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China Roundup: The race to become the largest economy in the world and the UK Treasury’s RMB Bonds

October 10, 2014

This week, there was fresh debate over whether China will overtake the US to become the largest economy in the world this year, the RMB inched a step closer to true internationalization, and all eyes were on Hong Kong to gauge the impact of the Occupy Central protests on the economy.

The Economy

China’s economy is slowing down, but will it surpass the US by the end of the year?

According to a new projection of the International Monetary Fund this week, the answer is yes. Although China’s nominal gross domestic product (GDP) in 2014 will only account for less than 60% of that of Uncle Sam, it will have bigger purchasing power because prices of the same products in China are much lower. So when the so-called purchasing power parity (PPP) is factored in, China’s GDP will reach $17.6 trillion by the end of 2014, slightly higher than the US’ $17.4 trillion.

But the relatively new methodology is far from perfect, many economists argue, who believe the traditional way of calculating the number using the exchange rate is still the most recognizable standard. In addition, the nominal GDP number, which is the basis of the PPP-adjusted GDP, could be inflated due to the way it’s calculated, experts say.

Even though the new ranking is a nice compliment for China’s miraculous growth, the statistical difference won’t change the downward pressure China’s economy is facing today. Both the official and the HSBC manufacturing Purchasing Managers’ Index (PMI) in September remained unchanged from the previous month, and the HSBC services PMI dipped moderately to 53.5 in September from 54.1 in August. The bank’s Chief Economist for China Qu Hongbin told the Wall Street Journal that in the near term “risks to growth… are still on the downside”.

Chinese top leaders have shown some tolerance to a lower growth rate, but it’s widely believed that Beijing will step in when the economy slips too far away from the expansion goal.

According to a statement posted this week on the central government’s website, Chinese Premier Li Keqiang said during a State Council meeting that China will launch a series of “significant projects” this year in the areas of water conservancy, information networks and environmental protection. Li also called for the continuation of targeted measures to lower financing costs for the economy; the People’s Bank of China (PBOC), the country’s central bank governed by the State Council, recently pledged to use various tools to ensure adequate liquidity and reasonable growth in credit and social financing, Reuters reported.

Banking and finance

China took another step forward this week in its effort to internationalize the RMB. On Thursday, the UK government announced that it will become the first western government to sell treasury bonds denominated in the Chinese currency; although the issuance is only of “benchmark size” (about RMB 2 billion), it is an important step closer for the RMB to become an international reserve currency.

The deal also enhanced London’s role as an offshore trading hub of the RMB. Earlier this year, China Construction Bank, the country’s second-largest bank by assets, became an RMB-clearing house in London—the first of its kind in a Western country. Agricultural Bank of China, the third-largest bank in the country, is considering issuing RMB-denominated global depository receipts (GDR) on the London Stock Exchange, according to the Chinese media. Once completed, it’ll become the first RMB equity investment product listed outside of China.

To help support the demand of overseas RMB assets, PBOC plans to include London and Singapore in a scheme called ‘Renminbi Qualified Domestic Institutional Investor’ (RQDII), which allows Chinese investors to buy foreign assets with the RMB. The central bank is also considering allowing individual investors in China to invest overseas through a ‘Qualified Domestic Retail Investor’ program, according to the Chinese media.

Currently, qualified investors in mainland China are lining up to participate in a “through train” program called the ‘Shanghai-Hong Kong Stock Connect’, which allows investors on both sides to tap into each other’s stock market (within a given quota). The program is expected to kick off later this month, although reports suggest that it may be delayed due to the political uncertainty in Hong Kong, where protestors have occupied parts of the city’s financial district to protest against Beijing’s handling of Hong Kong’s election reform in 2017.

Hong Kong’s economy under the spotlight

The two-week-long street protest in Hong Kong, also known as the ‘Occupy Central’ movement, has sparked concerns about the region’s economic stability. As a gateway for foreign investment and trade into the mainland, Hong Kong is one of the world’s most important financial centers and a crucial forefront of China’s financial reforms. Although a popular notion is that Shanghai is quickly rising as a challenger, it is unlikely to replace Hong Kong in the short term, as reforms in the free trade zone have been slow.

The worry that the political movement could drag down the city’s economy is not baseless—the protests have caused fluctuations in the stock market and some retailers are having a bad time due to paralyzed streets and shuttered storefronts. Sales at chain stores in the affected areas fell between 30% to 45% during China’s weeklong national day holiday (also known as the ‘Golden Week’), according to the local Retail Management Association.

But fears that Hong Kong will fall into chaos seem overblown for now. During the Golden Week, figures for inbound tourists went up 4.83% from the same period last year, according to the Hong Kong Tourism Board; the stock market is stabilizing after the slump of the first few days of the protest, recouping some of the previous loss; home sales remained stable as well.

According to an statement made earlier by Fitch, in the short term, the protest wasn’t affecting Hong Kong’s ratings in a significant way; but in the longer term, the rating agency said, there are two relevant questions: the first is whether the Hong Kong government will be able to resolve its political issues and carry out policies smoothly; the second is whether the political turbulence will affect the world’s perception of Hong Kong’s stability and attractiveness. Let’s see how that unravels.