With its voracious appetite for raw materials and a shift in focus towards high value goods production, China is emerging as a trade giant. Bruce Alter, Aster Saleh and Zeno Chow examine how banks can participate in the country’s phenomenal growth by facilitating import-export flows.
These are exciting times for China, which is enjoying tremendous economic growth. China has already emerged as an economic powerhouse. Since 1980, it has grown faster, for longer than any country in history. China now accounts for 13% of global GDP, based on purchasing power parity (PPP) exchange rates1. China’s accession to the World Trade Organisation and events such as the award of the 2008 Olympics attest to China’s growing importance on the world economic stage.
Key to China’s economic growth is its entry into global markets, not only through foreign direct investment, but, significantly, through its impressive growth of exports and imports.
From a commercial trade perspective, there are several important focal points for supporting China’s growth and global integration. These include supporting commodity and capital goods trade flows and linking the physical and financial supply chains. But what is the nature of China’s imports and exports and what role are banks playing in financing the burgeoning commodity and capital goods trade flows?
Commercial trade transformation
An understanding of the dynamics underlying China’s commercial trade flows provides insight into the economic transformation under way in the country today.
China has emerged as a trade giant for imports and exports, and the two are closely interconnected. On the export side, China has long claimed success as the world’s factory for light industrial goods for export, such as textiles and toys, and continues to enjoy success in this area.
At the same time, we are witnessing the transformation of China’s production focus to high value-added exports such as capital goods.
This transformation is reflected in the significant shift in China’s exports away from basic manufactured items and textiles into electronics, which now account for more than one-third of the country’s exports. The future promises to hold an ever-increasing outflow of such high-value products.
This transformation is necessitating the rapid development of China’s infrastructure. China has experienced a tremendous increase in infrastructure-related imports as it modernises across the transportation, power, shipping and telecommunications industries – to name a few – to foster the development of industry and stoke economic growth.
FDI ties
The large inflow of capital goods also ties to foreign direct investment, as foreign multinational companies build plants and buy equipment. China’s pipeline of foreign direct investment is impressive, with about a 70% share of the investment inflow going to the manufacturing sector in 2003. Projects to develop infrastructure go hand-in-hand with China’s efforts to support the surge in foreign direct investment.
At the same time, China is keeping a watchful eye on production to ensure goods meet high standards for quality. China has proven its ability to meet promised timeframes for order fulfilment and to satisfy the requirements of US and European importers. High-quality goods consistently delivered on time, along with access to markets and competitive pricing, have all contributed to China’s success story.
Success breeds success
As China broadens its production base to include higher-value products, the country’s requirement for raw materials has grown in parallel with increased global demand. For example, oil demand is rising rapidly as the government works to diversify energy sources and move away from a reliance on coal.
China accounts for about one-third of the growth in global oil demand, with net imports to China expected to be about $26bn by the end of the year. There is also a rapid rise in demand for natural gas and hydro-electric power2.
Companies on the ground in China – both multinational and state-owned enterprises (SOEs) – need raw materials and semi-finished goods for conversion to larger-ticket goods for sale in the domestic market and for re-export overseas. This in turn is driving an increased inflow of commodities.
Pricing pressure
The immediate challenge is to keep up with China’s voracious commodities appetite and the growing world demand for Chinese goods. These two demands are putting an upward pressure on pricing. For example, as the world’s largest steel producer, China requires a large inflow of iron ore and other raw materials for steel production. Commodity flows to China such as those of iron ore, copper, and oil have all seen price increases.
The persistent strength of China’s demand for base metals has had much to do with the spectacular movements in base metal prices over the past year. In recent months, China’s impact on metals has been most extreme at the margin in copper and steel.
Last year, China accounted for 121% of the increase in global copper demand and 90% of the increased demand for steel. Most metal analysts expect China to be a key source of relentless growth in worldwide demand for a considerable time to come3.
With international pressure to keep raw materials supply apace with demand, the related challenge is to maintain competitive pricing for commodity imports. Upward pricing pressure must be kept in check to facilitate China’s conversion of raw materials to finished goods at competitive prices. This impacts China’s ability to compete on big-ticket exports destined for large US and European importers and importers in developing countries, where China has made considerable inroads.
Banks’ role
Banks have an important role to play as intermediaries of import and export trade flows. Given China’s growth rate and trade requirements, the financing of imports and exports is essential to sustained economic growth. China’s voracious import appetite requires the traditional network and structured trade financing and risk-mitigation techniques along with the requisite credit expansion to the market.
One of China’s key concerns is to ensure a stable supply of raw materials and semi-finished products to sustain expansion. To address this concern, China has established joint ventures at sourcing points (such as mines), setting up plants and taking ownership in certain countries of origination. This accomplishes two important objectives tied to maintaining competitive pricing. It both ensures the steady flow of imports and aids import-finance structuring by diversifying country risk.
There is also a need to support high-value exports from China into more challenging markets such as Bangladesh, Sri Lanka, and Africa.
These markets are eager to expand their trade relationships with China for imports of affordable capital goods. China’s capital goods exporters need trade-financing and risk-mitigation tools that facilitate trade flows to these challenging markets.
Servicing all needs
By providing financing and risk-mitigation solutions that sustain competitive pricing on imports and exports, banks play a valuable role as facilitators and partners to all of the players.
The market has seen an active year of network and structured trade transactions in which banks play the multiple roles of facilitator, partner and intermediary. Banks are stoking the engine of growth by facilitating import and export trade flows with financing and risk mitigation. For example, over the past year, JPMorgan has participated in several structured trade deals.
The firm’s role is to facilitate the financial instruments needed to ensure product completion. This has meant extending credit to financial institutions in China (for example, to facilitate letters of credit), providing insurance coverage, working with the Export-Import Bank of the United States for exports from the US to China, or a combination of these solutions.
Unprecedented growth
China is in an unprecedented growth mode. As one of JPMorgan’s most important growth markets, the firm expects to continue to play a major role in supporting China, especially in the area of trade finance.
China’s economy continues to expand rapidly in all directions. The country’s emergence as an economic powerhouse is a success story in itself, but it is only the end of the beginning. Exciting times are ahead for all who participate in unleashing the vast potential of the China market.
Footnotes
1 “China and the World Economy. A reference guide”, JPMorgan Economic Research, April 2004, page 2
2 Ibid, page 4
3 Ibid, page 5
Bruce Alter is Asia regional head of trade for JPMorgan Treasury Services Asia. Aster Saleh is regional head of structured and network trade, Asia Pacific, and Zeno Chow is head of corporate trade sales, Asia, for the same company
