Investing in China’s Future: The New Silk Road Economy

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By Matthew Zito

SHANGHAI – A report issued last week by the World Bank stating that China’s economy had grown much faster than previously anticipated caused some commotion among economic observers. While the significance of the report was somewhat exaggerated by its use of purchasing power parity (PPP) as its primary indicator, the news should nonetheless assuage doubts that China is on its way down. But where does the future of the Chinese economy lie? This article looks at some macro-scale trends in China’s investment environment to identify how foreign investors can get in on the ground floor of tomorrow’s opportunities.

Silk Road Economic Belt

On his recent European tour, Chinese President Xi Jinping reiterated calls for the creation of a “Silk Road economic belt” linking China with its overland neighbors, manifested in cross-border trade agreements, joint infrastructure projects, and other forms of high-level economic and cultural exchange. However, this newest of Chinese foreign policy slogans has little in common with the historic Silk Road connecting China to Central Asia – the geographic range envisioned in this “new Silk Road” extends all the way to Central and Eastern Europe, as evidenced by infrastructure deals proposed or signed between China and Romania, Serbia and Hungary, and on to Germany, where Xi invoked the term in a recent speech.

The flexibility of the concept is revealed by a “maritime Silk Road” additionally proposed by President Xi at the 16th Asean+China Summit in Brunei. Since then, the term has been used to emphasize stronger economic cooperation, joint infrastructure projects, and cooperation on maritime security between China and its neighbors in the wider Asia-Pacific region.

Related: China – The Great Infrastructure Developer

Analysts see this as in response to recent political tensions in the South China Sea, as well as instability in the Malaca Strait, through which an estimated 85 percent of imports to China and 80 percent of energy imports are transported. Together it is hoped the two silk road initiatives will ensure China’s ability to import  a necessary volume of raw materials and energy to feed its continued economic growth.

This upsurge in infrastructure and trade agreements has direct significance for foreign investors looking at China and/or its neighbors in Central and Southeast Asia. As these projects mature and impediments to trade are gradually reduced, this will facilitate the movement of goods between markets and the ease with which foreign business can establish a transnational presence in Asia. And as new energy markets open along the new Silk Road, costs are likely to come down for businesses operating in China.

Tier-Two Cities

Of China’s some 600 cities, four are definitively ranked as “tier-one”: Beijing, Shanghai, Shenzhen and Guangzhou. Together they are home to roughly 9 percent of China’s national population. As for the ranking of the other 596, it depends on who you ask. The problem lies in there being no clear indicator for what divides the lower tiers (two and three being the most important) from one another.

Tier-two is commonly defined as provincial capitals and special administrative cities (a total of 23); while tier-three is generally classified as prefecture and county-level capitals. But because this method of categorization does not take into account population or economic indicators, some China-based firms have adopted more complex or creative benchmarks: one current method uses the number of Starbucks locations in a given city to assign its tier level; another defines a tier-two city as having a population of 3 million and a minimum per-capita GDP of US$2000 (a total of 60 cities).

Despite its ambiguities, the ranking system, which was started in the private sector, does have its applications for strategic decision-making, especially for property developers. Any way you slice it, tier-two and -three cities are the most important engines of economic growth in China today. Data from the U.S. Commercial Service shows that tier-two cities account for 54 percent of total imports from the U.S. More than 50 percent of the richest Chinese are said to live outside traditional centers of wealth, where the strongest growth in the oft-referenced Chinese middle class is also expected to occur.

Related: Chris Devonshire-Ellis on China’s Economy – Dukascopy Interview

Three areas are commonly cited as the rising stars of the Chinese economy: Sichuan and Chongqing in the southwest; Anhui, Jiangxi and Hunan provinces in the Yangtze basin; and Hebei and Henan in the central north. As infrastructure projects in these cities continue to keep pace with economic growth – e.g., inland cities are being serviced by more and more airline routes – this will significantly reduce the transportation and logistics costs of local investment.

These savings, along with the proximity of inland cities to emerging markets and their lower wage costs, are expected to be major pulls for foreign and domestic investors to relocate their production facilities and sales outlets further inland. While in the long-run, the economic boom in lower tier cities is likely to result in eventual wage increases, analysts note that base wages in these cities are much lower than along the eastern seaboard (compare an average monthly minimum wage of RMB 1,200 in Chongqing to RMB 1,820 in Shanghai).

Western China

China’s western regions, while requiring a more nuanced investment strategy than the eastern megacities, are a third channel of future opportunity for foreign companies. On one hand, the provinces, autonomous municipalities, and autonomous regions classified as western China – Chongqing, Gansu, Guizhou, Ningxia, Qinghai, Shaanxi, Sichuan, Tibet, Xinjiang and Yunnan – are the ongoing recipients of focused government investment in infrastructure, industry, and education; on the other, they are generally subject to tighter regulations than their eastern counterparts, and certain locales are home to ongoing ethnic conflict.

Well established industries in the region include mining, petrochemical, environmental protection, biomedical, pharmaceutical, green technology, agriculture processing and chemical manufacturing. In February, 2014, the National Development and Reform Commission proposed a new initiative of western development in nine major fields, including infrastructure, urbanization and environmental protection.

Related: Luxury Brands, Westward Expansion Fuel Chinese Automotive Industry

The construction of infrastructure in these provinces – including railways, highways, airports and energy stations – is of critical importance to China’s long-term targets of resource extraction and logistics integration with surrounding nations on the new Silk Road. Accordingly, such projects received US$53.87 billion in government investment in 2013.

One reason for this mass investment, as noted in state media, is that while China is on track to meet its GDP and residential income growth targets in the west, infrastructure has lagged sorely behind the targets of the current five-year plan. Nevertheless, the western regions likely outperformed eastern China in terms of major economic indices for a seventh consecutive year in 2013. The cities of Chongqing, Chengdu, Xi’an and Nanning, relatively well-developed and free of the extremism currently scaring off stronger investment in Xinjiang, are expected to perform especially well in the coming years.

Case Study: Lanzhou New Area

One example recipient of government largesse in western China is the Lanzhou New Area – established in September 2012 and touted as the first state-level development zone in northwestern China. Part of China’s ongoing mass urbanization campaign, the New Area is a planned city about one hour’s drive from Lanzhou and expected to someday house some 500,000 residents.

Combining all three trends described above, the New Area is hoped to become an important economic and logistics center on the historic silk road. As one example, the development zone is home to a high-tech research center, dubbed “Wisdom Valley,” whose target annual revenue by 2030 has been set at over US$45 billion. Aiding these ambitions is a high-speed railway connecting Lanzhou to Urumqi slated for completion in late 2014.

With these developments the ground is primed for the rise of western China. Foreign investors are invited to contact Dezan Shira & Associates for more information on market entry strategy, business advisory, and regulatory compliance.

Asia Briefing Ltd. is a subsidiary of Dezan Shira & Associates. Dezan Shira is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please email china@dezshira.com or visit www.dezshira.com.

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