The Deloitte Research Monthly Outlook and Perspectives
9 November 2021
Regional growth divergence in the year of the tiger
China's economic performance in Q3 has confirmed the trend of economic deceleration (Q4 growth is likely to be a tad lower than 4.9% for Q3) but 2021 growth will almost certainly exceed the implicit target set by the government of around 7%. But key questions remain as to what new growth driver will fill the gap caused by a potential slowdown in property-related investment in 2022. Even uncertainties around a property tax and the potential liquidation of Evergrande are unlikely to spill over into consumption. We are therefore of the view that a more accommodative monetary stance is needed. Such counter-cyclical measures, which we have advocated for, are also necessary in the regional context, should energy and commodity prices stay high. Here, we will preview the prospects of regional economies in 2022 because of their close links with China through trade, investment and tourism.
Headwinds are weakening the current state of Asian economies. There is little doubt that the global economic recovery lost momentum in the third and fourth quarters of this year, due to the resurgence of COVID-19, supply side dislocations, rising energy prices and a deceleration of Chinese economic activity. Yet, despite various risks, we can expect to see a faster pace of normalization of economic activity as the worst effects of the pandemic on the economy are overcome. As the region recovers, however, there will be a significant divergence in economic trajectories, closely linked to state capacity, differing levels of sensitivity to upside forces in the global economy, and the willingness of countries to undertake longer-term reforms.
Among these economies, China is expected to settle into a period of stable growth at around 5-5.5%, although this will mask the sizable qualitative changes underway in the economy. India will also recover after a difficult period, but the pace of growth could be constrained by headwinds such as continued weaknesses in its banking and non-banking financial sectors. Besides from these Asian giants, Vietnam and Indonesia represent the high growth breakout nations, whose patient accumulation of reforms will yield positive results and should bring about a noticeable acceleration in economic growth compared to pre-pandemic times. Advanced regional economies, such as Australia, New Zealand, South Korea, Taiwan, Hong Kong and Singapore, will also grow modestly with positive structural transformations. Others, notably Thailand and Malaysia, will struggle against domestic headwinds.
Where do the regional economies stand today?
A confluence of adverse developments has contributed to a loss of momentum in the global economic recovery in recent months, which has had a knock-on effect on regional economies. As the delta variant swept through the region, many countries such as China, Vietnam, Australia and New Zealand responded with strict lockdowns that curtailed economic activity sharply. In others, the response was more calibrated but still involved social distancing and other measures which slowed growth. The resurgence of the virus equally damaged business confidence, further undermining the economic recovery. These public health measures caused more severe dislocations in global supply chains that previously anticipated, and rising energy prices and power shortages have acted as a further drag on economic activity. Noting these various impediments to the economic rebound in the second half of 2021, the IMF has revised down its forecast for global economic growth in 2021 by just 10 basis points to 5.9%. In a show of confidence that recent headwinds won't linger long enough to wreck substantial damaged, the IMF has, however, maintained its forecast for global growth of 4.9% for 2022.
Chart: Daily Covid-19 new cases
Our view remains cautiously upbeat as well. This optimism comes from our baseline scenario for the global pandemic, as well as the various reasons why drags on growth are likely to dissipate:
- The rollout of vaccines is improving, even in countries which were initially slow to vaccinate.
- Large populous countries such as India and Indonesia are experiencing precipitous declines in COVID-19 infections even when vaccination rates are not high, suggesting a good degree of resistance within the population.
- Governments are generally shifting to a public health stance that assumes COVID-19 will be endemic, and one which societies have to learn to live with. This will necessitate avoiding harsh economy-wide restrictions in favour of selective and calibrated responses to episodes of rising infections.
While monetary and fiscal stimulus in the region is mostly being wound back, policymakers will not hesitate to add stimulus should the risks to economic growth become serious. If the headwinds to growth caused by the pandemic are reversed and as the supply chain issues create fewer hindrances to factory activity, then the question is, how strong could the recovery be? This will be driven by the build-up of excess savings which point towards a substantial release of pent-up demand, and the strong desire among consumers to return to normal.
Should we worry about risks in China hurting the region?
The signs of a slowdown in the Chinese economy and the risks this present serve as a caution to the rest of the region. But we also believe that these risks can be mitigated by several factors. Firstly, the Evergrande saga has the potential to hurt the economy through its knock-on effects, but the Chinese authorities have shown that they have the financial resources, the policy tools and the levels of control over the financial system to contain known financial risks. Moreover, China has a large current account surplus as well which provides another strong buffer in the system. Second, in response to bottlenecks in production caused by power outages, the authorities have responded by stepping up coal production which is beginning to bring the situation under control. For example, Toyota was reported to have cut planned production in its China units by 40% in September-October, but reductions in production for November will be lower at 15%. Third, while consumer spending and services output has been hit by stringent lockdowns, restrictions have eased as outbreaks have been brought under control, and there are signs that the authorities are shifting to much more targeted approach to minimize the economic impact. Lastly, we expect a modest degree of additional policy support in view of the rising risks to growth. Local governments are likely to step up infrastructure spending, while the central bank may cut reserve ratio requirements to release more liquidity into the system. Taken together, the downside risks in China are likely to be contained.
Reform in Hainan points to renewed focus on localized openings
The implementation of China's first ever negative list for services in Hainan has garnered significant attention among foreign investors. While this new negative list does indeed shine a light on where the future direction of market reform is heading in China, it is perhaps not the overarching reason why multinationals are increasingly growing their presence on China's southern island province. Given the relatively limited openings to come out of Hainan's negative list for services, it is worth revisiting then some of the more attractive features of the Free Trade Port, and why foreign investors should be keeping a close eye on localized reforms.
Hainan's Free Trade Port
Following several decades as a Free Trade Zone (FTZ), Hainan officially became China's first and only Free Trade Port (FTP) in April 2020. According to a master plan released by the State Council, the authorities aim to have "basically established" a free trade port system focusing on trade and investment liberalization by 2025, and for the port to have become "more mature" by 2035. Covering the entire island at 35,000km2, the size of the Hainan FTP alone sets it apart from China's other FTZs as well as global trading hubs like Hong Kong and Singapore. But beyond its size, the Hainan FTP offers numerous other benefits to foreign investors, including but also going beyond many of the usual preferential policies associated with China's FTZs.
Besides from the customary streamlined processes for starting a business, several FTZs, Hainan included, offer a reduced rate of corporate income tax (CIT) at 15%, significantly lower than the national standard rate of 25%. Similarly, both the Hainan FTP and the free trade areas listed in Figure 1 have introduced a reduced individual income tax (IIT) rate of 15%, although in Hainan this extends to both domestic and overseas talent. One of Hainan's most attractive features, however, is its customs policies. While other free trade areas generally offer limited policy incentives designed to boost trade, Hainan features a zero-tariff policy on offshore duty-free goods, certain exemptions on import duties and VAT, and most notably, exceptions on import tariffs for imported goods entering the rest of the Chinese mainland.
Figure 1: Comparison of preferential offered by selected free trade areas
Numerous market openings have also accompanied the launch of the Hainan FTP. In the telecommunications industry, JV restrictions on value-added telecommunications services have been removed, and companies registered in Hainan are now able to conduct online data processing and transaction processing services. In the education sector, foreign companies are also permitted to operate international schools and vocational colleges independently, while in finance qualified overseas fund futures institutions will be able to set up wholly-owned foreign institutions, and controls on the capital account will be loosened in the FTP. Other openings such as removing shareholder restrictions on automotive manufacturers are just an acceleration of existing plans to do so nationwide by 2022.
China's first negative list for services
Unlike other FTZs in China, the Hainan FTP now has two separate negative lists. The first is the Special Administrative Measures for the Access of Foreign Investment in Hainan Free Trade Port (2020 Edition), which applies to all foreign investment across the island. More recently, authorities have also issued the Special Administrative Measures for Cross-border Services Trade at the Hainan Free Trade Port (Negative List) (2021 Edition), otherwise known as the negative list for services which is the first and only one of its kind in China. This particular list sets out the areas in which foreign participation in services sectors is restricted or outright prohibited in the FTP, and is grouped into 11 categories such as finance, business services, education and scientific research. Sectors not included in the list should, on paper, grant foreign and domestic companies equal treatment in the market.
While the specific openings in the negative list for services are somewhat limited, there are niche areas that could offer new business opportunities to foreign investors (see Figure 2). For example, under the national Negative List for Foreign Investment and the Negative List for FTZs, investment in market research is restricted to joint ventures and investment into social research is prohibited. The Hainan negative list for services, however, removes such restrictions for companies with the necessary investigation license. Other measures such as removing stringent qualification requirements for foreign teachers will be welcomed by overseas education providers, although its impact will be limited in the short run as China's borders remain effectively closed to new foreign talent.
Figure 2: Notable openings from the negative list for cross-border services
According to customs data, the total value of trade in goods in Hainan in the first three quarters of the year reached RMB101.35 billion, up 60.4% year-on-year. This exceeded the entire total of 2020 and surpassed RMB100 billion for the first time in a single year. During the same period, the number of foreign trading enterprises registered in Hainan increased 128% year-on-year, while the island's exports increased 27.5% and imports by 74.4%. The rapid growth in Hainan's foreign trade and investment certainly signifies the value multinationals attach to the preferential policies on offer in the FTP and FTZs more broadly. Whether the relatively modest openings from the negative list for services will provide a noticeable boost foreign investment, however, remains to be seen.
More localized reforms to follow
Using Hainan as a benchmark, the authorities have made clear their intentions to expand service openings nationwide and implement more negative lists for pilot FTZs. The government will also rollout a nationwide negative list for cross-border services trade, and having just released a revised draft Negative List for Market Access, policymakers are also currently drafting a shortened Negative list List for Foreign Investment which is equally expected to carry a heavy focus on services. Taking their cue from Hainan, officials in Qianhai have indicated that they will similarly formulate their own negative list for cross-border services, in addition to a new negative list specific to the financial sector. It is vital then that foreign investors in China stay abreast of local openings in FTZs and closely monitor the regional focus areas of each development zone. In this way, multinationals can better align their business strategies with local government priorities, allowing them to make full use of the sector openings and unique preferential policies that could be available to them, while also anticipating nationwide openings.
Forging a data security shield a must
On 1 September 2021, the new "Data Security Law"(DSL) formally went into effect, marking the establishment of China's first comprehensive data regulatory framework. The law aims to further strengthen the existing protection regime for China's fast-growing digital economy by spelling out how data is collected, used, developed, and protected. DSL will join the "Cyber Security Law"(CSL) and the forthcoming "Personal Information Protection Law"(PIPL) as the three core pillars that support China’s data and cybersecurity governance. The implementation of the DSL increases the scope of data security regulation but including intermediary providers and cross-border data transfers.
- Compliance for intermediary data service providers: As the capability to collect, analyze and use data has increased in China, the demand for data to analyse and process has increased, creating a vibrant data trading market. Over the last few years numerous data trading platforms have emerged. These data trading platforms act as intermediaries, providing a platform for data suppliers and data purchasers to trade. Previously, there was a lack of rules and regulations to monitor and control the data transaction process and a lack of standards for intermediary service providers to conduct data transactions. This has improved with the introduction of under the DSL, in which service providers must explain the source of the data, examine the identity of both parties to the transaction, while keep audit and transaction records when providing services.
- Stricter regulation of cross-border data transfers: For Chinese companies with overseas operations and MNCs in China, cross-border data transfers are inevitable when engaging with parties outside China’s borders. In line with the existing trend of tightening cyber security practices and regulations, the DSL extends this to the realm of cross-border data transfers. Under DSL, Critical Information Infrastructure Operators are required to store the important data in the territory of China and cross-border transfer is regulated by the CSL. From now on, companies should carefully assess whether they fall within the scope of a "Critical Information Infrastructure Operator" before transferring data to an overseas party. They should also closely monitor future legislative developments to avoid compliance risks and potential penalties.
- Promoting ethics and social development: Data analysis has brought greater convenience into people's daily lives. But at the same time it has also brought the misuse of users' personal data and infringement of privacy. For this reason, the DSL stipulates that any organization or individual engaged in data processing activities or R&D of new data technologies should take the responsibility of ensuring that these be conducive to promoting economic and social development, enhancing people's well-being, and complying with social and professional ethics. Enterprises engaged in data trading, software development and other related activities should conduct a careful morality and ethics review of their data analysis products so as to be compliant with the DSL.
- Enhancing public interest: Thanks to the data revolution China has made great improvements in the effective delivery of public services to its citizens. But a certain segment of the population such as the elderly and persons with disabilities have experienced many barriers to using digital technology. In order to protect public interest and ensure that these groups have equal access to public services, the Data Security Law emphasises that the needs of the elderly and persons with disabilities should be fully considered by any organisation and individual when designing and developing public service data applications.
The cost of violating the DSL is high, and enterprises should pay attention to compliance requirements related to data security and cyber security to avoid penalties. We recommended that enterprises strengthen their data security protection efforts across the board and create a data security governance system in accordance with the obligations stipulated in the DSL and CSL in the course of using and processing data, in order to be in full compliance with the new requirements in data security. This can be done in the following ways:
First, by conducting an internal data mapping exercise.
To establish a data security governance system, companies should first conduct internal data mapping exercises to determine whether data collected within China needs to be exported outside of China and whether any of this data could affect China's national security. If so, such data should be subject to increased scrutiny. Based on thorough understanding of its data, a company will strengthen its data security protection efforts on all fronts and such efforts are key to establishing a comprehensive data security protection system.
Second, by establishing a data security management department: A data security management department is key to helping companies build a data security governance system. According to DSL, companies need to specifically designate a person responsible for data security and establish a data security management department within the company. This will help companies to respond to the relevant regulations and provide authorities with the data they need to perform their duties. At the same time, the data security management department should assist the enterprise to strengthen training of employees on data processing security and improve the overall awareness of data security protection issues throughout the enterprise.
Third, by setting up a data classification and grading system: Grading and classifying data based on its national security sensitivity can help companies meet their compliance and operational needs and is an important element in creating a data security governance system. The data classification and grading system may include data identification, classification, and grading - and should include all aspects of an enterprise's operations. Enterprises should establish a management system for data classification and grading, starting with management and extending to business and technical departments, to achieve a systematic management of data through classification and grading. Enterprises that have already established a classification and grading management system can make appropriate adjustments to their existing systems based on several national and industry standards that have been introduced recently such as the Data Security Grading Guideline for Financial Data Security.
Finally, by establishing a regular risk assessment regime: Creating a data security governance system also requires enterprises to establish a regular risk assessment regime for critical data, conduct regular risk assessments of data processing activities, and submit such risk assessment reports to the authorities in order to enable them to better detect risks in the use of data. Enterprises need to take measures to reduce security risks in data processing and have contingency plans in place to respond to security incidents in order to avoid unnecessary losses due to information leakage caused by genuinely innocent mistakes.
Chinese EVs are going global
With electric vehicles becoming the new engine for growth in the automotive sector, China’s stagnant car export market is poised for a new period of expansion. In the first nine months of 2021, 1.32 million vehicles (eight percent of the total number of vehicles produced in China) were exported, a 117.5% increase over last year. Exports are expected to hit 1.6 million for 2021, ending a 10 year-long period during which car exports stagnated at around 1 million units per year. Among all segments, NEV exports jumped 450% y/o/y to 173,000 units, accounting for 13% of the total cars exported from China. The market share of NEV in total car exports is expected to grow to 20% in 2021. This remarkable shift ushers in a new era for China’s car exports. We expect that many of China’s domestic car companies will embark upon a full-blown globalization strategy in the coming years.
Looking back upon the last 20 years, one can see three different phases in Chinese carmakers globalization efforts. The first phase (2000-2010) was characterized by a “testing the water” type strategy when China’s indigenous auto manufacturers for the first time started selling their low-priced cars and trucks to less developed countries in Latin-America, the Middle East and Africa. What they got in return from those markets was a lot of negative publicity due to the relatively poor quality of their vehicles and the cut-throat competition among their domestic rivals to keep prices down.
The second phase (2010-2019) saw substantial changes not only in global entry strategies but also in their targeted markets. During this phase, Chinese carmakers first embarked on a buying spree, from State-backed car enterprises to bootstrapped private car companies. They tried to snatch up under-performing overseas assets in order to gain market access and technology. At the same time, Chinese car companies began building knock-down production sites in Southeast Asia, the Middle East, and East and Central Europe, while increasing the content of parts sourced locally. They subsequently established joint ventures with local OEMs on technology license agreements. Their most recent effort is to establish fully-owned plants as well as sales and after-sales networks in local markets. Nevertheless, the period was also marked with turmoil as geopolitics, global trade frictions and currency volatility together somewhat muddied the future of Chinese carmakers’ overseas expansions.
Entering the 2020s, China’s car exports are set for a new period of growth as they are betting big on Europe’s EV gamble. With this they aim to shed their brand image of low-priced and low-quality cars made in China. Since 2020, seven carmakers including traditional car companies and EV startups have rolled out European strategies. NIO and Xpeng have both chosen Norway as the first destination for their global debut but expansion to other European countries is also in the works.
The NEV startups have established a rapidly growing fan base and sales volume in China with their high-performance EVs featuring longer range, intelligent driving capabilities (some of the features are equivalent to level-3 autonomous driving) as well as their novel retail and service model. Selling to the overseas market is a natural expansion for these companies who also want to compete with global rivals head-to-head. For the auto industry, the Chinese government is aiming high for domestic carmakers haven’t yet become strong global companies on par with their Japanese and South Korean counterparts. But there is a strong political push for China’s car industry to adventure globally.
As for why China’s NEV companies have set their eyes on Europe as the starting point for their international entry, there are multiple reasons. First, the stringent emission standards of the EU provide a strong incentive for NEV development. According to the latest regulations, the EU requires that the average CO2 emission of every new car sold falls under the 95 g/km target (equivalent to a fuel efficiency of 4.1L/km). And each gram of the CO2 over the limit will cost carmakers 95 Euros per car in fines. It is unrealistic to meet the target only via gasoline cars. Hence, selling more electric vehicles is the solution.
The second push comes from European governments. Various purchase incentives (including upfront cash and tax-reduction) have been introduced to lure more customers into the EV market. A few countries even set forward radical pro-EV policies with generous incentives attached. Norway is the world leader in promoting EVs given its plan to ban gasoline cars by 2025 and it is coming closer to this grand ambition as the latest sales figures point to an over 80% EV penetration in the country. In addition, Europe’s fast-growing EV charging infrastructure as well as European’s favorable attitudes toward EV all have made Europe a promising target market to tap into.
But it’s also worth pointing out that Chinese carmakers’ entry into the European market is fraught with danger. To start with there is the certification of vehicle compliance, a pre-requisite for market entry, which is extremely stringent. Then, there is the whole question of localization strategy – from parts sourcing and logistics arrangements to the establishment of a functioning sales and service network. A more difficult task is to develop and sell EVs that are tailored to the needs of European customers. Last, but not least, the introduction of the General Data Protection Regulation (GDPR) – EU’s legislation on the protection of car drivers' personal data – has added a significant compliance burden on Chinese carmakers. At the same time the window of opportunity is narrowing as European carmakers have also ramped up their production of electric cars. We suggest Chinese carmakers learn from their previous failed attempts, screen for viable markets, develop their value propositions, and take a deep dive into the sea of policies and rules of the targeted countries before trying to set sail on their stormy waters.
Life science and healthcare
The efficacy of connected medical alliances
Medical alliances were first conceived of in 2010 to ease pressure on the medical system, especially on public hospitals. Various pilot projects were set up and their success led, in 2017, to the State Council releasing its Guiding Opinions on the Construction and Development of Medical Consortia which strongly advocated the promotion of medical alliances and the creation of medical consortia. The Plan of Public Hospitals' High-Quality Development Promotion Action (2021-2025), issued by the State Council in September this year, re-emphasized 8 specific actions to promote the high-quality development of public hospitals during the 14th Five-Year Plan period, which includes the promotion of the establishment and practice of a hierarchical medical treatment system and medical alliances, and makes it one of the benchmarks to evaluate reform of public hospitals in China.
The construction of medical alliances is one of the key platforms of China's medical reform. Through targeted solutions to allocation and utilization of the existing medical resources and in-depth exploration of the development of innovative models, combined with the in-depth development of the "Internet+health" platforms during the 14th Five-Year Plan period, the government hopes to achieve, through medical alliances, a balance between the huge demand of the population for the medical services and the goal of promoting the fair distribution of medical resources to downstream cities and regions.
The current state of medical alliance development in China
Though the construction of a wide-ranging framework of medical alliances with a hierarchical medical treatment system at its core, doctors and medical institutions strive to provide more efficient medical solutions for patients.
The current medical alliance framework consists of the following four main parties:
- Urban Medical Group: a medical consortium mainly composed of tertiary and secondary hospitals and community hospitals at the grassroots level in the urban area
- County Medical Community: a medical community led by county-level hospitals and co-organized with other county medical institutions, township health service centers, and community health service centers.
- Cross-region Specialty Alliance: a specialty medical center tapping into the superior specialty resources in the region through cooperative networking among other medical institutions in the region.
- Telemedicine Collaboration Network: utilizing the internet to erase geographical barriers and establish telemedicine service networks with medical institutions in rural and underdeveloped areas that are relatively lacking sufficient medical professionals.
By the end of 2020, more than 15,000 types of medical alliances had been established. The telemedicine cooperation network alone covers over 24,000 institutions in all prefecture-level cities, with 7,700 hospitals at or above the secondary level providing online services. Especially during the pandemic, the number of online healthcare users has significantly increased (Figure 1). The “Internet+” medical service has improved the accessibility of resources, the sharing of high-quality resources and the efficiency of medical services. As a result, patients’ satisfaction levels have shown a marked improvement.
Figure 1: The user size of online healthcare (H1/2020 to H1/2021, million)
Barriers in the development of medical alliances
However, the field of medical alliances is not without its bumps. Despite spectacular progress in the development of medical alliances, there are still quite a few challenges ahead.
- The upsurge in the needs of geriatric medicine and chronic disease management as a result of an aging population
The aging of the Chinese population will lead to a gradual increase in the share of chronic diseases and will result in a substantial increase in the demand for chronic disease treatment and management. For the elderly and patients who need long-term or even life-long medication, the popularization and improvement of medical alliances and telemedicine are a matter of pressing concern in the regards of accessibility and accuracy.
An increase in demand for medical services due to an increase in disease prevention awareness.
With the improvement of living standards, other healthcare needs -- such as disease prevention, health monitoring and management -- may also see rapid growth. The effective and efficient use of a hierarchical medical treatment system will become important in this case.
In addition, the shortage and uneven distribution of quality medical resources (Figure2 and 3) have limited the capacity of primary medical institutions in China to meet the needs of the population and even current medical alliances are having difficulty in meeting the surging demand for medical and health services. The development of more innovative models of medical partnership are worth exploring.
- The close "Internet+" type medical alliance established in Tianjin is a good example. When digitalization empowers the medical system, the resources are more effectively allocated while the capacity of primary healthcare institutions to care for patients is vastly enhanced. With such enhancement, the provision of health maintenance services can truly be established.
The transformation of China's healthcare industry in 2020 was brought about by the acceleration of digital deployment in the hospital and health care provider network. It is predicted that, in 2021, "digital intelligence" will be the key development area for the healthcare industry, bringing more innovative and personalized medical services, especially in the real-time monitoring of health data as well as the convenience of online medical consultation, to millions of people across China. At the same time, the Chinese government will continue to promote the reform of the medical industry. The policies introduced in 2020 will plant the seeds of change in the healthcare sector in 2021, which will help the development of high-quality innovative companies.