It’s like a Formula One starting race –
everyone’s jostling for position,” says Philippe Jaccard of
Citigroup.
The financial infrastructure is now in place to allow an Argentinian
grain producer, for example, to sell goods for renminbi then use the
proceeds to buy farm machinery from China. Cross-border trade in
renminbi totalled Rmb70.6bn ($10bn) in the first half of the year. But
that figure remains tiny compared with the $2,800bn worth of goods and
services traded across China’s borders last year, most of which was
settled in dollars or euros.
One of the obstacles to greater global use of the renminbi is a lack
of ways for foreign companies to invest their renminbi or hedge their
exposure to the currency. Strict capital controls place China’s
financial markets almost entirely off limits. But that is changing.
Last month, China opened its domestic interbank bond market to foreign
central banks and commercial banks that have accumulated renminbi
through cross-border trade settlement. Curbs on the free flow of
renminbi in Hong Kong have also been lifted. Since July, financial
groups in the special administrative region have been able to create a
range of renminbi-denominated investment products and hedging tools –
all open to global companies and investors.
McDonald’s, the US fast-food chain, last month became the first
foreign multinational to issue a renminbi-denominated bond in Hong
Kong. It plans to use the proceeds to fund its operations on the
Chinese mainland. Robert Cookson

The second element is the financial backing from a banking system that
has been mobilised to follow behind these businesses. Yi Huiman, a
senior executive at Industrial and Commercial Bank of China, told a
conference recently that the institution was working with the
government to provide “railroads plus finance” around the world.
Vale, the Brazilian company that operates the giant iron ore mine in
the Amazon, announced on Friday that it had signed a $1.23bn credit
with two Chinese banks to finance the purchase of 12 huge cargo ships
from a Chinese shipyard, which will transport iron ore between the two
countries.

The scale of these transactions is clearly much smaller than
Beijing’s holdings of US securities, estimated to be in the order of
$1,500bn, but the underlying dynamic is the same: the Chinese
financial system is starting to recycle some of its holdings of
foreign currency into the economies of its developing country trading
partners, in order to stimulate demand for its own goods.

The impact is already apparent in China’s trade statistics, with the
biggest increases in exports in the past year coming from developing
countries. Trade with the Association of Southeast Asian Nations
increased by 54.7 per cent in the first half of the year, and by 60.3
per cent with Brazil.

If Chinese investment does indeed help to kick off a growth cycle in
other parts of the developing world, it will be a tonic for a global
economy in which the outlook for many leading economies remains
subdued, with some even facing the risk of a double-dip recession. The
combination of Chinese demand and booming investment is one reason for
Brazil’s ability to record China-style growth rates of 8.9 per cent
in the first half of the year.

Yet for western economies there are also plenty or risks involved. The
investment push is likely to herald an era of intense competition
between developed-world multinationals and state-owned Chinese
companies. The strong financial backing that such groups receive is
also likely to fuel accusations that they are not playing on a level
field. It is perhaps no surprise that some of the multinationals that
in recent months have publicly voiced criticisms of Beijing’s
industrial policies – GE and Siemens – operate in sectors in which
China is becoming a fierce competitor, such as power equipment and
railways.

China’s new clout is also raising questions about the future of the
dollar. Chinese officials have talked about a long-term goal of
replacing it as the global reserve currency with a basket of others,
potentially including the renminbi.

As trade with the developing world balloons, Beijing has also been
taking important steps to expand the international use of the
renminbi, including allowing overseas holdings of the currency to be
invested in the onshore bond market. Some economists believe it could
become the reference currency for Asian trade over the course of the
next decade.


Yet the irony is that, while there is strong economic momentum behind
the Chinese currency taking on a much larger international role,
Beijing is reluctant to let this happen. “China is still very
hesitant about whether it really wants the currency to be
international,” says Yu Yongding, an influential economist at the
Chinese Academy of Social Sciences think-tank.

To become an important trading currency is one thing: but to become a
global reserve currency with the power to threaten the role of the
dollar, the government would need to lower capital controls and open
up its domestic bond market. This would mean giving up its tight
control of exchange and interest rates.

Furthermore, if economic integration with other developing countries
is really to take off, it will require careful management by Beijing.
There is a very real risk that the new-found interest in emerging
markets will provoke a backlash, especially if China’s exports of
manufactured goods keep up such a rapid pace of growth.

There are already plenty of warning signs. India, for instance, has
tried this year to reduce supplies of Chinese power equipment in
favour of goods made by local producers. For several months, New Delhi
blocked Huawei, the Chinese maker of telecoms equipment, from the
Indian market.

In Brazil, there are fears that companies such as carmaker Lifan want
to use the country to assemble kits of nearly-completed cars made in
China rather than promote a domestic industry. There is also concern
about fresh competition for access to markets elsewhere in Latin
America. Kevin Gallagher of Boston University calculates that 91 per
cent of Brazilian exports of manufactured goods to the region are
under threat from lower-priced Chinese products. If that market wilts
away, industry is likely to become much more critical of the new China
ties.

China’s growing links with the rest of the developing world could
provide a huge boost both to the country itself and to the global
economy during the course of the next decade. But a wave of
protectionism could yet halt the process. Beijing will need to work
hard to ensure its new partners in the developing world do not feel
steamrollered by the Chinese juggernaut.