The Deloitte Research Monthly Outlook and Perspectives

Economy

Should China be keeping its powder dry?

With Chinese New Year just around the corner, the country is unlikely to see its annual mass migration (nearly three billion passengers in the 40-day travel rush in a normal year) in the lead up to the year of the tiger due to strict Covid protocols. The Beijing Winter Olympics will naturally reinforce risk aversion on the policy front, but on the economic side, our view remains that the Winter Games will be relatively muted. Additional environmental protection measures for the Games, which are highly-anticipated, will weigh in on the manufacturing industry in provinces such as Hebei for two months. But in the grand of scheme of things, most people are willing to sacrifice the most important occasion of the year if China's longstanding zero-Covid approach holds up. Of course, there the debate around the zero-Covid policy will, especially concerning the economic impact should more major economies follow the approach taken by the UK – that people “must live with Covid in the same way we live with flu,” to quote Prime Minister Boris Johnson.

Our baseline scenario on China's Covid policy is that the existing stance won't waver for a few months due to the desire for stability. But we could also see more calibrated methods taken by local governments. A case in point was a medium risk area in Shanghai that was accurately pinpointed to a milk tea shop. Going forward then, the one-size-fits-all approach of mass testing and blunt lockdowns will be replaced by more focused containment measures that are currently being perfected by Shanghai and Guangdong. The reality of the situation in China is that their zero tolerance for any Covid cases continues to enjoy popular support. That said, the zero Covid policy and the Winter Olympics could amplify the perception that policy ought to play a greater role in reflating the slowing economy. Is this perception warranted?

Before we address reflationary policies, let's quickly review China's economic scorecard for 2021. By any measure, 8.1% of GDP growth is impressive. It is even more impressive in light of the fact that the Chinese government achieved this with minimal policy support (fiscal policy has been tight throughout the year while monetary policy only began to loosen in the wake of the Evergrande fallout). One could also argue that a number of regulatory initiatives and the decision not to bail out Evergrande, China's second-largest developer, were been made under the assumption that the economy would remain resilient. However, 8.1% of headline GDP growth does not mask the evident trend of economic deceleration. Such deceleration is particularly pronounced in the property sector where investment growth has collapsed in recent months. Of course, subdued sentiment in the property sector has prompted swift policy changes including an effective shelving of the three red lines, a cut to short term interest rates and repeated policy assurances on the property sector's healthy development.

Chart 1: property investment growth has collapsed in recent months

Source: Wind

If 2022 is continuation of 2021 for the Chinese economy, external demand is likely to shine thanks to the global recovery. But if the property sector stays in a slump, achieving a GDP growth rate of 5% will be challenging. Assuming China runs a hefty current account surplus in 2022 as in 2021, and also assuming that consumers will stay resilient (which is plausible), nevertheless, investment has to hold up in order for GDP growth to reach the general 5% mark. So far, the risks from Evergrande's fallout have been well contained. With an orderly consolidation of the real estate industry well underway, consumers may feel more confident in taking on additional debt, which is the implicit policy goal. As Premier Li Keqiang said in the 2020 government work report, "governments at all levels should tighten their belts". To be precise, local governments need to adapt to an environment in which revenues from land sales are expected to fall significantly. From this perspective, both the central government and consumers have to step up.

On fiscal policy, the central government will run a larger deficit by increasing fiscal transfers to less well-off provinces and to provide more subsidies to firms through fee cuts and subsidies to those who are more affected by the zero Covid policy. On monetary policy, China is merely in the beginning of an easing cycle. We have been repeatedly advocating for decisive action which are aimed to improving liquidity conditions. Such decisive actions will entail more than continued reductions of reserve requirement rate and LPR. As the Fed is being forced to take a more hawkish stance towards inflation, interest rate differentials between China and the US will narrow quickly. Volatilities in the US equity market this year has changed the market consensus on the number of rate hikes by the Fed to three or four, perhaps even five. And finally, the standoff between NATO and Russia on Ukraine, no matter what outcome, will be strengthen the dollar in the short term. All in all, policymakers must stay vigilant about the unintended consequences of the Fed's unwinding of its multi-year easing. As such, China needs to clearly and credibly signal reflation, but at the same time, refrain from firing off all of its bullets.

Chart 2: Repeated cuts of LPR signals reflation

Source: Wind

Energy

Floating solar: from niche to nascent 

As a clean, renewable source of energy, solar plays an essential role in battle against climate change. Besides from ground-mounted and rooftop solar installations, floating solar is gaining in popularity, due in large part to government support, declining costs, and the absence of any land constraints.

Floating solar is a relatively new concept. It doesn’t take up land space and can be mounted on a structure that floats on a variety of water bodies, such as the sea, hydropower dam reservoirs, wastewater treatment ponds, or drinking water reservoirs. In addition, the cooling effect brought about by the water bodies can improve the performance of solar panels by 5 to 10%. Furthermore, the installed floating solar panels shade the water, thereby reducing loss from evaporation.

Fastest growing solar subsector with the Asia market leading the way

Initially considered a niche technology, floating solar photovoltaic (PV) is now the fastest-growing solar PV category, alongside ground-mounted utility-scale solar and rooftop PV. Floating solar power has been widely deployed in more than 60 countries and the project scale and unit capacity are constantly reaching new highs.  It is estimated that total floating solar installations would have exceeded 4GW by the end of 2021, with 1.5GW of new installations in 2021 alone. Growing levels of government support and falling costs will drive almost 10GW in new floating solar deployment by 2025.

Asia dominates current project pipelines and accounts for about 60% of global incremental capacity. Growth in Asia is mainly driven by the increasing scarcity of open land to build solar power plants and the rapid depletion of fossil fuels.

As the world's largest market for floating solar, China will lead the category over the next five years, with India and South Korea trailing closely behind. Country-level targets, such as China's carbon neutrality goal, South Korea’s 9th Basic Plan, and India’s 2022 solar installation target, will all contribute to growth in this category in these countries. China has recently put into operation the world's largest floating solar power plant in Dezhou, Shandong province. The 320MW floating solar project is part of a larger renewable energy project that also includes a 100MW wind farm and 8MWh of energy storage nearby.  At its full capacity, the PV complex is expected to generate around 550 million kWh of electricity per year. Investments in floating solar development are also anticipated to increase in the ASEAN countries. For instance, Scatec, a leading renewable power producer in Norway, recently announced its plan to invest USD1 billion to build a floating solar equipment production line and develop a floating solar energy project in Vietnam, with a capacity of 1,000 megawatts (MW). 

Higher costs and risks

Different from ground-mounted projects, the cost structure of floating solar PV projects includes a floating structure and an anchoring system. Costs will also depend on factors including water body depth, wind loads, distance to shore, water quality and salinity, and so on. In general, the capital costs for floating solar are 10 to 15% higher than ground-mount projects of a similar size and location. However, economies of scale are expected to drive costs down over time. In some European countries, the cost of a 20+MW system is already regarded as competitive.

Floating solar still has a limited track record and is therefore perceived to have higher risk. There are uncertainties in terms of lifetime costs of floating solar and long-term environmental impact. Developers will have to face various technical challenges arising from this new operating environment, such as electrical safety, anchoring and mooring issues, and post-construction operation and maintenance. 

Chart 3: Proposed bids for various tendered floating solar projects (USD/Watts peak)

Source: World Bank, SERIS, Bloomberg, Deloitte Research

Clear potential for hydro-floating solar hybrid

The operational model of adding floating solar capacity to existing hydropower plants shows clear potential. These two sources of power complement one another: solar energy can be used to boost the energy yield of hydropower plants and help to manage periods of lower water availability, while hydropower can smooth variable solar output. Most importantly, installations of the floating solar system can utilize the hydropower plant's existing electricity transmission infrastructure, thereby lowering the overall project capital expenditure of the floating solar system.

With this new trend, we are seeing mergers and acquisitions among solar power plants developers and hydropower developers. For example, Scatec Solar acquired SN Power, while Statkraft, a Norwegian hydropower producer announced the acquisition of Solarcentury, a major player in Europe. The integration of various renewable energy developers points to a promising future of hydro-floating solar hybrid models.

Logistics

Landmark deals point to deepening transformation and integration 

In November 2021, the Ministry of Transport issued the 'Development Plan for Integrated Transport Services during the 14th Five-year Plan', which provided development goals for the logistics industry in light of the post-pandemic economic situation. The plan emphasizes the quality, efficiency and innovation of development and proposes to establish a full coverage and integrated freight and logistics service system.

In-depth transformation and upgrading of the logistics industry appears to be more imminent under the new plan, especially in terms of increasing centralization, higher efficiency and expanding coverage. Moreover, its transformation also includes the construction of smart logistics and multimodal transport systems, and strengthening of global logistics network. The performance of capital markets in 2021 also saw similar trends. Statistics from CVSource shows that the disclosed capital inflow into China's logistics industry in 2021 totalled about RMB318.8 billion, a 38% increase over the previous year, while 359 transaction deals took place, up 11% from a year ago. Average transaction size also reached RMB890 million, exceeding the pre-epidemic level. A higher financing value on average shows that capital has been actively flowing to the leading enterprises of the logistics industry, and that industry consolidation will continue into the future.

Chart 4: Financing scale of China's logistics industry during 2017-2021 (including IPO financing amount)

Source: CVSource

IPO fever in smart logistics

In 2021, a total of five logistics enterprises went public while seven others are either preparing for listing or have submitted prospectuses.  This round of listed logistics enterprises mainly focuses on integrated supply chains, Internet logistics and other tech-enabled areas, reflecting digitalization and intelligent transformation within the industry. It is worth noting that due to the introduction of SEC's new regulatory policy related to Chinese listed companies and the launch of China's internet security law, many logistics companies may abandon NYSE listing plans and switch to listing in Hong Kong and through A shares.

Chart 5: 2021 IPOs in Logistics

Source: Public information

Integration deepens through M&A activities 

The development history of the logistics industry could also be seen as one of mergers and acquisitions, since M&A is the main method of inorganic growth for most of world's logistics giants. Today, China's logistics industry is seeing a new wave of M&A with the following three trends: 1) accelerated integration of domestic regional logistics enterprises, 2) the strengthening of international logistics networks and overseas transport channels to develop cross-border e-commerce business by domestic logistics operators, and 3) continued investments by foreign logistics giants in the Chinese market to enhance Asian coverage. Here are some illustrative deals made in 2021.  

• The birth of China's logistics "giant" state-owned enterprise to build an integrated logistics system: On December 6, 2021, China Logistics Group was officially established, which aims to enhance China's overall competitiveness in the logistics industry by integrating national sea, land and air logistics networks.  On December 16, Shanghai Airport (Group) Limited confirmed that it would complete the merger and reorganization of Pudong Airport and Hongqiao Airport valued at RMB19.13 billion to optimize airline operations and management, and provide financial support for the construction of smart logistics hubs at Shanghai airports. On the port front, China Merchants Port has become a strategic shareholder of Ningbo Port, while Liao Port has acquired Yingkou Port Group. The integration of these port resources is conducive to promoting regional port cooperation.
• Accelerated investment in international logistics networks by domestic logistics operators: In July 2021, CTS Logistics acquired Jiacheng International, which is mainly engaged in cross-border e-commerce. In September, SF Express acquired Kerry Logistics, the world's leading integrated logistics company, in order to enhance cross-border e-commerce business by extending its logistics network and customer relations overseas. That same month, CSPL laid out its European trans-shipment hub by acquiring a 35% stake of CTT in Hamburg, Germany.
• Foreign operators increase presence in domestic logistics market to enhance global coverage: In October 2021, through the acquisition of Best Express, J&T Express increased its domestic market share from less than 5% to 10%-15%, indicating that it will officially enter Taobao platform and open up multi-channel cooperation. In December 2021, Maersk group of Denmark announced the acquisition of Hong Kong Li & Fung Logistics, a contract logistics company, in order to strengthen its logistics presence in the Asia Pacific region and enhance its supply chain management capabilities.

Climate change & sustainability

Exploring regulatory foundations for a low-carbon transformation

Strengthened regulation on GHG emissions data quality

Several data fraud incidents related to companies' greenhouse gas (GHG) emissions in 2021, as well as the plan to include eight high-emission industries in the national ETS during the 14^th Five-Year Plan (FYP) period, highlight the significance of data accounting and disclosure of GHG emission. This will be a priority area of focus for the relevant regulatory authorities in 2022. In January, both the National Development and Reform Commission (NDRC) and the Ministry of Ecology and Environment (MEE) highlighted, in their 2022 work plan, the establishment of a unified and regulated carbon accounting system, as well as improvement in a long-term mechanism on GHG emissions data quality control. Meanwhile, guidelines on the 'Accounting and Reporting of Enterprises’ Greenhouse Gas Emissions', relevant to 24 industries, are currently under revision. A draft version for the power industry was released in 2021, and a revised version for other industries such as construction materials (e.g. cement) is expected to come out in 2022. Strengthened regulations on GHG emissions data and a standardized accounting system require businesses to enhance their carbon accounting capabilities.

Measures for the 'Management of Enterprise Environmental Information Disclosure', which will come into effect in February, apply to key polluting organizations, listed companies and bond issuers. Listed companies and bond issuers in particular are required to disclose their climate-related information such as GHG emissions data and ETS compliance status. It is the first document that asks local ecological and environmental authorities to set up a centralized disclosure system of businesses' environmental information. Specifically, the Measures require disclosure to be "comprehensive, accessible, and comprehensible" for the public and encourages public stewardship. However, disclosure channels are by far disjointed. For example, the Chinese Securities Regulations Commission (CSRC) also requires listed companies to disclose their environment information, which overlaps with the Measures. Therefore, consolidated disclosure channels are likely to be built up through collaboration among pertinent authorities. As the disclosure system becomes increasingly sophisticated and transparent, companies are necessitated to enhance their management on environmental performance and disclosure.

Market vibrancy of ETS expects to improve in 2022

Since the national Emission Trading Scheme (ETS) was launched on July 16, 2021, the compliance rate of businesses reached 99.5%, and a total of 179 million tons of allowances have been traded with a total transaction amount of RMB7.661 billion. The carbon price remained generally stable, trading in a range of RMB40 and RMB60 per ton. With a turnover rate of less than 2%, the carbon trading market is far from vibrant. And the transaction volume only temporarily spiked in December, as the end of the first compliance period was approaching. Compared with the first compliance period, the ETS is expected to be more active in 2022 due to the following factors, 1) tightening allowance distribution in 2022, 2) expanding coverage to include new industries such as cement and electrolytic aluminium, and 3) upcoming new derivative products and new players (Guangdong Futures Exchange plans to launch carbon futures within two years).

Meanwhile, the Chinese Certified Emission Reduction (CCER) scheme is expected to relaunch in 2022. It is estimated that the existing CCER is about 30 million tons and the market size is expected to reach 350 to 400 million tons per year if the 5% offsetting limits and expanding ETS are taken into account. Regional pilot ETS programs indicate that the price of CCER is much lower than the allowances. Therefore, the relaunch of CCER not only helps businesses to reduce the costs of reducing emissions, but also allows businesses to profit from managing their carbon assets, thus also adding vibrancy to the ETS.

Chart 6: Overview of the national ETS during the first compliance period (2021.7-2021.12)

Source: Wind

Cities accelerate carbon peaking and define low-carbon transition pathways

By the end of 2021, 87 cities or provinces have been enlisted as 'low-carbon city' pilots. The recently released work plan for the Development of 'Waste Free Cities’ during the 14th FYP also sets the target of developing about 100 'waste free' cities by 2025. Among the 87 low-carbon pilot municipalities, 18 and 42 cities have proposed to peak carbon emissions by 2020 and 2025 respectively. Shanghai, Beijing, Suzhou, Jinan, Wuxi, Dongguan and other cities have included the 'early carbon peak agenda' in their 14^th FYP, i.e. to peak emissions earlier than 2030, the established national target. Cities are in different phases of transition and design low-carbon transition pathways applicable to their demographic mix and industrial makeup. A few cities such as Wuhan, Shenzhen and Kunming have already achieved carbon peak. Municipalities and capital cities of coastal provinces with a lower carbon intensity than the national average have great potential to peak emissions ahead of the national timeline, while traditional industrial cities are facing increasing pressure to move towards a low-carbon transition. Below are three types of low-carbon transition pathways for cities.

Chart 7: Low-carbon transition pathways by Chinese cities

Source: Government websites, public information, Deloitte Research