Domestically, Beijing will focus on faster technological progress, boosting consumption, new urbanisation & supply-chain enhancement. While China may cut back on Belt & Road Projects and outbound investment, the strategy is not designed to close off the world’s second-largest economy.

China’s economic performance throughout the Covid-19 crisis has set it apart from the crowd. Not only was the initial rebound quite impressive, the growth momentum has been maintained as recently shown by purchasing managers index data, in stark contrast to other major economies that are still struggling to escape the grip of the pandemic.

If the strength and breath of the recovery continues, the market will soon have to upgrade its growth forecasts again, further widening the gap between China and the rest of the global economy, which is expected to contract by more than 5 per cent this year.

With China’s growth set to return its pre-Covid-19 path, there seem to be few roadblocks ahead for China’s near-term recovery. However, looking further ahead, dark clouds still lurk. China’s medium- to long-term growth prospects remain challenged by a number of chronic internal problems, such as an ageing population, rising debt, and an improving but still unbalanced growth model.

At the same time, the external environment is also restraining growth in areas such as trade, investment and technology. Navigating these currents is likely to require a new development strategy from Beijing that guides the economy to safer shores.

At the upcoming fifth plenary session of the Chinese Communist Party, Beijing is expected to unveil such a strategy in the 14th five-year plan. The market is likely to take keen note of details of the newly proposed “dual circulation” initiative, which could contain the guiding principles for China’s future economic development.

As the name suggests, the plan consists of two “circulations”. The “inner circulation” encompasses domestic economic developments that aim to extract China’s growth potential through faster technological progress, boosting consumption, new urbanisation, supply-chain enhancement, and so on.

The “outer circulation” aspect defines the relationship China wants to build with the rest of the world. While Beijing has signalled that more emphasis will be placed on domestic developments, fears of China turning isolationist are misplaced.

Unlike some countries that have turned decidedly anti-globalisation, China still wants to further its integration with other nations in areas where mutual benefits are possible.
The two aspects of the strategy will reinforce each other by strengthening and balancing economic development.

This growth initiative has two elements. First, it regroups all major economic reforms carried out in recent years but not yet completed into two “circulations” and prioritises domestic development.

This represents a pragmatic response from Beijing to the increasingly challenging external environment, where global integration has increasingly run into strong opposition in some areas.

Second, some outward developments such as certain Belt & Road Initiative projects and outbound investment in sensitive technology may be excluded from “outer circulation” as they have aroused scepticism and suspicion in some countries. De-emphasising these projects will help free up resources that can be ploughed back into domestic development.

It is important for investors in Chinese markets to appreciate the implications of this dual circulation strategy. The focus on domestic development will, for example, help drive resources and favourable policies for sectors linked to innovation that aims to rescue China from foreign technology sanctions.

It will also lead to a boost in consumption that taps the purchasing power of the burgeoning middle class, and to urbanisation that builds bigger, smarter and more environmentally friendly city clusters. Financial assets linked to these sectors could outperform those that do not enjoy favourable policy support in the years ahead.

Externally, China’s continued growth differential from the rest of the world amplified by the pandemic – is likely to entice more foreign capital to renminbi-denominated assets. Recent reforms to open the onshore bond market have earned China a ticket into the FTSE Russel’s World Government Bond Index, which could trigger up to US$150 billion flowing into onshore bond markets over the next few years.

Beijing has also expanded market access for foreign investors by streamlining the qualified foreign institutional investor and renminbi qualified foreign institutional investor schemes, and broadening their coverage of financial instruments.

Many foreign institutions, including those from the US, have responded to the liberalisation by recently taking up majority ownership in their Chinese joint ventures and raising investment in China despite rising tensions in Sino-US relations.

All this should help global investors understand that the dual circulation strategy is not designed to close the world’s second-largest economy, but instead, aims to better develop it for all those willing to participate in China’s growth opportunities.

With an open and cooperative mindset, a stronger China could help reshape the existing international economic and financial order to maximise the benefits for all in a fast-changing world.

Author: Aidan Yao, Senior Emerging Asia Economist at AXA Investment Managers. Prior to joining AXA IM, he was a senior financial market analyst at the Hong Kong Monetary Authority for two years. He started his career at the Reserve Bank of New Zealand in 2007, serving as an economist and later senior financial market analyst until late 2011. He holds a master degree in finance (2006) and a bachelor degree in economics and finance (2005) from the University of Otago (NZ). He is also a chartered financial analyst.
Editor’s Note: The article reflects the author’s opinion only, and not necessarily the views of the editorial opinion of Belt & Road News.