The Deloitte Research Monthly Outlook and Perspectives


The Deloitte Research Monthly Outlook and Perspectives

Issue 67

26 August 2021


Recovery unlikely to be derailed by the Delta variant

What impact will the Delta variant have on the economy? This is the question that most economies are wrestling with, not least China which has set a global example on how to control the virus since the outbreak. Evidence so far seems to suggest that the new variant is more contagious but less deadly thanks to vaccine popularization. Based on informal surveys taken by Deloitte's global economist network, the recovery in major economies such as the US (our US economist sees a minor negative effect on consumption in Q4 of 2021), Germany, the UK and India remains on track. Financial markets clearly agree with this hypothesis with risky assets (mainly equities) staying buoyant while the widely watched Treasury yields under check (10-year yields around 1.3%). Is it a too-perfect scenario where the global recovery is accompanied only by a moderate inflation? Perhaps, but the uncertainties brought about by the Delta variant could keep inflation risk contained in the short run.

For China, the risk of the Delta variant causing major economic disruption as seen last year is unlikely. Why? The reality is that China's borders are essentially closed. China has almost perfected its playbook of contact tracing, mass testing and localized lockdown. For example, travel curbs can be immediately implemented in cities where a large number of cases emerge (perceived to be around 10), but such restrictions are only imposed in affected districts (e.g. Nanjing of late) rather than across the whole city (e.g. Wuhan in late January of 2020). Policymakers are prepared to phase out such restrictive measures as soon as they reach zero cases again. Meanwhile, China continues its impressive rollout of vaccines. We believe that the inoculation rate among adults could exceed 80% by late 2021. This is an unthinkable feat for most countries where vaccinations cannot be mandated. Indeed, according to local media reports this week, the central government is expected to set a deadline of August for all adults to be vaccinated except those with medical conditions. If past experience is of any guide, we can anticipate local governments to implement this with gusto.

The more relevant question for China then is whether it would ease border controls as other countries (led by the UK and the US) begin to tolerate caseloads so long as medical systems are not being overwhelmed. In Singapore, the government's move from defining COVID-19 as pandemic to an endemic suggests that for open economies, the cost of restrictions is outweighing the benefits of safety. But Singapore does not live in isolation. In the end, unless more cities adopt Singapore's approach, travel bubbles in Asia will remain elusive. The debate on this zero tolerance approach to COVID-19 in China has taken place in a very different context because China does not rely on tourism and the benefits of opening up borders are difficult to quantify. The general public also favors draconian measures to contain the spread of the virus. However, due to complacencies in dealing with the Delta variant (e.g. Thailand) and difficulties in implementing effective lockdown measures where an informal sector plays a large role in the economy (e.g., Indonesia), it is safe to assume that GDP growth for a number of ASEAN economies is likely to be revised downwards in 2021. However, we see no reason to alter China's 2021 growth projection of 8-8.2%.


Chart: persistent divergence between PPI and CPI

Source: Wind

Would an economic slowdown change the calculus around zero tolerance for new cases in China? If so, how would the economy be affected in 2022? July data have provided guidance on the type of policies we can expect in the future. As expected, China's exports continue to outperform (YoY 19.3%) while consumption is recovering. But the sharp fall in total social financing (only RMB1.06trn in July down from RMB3.67trn in June) has raised concerns that property developers may be unlikely to participate in land auctions unless housing policies become less restrictive. So far, policymakers' stance towards the residential housing market is being guided by the principle of "homes are for living in, not for speculation". Mortgage lending come under much closer scrutiny. In some sense, July data underscores the risk of a potential economic slowdown brought about by decelerating growth in external sectors (current torrid rate of growth is hard to sustain) and lacklustre investment (e.g. in the property sector). Precisely due to such risks, the cut to the reserve requirement rate last month was a necessary pre-emptive move. Could more economic stimulus measures be on the cards? We see a more proactive fiscal policy, but relief through tax cuts are warranted for enterprises.

China's impressive recovery has fuelled a commodity price boom which has eroded margins in the manufacturing sector. Despite a significant pullback of iron ore prices from early 2021 (almost 30% correction from this year's peak), the elevated price level represents a challenge to the steel sector against the backdrop of China's stated goal of carbon neutrality. That is why the persistent divergence between PPI and CPI requires a policy response which is squarely aimed at mitigating the industries which can't pass on higher input prices to their downstream sectors. All in all, 2021 is likely to be a good year from a growth perspective but 2022 could see challenges unless domestic investment is significantly revived. How will the growth rate be set in 2022 against the backdrop of China's recently announced policy of "common prosperity" with the framework of "third redistribution" which refers to greater spending on social security and more fiscal transfers being earmarked for reducing income disparity between regions and among income groups? Of course, the key issue is to enlarge the pie while at the same time increase fairness. From this perspective, we see a more expansionary fiscal policy in 2022.


Chart: Top 10% Chinese people possess 68% of total wealth

Source: Wind


A flurry of policies to bolster cybersecurity

Frequent cybersecurity incidents and an increasingly complex business environment have increased the need for security and data protection in all organizations. Over the past 30 days, China's cybersecurity landscape saw a flurry of new announcements that will have notable implications for all firms in China.

Firstly, the release of the Three-year Action Plan for the High-quality Development of the Cybersecurity Industry (2021-2023) marks a national level policy that further enhances the influence of cybersecurity regulations in China. According to the plan, the cybersecurity industry will exceed RMB250 billion with a 15% CAGR by 2023. Such a targeted market size will expand by 25% compared to 2019.

In addition, the Data Security Law, which will be officially implemented on September 1, not only sets out the responsibilities and obligations of organizations and individuals in the process of data sharing, but also clarifies regulatory requirements. As the law covers data collection, data sharing, data flow, data application and other processes, investments on data security should be enhanced and protection systems should be strengthened so as to ultimately improve data security. Meanwhile, it also eliminates gray areas in data activities and forms a restrictive mechanism, thereby disallowing the arbitrary use of user data.

Cybersecurity has also been considered a key component of the 14th Five-Year Plan by local governments. The cybersecurity section of the Plan further clarifies that the minimum investment in cybersecurity by the government and public institutions should be no less than 10% of total IT investment.

Driven by a flurry of policies, a new development cycle in the cybersecurity industry is ramping up. It is worth noting that regulators have gradually clarified the boundaries of cybersecurity policies, which has enabled the formation of a more enhanced governance system to catch up with the development and commercialization of digitalization in China, which is widely viewed as being ahead of governance capabilities and societal understanding. The policies that are being rolled out in rapid succession are meant to ensure that the cybersecurity and data security of business operations must be guaranteed under transparent supervision, which will have a positive impact on the cybersecurity industry:

Policies to boost growth of the cybersecurity industry: Such policies bring new potential growth opportunities to the cybersecurity industry. The release of updated regulations has improved cybersecurity management and set a more stringent standard for organizations in terms of governance and investment in cybersecurity. State-owned enterprises will be the key targets for such developments.

Overseas IPOs must ensure data compliance: From now on, companies seeking to list overseas are required to submit a cybersecurity review alongside IPO materials to the Cybersecurity Review Office if the company is in possession of the personal data of more than one million individuals. In terms of national security risks that the review focuses on, two new items have been added for such companies. First is the risk of core personal data being stolen, leaked, destroyed and illegally used and transferred overseas. The second is the risk that core data, important data, or a large amount of personal information will be affected, controlled, or maliciously used by foreign governments after such companies are listed overseas. Therefore, all data handling organizations should ensure full compliance in data processing, with a special focus on whether data processing procedures will negatively affect national security.

The cybersecurity industry drives the agglomeration effect: As an important area of support for new infrastructure, cybersecurity related plans have been implemented in Shanghai, Guangdong and other localities, which will promote the development of the cybersecurity industry nationwide. Given its role in driving local development, cybersecurity will receive more policy support from the 14th Five-Year Plan, further accentuating the industry's agglomeration effect.

Companies should actively invest in cybersecurity: In addition to penalties for legal liability, non-compliant cybersecurity practices will negatively affect the company's brand and reputation. Therefore, enterprises need to approach cybersecurity construction from a strategic level and put in place high-level plans for management structures, organizations, processes, systems and investment budgets. Enterprises must conduct top-to-bottom cybersecurity planning and the cybersecurity department within enterprises needs to better plan predictive budgets. In terms of capital investment, the Three-year Action Plan for the High-quality Development of the Cybersecurity Industry clearly defines that the security investment of key industries such as telecommunications should account for 10% of IT investment by 2023. The investment in cybersecurity in telecoms and other key industries will also reach 10% of total investment on informationization in 2023. In the future, it will be clear that the proportion of investment by government and enterprises in cybersecurity should be no less than 10%. Both numbers will become benchmarks for enterprises as to the level of investment in cybersecurity that is expected of them.


The looming mineral crisis for EVs

While the global automotive industry has been grappling with a semiconductor shortage, another raw material shortage crisis is looming on the horizon. In early June, Wang Chuanfu, chairman of the leading electric vehicle and battery maker BYD, sounded a powerful alarm. By switching to an all-electric future, Mr Wang argues that China’s auto industry has managed to mitigate concerns around energy security and a dependence on foreign oil. But the electric vehicle industry will soon have to deal with its own “oil curse” — a shortage of rare earth metals.

Coincidentally, the same concern has been rising on the opposite side of the Pacific Ocean. The US Department of Energy has brought up a key development goal in its latest National Blueprint for Lithium Batteries (2021-2030), highlighting the need to reduce or eliminate US lithium battery manufacturing dependence on critical materials such as cobalt and nickel.

For a long time, the development of lithium-ion batteries (the most common type of battery for EVs) aims to strike a balance among three key factors: cost, safety and performance. As an important component of lithium-ion batteries (LIB), cathode materials play a decisive role in improving battery performance and reducing the cost of the whole cell. Based on different chemistry combinations, there exists a variety of lithium-ion battery systems, among which lithium iron phosphate (LFP) and nickel-manganese-cobalt (NCM) are the two most popular technology routes. The former prides itself on a longer cycle life, higher levels of safety and lower costs, despite the fact that it faces an upper limit on energy density. NCM, on the other hand, has an unparalleled advantage around energy density which translates into higher e-range and also makes it the most preferred battery system in today’s EVs, especially in mid- to high-end EV segments.

It’s well known that driving range and cost are the two main obstacles for large scale EV adoption. Thus, battery manufacturers and original equipment manufacturers (OEMs) have been focusing on increasing energy density, and at the same time, reducing costs. This has also been evident in a recent cathode formula of reducing the content of cobalt by replacing it with more nickel.

Cobalt is an expensive critical material, with around 60% of the world's cobalt supply coming from the Democratic Republic of Congo. The country’s political instability has sent cobalt prices on a rollercoaster rise over the last few years. The price volatility of cobalt and the technological imperative to boost energy density have prompted battery and auto makers to significantly reduce reliance on this rare earth metal and increase the proportion of nickel. South Korean battery manufacturer LG’s new NCMA (nickel, cobalt, manganese, aluminium) battery is reportedly using a 90% nickel cathode.

Nickel, however, has its own problems. Despite being one the most abundant metals on earth, nickel supply is constrained and investment in nickel mines has been lagging over the past decade. Furthermore, it is not easy to produce class-one battery-grade nickel, which, at present, only makes up less than 10% of the total nickel produced around the world. Indonesia accounts for 24% of global nickel reserves, making it the largest nickel producer in the world (26%). According to the International Nickel Study Group (INSG), global nickel output has dropped 7.6% to 2.352 million tonnes last year due to the Indonesian government’s ban on nickel exports and covid-related disruptions. Like other commodities, the price of nickel has also fluctuated over the past few years, mainly due to soaring demand and tight supply.

To mitigate the risk of price volatility, a few battery makers and OEMs have signed long-term contracts that allow them to pay at fixed prices, and many others have invested in leading nickel ore suppliers or established joint ventures. From a long-term perspective, however, a more acute and looming threat is the supply gap. According to Benchmark Minerals, demand for nickel from the EV market is expected to reach around 1.4 million tonnes a year by 2030, almost ten times that of the current demand level. That will further exacerbate the structural shortage of class-one nickel.

Some companies have committed to meaningful efforts to reduce reliance on critical rare earth metals. These initiatives fall into three categories. The first is to pivot to lithium iron phosphate (LFP) batteries and overcome the bottleneck in energy density via technological breakthroughs. For instance, BYD’s blade battery and CATL's cell-to-pack technology have all enabled higher energy density which in turn leads to longer e-range. The second option is to establish battery recycling systems by recovering and reusing valuable materials such as nickel and cobalt from end-of-life batteries. The third is to develop alternative technologies to the current lithium-ion battery. For instance, CATL announced last month it has developed a sodium ion battery that contains no nickel, lithium or cobalt, even though it may not be an ideal solution for today’s EVs.

As the auto industry transitions to an all-electric future, it should also be prepared for a looming mineral shortage. It has been widely recognized that securing supplies of key materials has become the top priority for automakers after the semiconductor crisis. Forward-looking companies have started to gobble up raw materials globally, and at the same time, made significant investments into sustainable solutions. After all, the industry cannot afford another hit from global supply chains.

Life Science and Healthcare

The future of China’s mature drugs market

Almost three years have passed since China’s first round of volume-based procurement (VBP) was first introduced in November 2018, and chemical generics’ VBP has gradually become the norm. As of June 2021, the first two rounds have completed the expected procurement volumes, while the third and fourth rounds are now under procurement and the latest fifth round will go effect in October 2021. Currently, procurement volumes of selected drugs have reached over 80% of the country’s mature drug index, 1 shrinking the original market value by 82% on average (Figure 1)2. The generics market underwent a rapid rectification in just two to three years, and in tandem with the “tripartite” medical reform,3 reshaped the market and encouraged pharmaceutical companies to transform innovation and development.
Figure 1: Total market value reduction rate after each VBP round (bln RMB, “4+7” to 5th round)

Source: GBI

VBP tender results in retrospect

At the moment, a total of five rounds of VBP have been completed, which has resulted in three different types of players emerging in the market:

  • Domestic generics leading pharmas show promising bid results without yet gaining much revenue

Domestic pharmas with a dynamic product portfolio and mature supply chain have the upper hand in VBP tenders as they are better able to maintain profit levels with a significant price-cut to secure bids. After five VBP rounds, bid-winning companies now dominate the off-patent generic drug market, especially those large pharmas with multiple winning bids. The trade-off of high pricing for high volume indeed expands companies’ market share, even though many of them say that VBPs have not brought about significant revenue growth (Figure 2). In the long run, these companies may adjust their strategies according to VBP policies in order to improve their financial performance.


Figure 2: Revenue YoY growth comparison between top 10 publically listed VBP winners (2019 vs. 2020)

Source: Wind, companies’ annual reports

  • Domestic generics SMEs face rising sales pressure and diminishing competitive power

Small- and medium-sized pharmas are one of the primary targets of China’s medical reform, and some SMEs are likely to be eliminated throughout the transformation process. Given that their products pass consistency evaluations, the production technologies and volumes of these companies are incomparable to large pharmas, leaving them little space to cut prices. Additionally, these companies often have a small product portfolio, thus each bid is crucial to their overall business performance. In such a predicament, enterprise transformation seems to be the only way out.

  • MNCs switch from being wait-and-see observers to active participants

Due to the global price consistency, many MNCs chose not to participate in the early rounds of VBP and have shown little interest. But as the China market is fast-growing in importance globally, numerous MNCs have begun to build China-specific strategies and shown increased enthusiasm in VBP participation. In the fifth VBP round, ten MNCs won 13 products, a huge jump from a total of five MNCs winning five products in the fourth round.

With VBPs’ rapid popularization, pharmaceuticals’ drastic price reductions can contribute to China’s medical reforms such as lowering the National Healthcare Security Administration’s (“NHSA”) expenditure, rectifying industry conduct, and eliminating sky-high profit margins. As this trend continues, biosimilar and Traditional Chinese Medicine (TCM) VBPs are on the horizon. Since 2020, the Chinese government has released multiple procurement-related guidance documents and have begun experimenting with tenders at the provincial level. Although biosimilars and TCM VBPs can reference the progress of generic drugs, they still face many challenges in execution:

  • Biosimilars need a tailored evaluation system

China’s current biopharma market is booming. While many products are in their clinical trial and application stages, 16 biosimilar products have been approved as of June 2021. As biosimilar requires a more advanced production technology and quality control regime, it is now facing difficulties in evaluating its “consistency” with the originators. The National Medical Products Administration (“NMPA”) recently released a document aimed at tackling this issue, emphasizing the standard of “similarity” rather than “consistency” when evaluating biosimilar. The document also pointed out that, unlike generics, evaluations must differ from drug to drug. To ensure patients’ treatment safety and quality, the NMPA must establish rigorous similarity standards and create a well-rounded evaluation system of biosimilar before the first national VBP. In the future, national VBP of biosimilar may refer to Anhui’s regional insulin VBP to procure a single product type per round.

  • TCM market still needs standardized management

The current TCM market has much room for improvement, with issues like a lack of transparency and low standards around the origins of raw materials and inconsistent profit margins across the value chain. To address these issues, the country may turn to VBPs coupled with improvements to the TCM hospital network in order to reshuffle the overall TCM market. Currently, provincial procurement in TCM has expanded to an group of 12 provinces led by Guangdong. As the country’s TCM index undergoes a standardization process, this alliance may quickly expand to all 32 provinces and municipalities. Supported by policies targeted at the TCM supply chain, the market may welcome a positive change in the next few years. What’s also worth noting is that the index released by the 12-province alliance included drugs exclusively produced by companies in the alliance’s jurisdiction. Even so, these companies still chose to lower their prices in order to secure at least 70% of hospital market sales. TCM companies have responded positively to the regional VBP rounds, and they have an easier time participating in the national VBPs than their counterparts in the national biosimilar VBPs.

In an environment of promoting the fifth generic VBP round and the continuation of medical devices VBP, the NMPA achieves a significant milestone in market transparency as well as healthcare expenditure control. The possibility of future biosimilar and TCM product VBPs are increasingly high. Compared to generics, biosimilar and TCM drugs need more product-specific reviewing standards in order to succeed in large-scale procurement. With the promising growth of VBPs, China’s pharmaceutical market will continue to improve towards high-quality standardization.



[2] GBI

[3] Reform of medical care, medical insurance and the pharmaceutical industry

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