A successful outcome of PM David Cameron’s visit could support UK’s fragile recovery, foreign investment, London’s City and Chinese banks.
On December 5, 2013, Prime Minister David Cameron will lead a delegation of British ministers and business executives to China. When the announcement was first made in early November, it was seen as a sign of warming in bilateral relations, which had been frozen after Cameron’s decision to meet Dalai Lama in May 2012.
During the past year and a half, PM Cameron has sought to align China better with his administration’s “commercial foreign policy.” The latter been supported in business circles, but criticized among some Western diplomats and human rights advocates. Meanwhile, the bilateral wounds have been healing since the G20 Summit in St Petersburg in last September, when President Xi Jinping invited PM Cameron to Beijing.
In effect, setting aside the Dalai Lama discomfiture, the bilateral relations between London and Beijing have been improving since the onset of the global crisis in 2008.
Today, the UK is seen as the most open Western economy to Chinese investment, despite London’s ‘special relationship’ with Washington. Conversely, London cannot afford to ignore the contribution of Chinese trade and investment in Britain.
Short-term improvement, medium-term challenges
As PM Cameron has acknowledged, the UK can only thrive in the global economy if it can tackle the deficit, invest in infrastructure, commit to a smaller government and open up to new world markets, especially in the large emerging economies. In this view, China is the benchmark test to Cameron who has promised to forge a relationship that will “benefit both our countries and bring real rewards for our peoples.”
The good news is that, in the past few months, Britain has enjoyed a slate of upside developments. Thanks to the close relationship with the United States, Britain has managed to benefit from America’s lingering recovery. It has also been propped up by the temporary stabilization of the Eurozone crisis, due to the European Central Bank’s (ECB) pledge to defend the euro “by any means necessary.”
These two shifts support Britain’s efforts to leave behind the stagnation that has haunted the UK economy since 2008/9.
The longer-term growth model is a different story. In the past, the UK’s growth rested on housing and mortgage-lending, the huge expansion of the financial sector, government services, as well as oil and gas production in North Sea.
With the global crisis, that model has been exhausted. The new growth model is likely to rest on banking that will be less profitable but more resilient, as well as the exploitation of shale energy. However, both will require time.
Currently, PM Cameron’s government seeks to position the economy in a favorable position, boosting risky assets, especially property, equity and credit. London needs Beijing to overcome its short-term challenges. In turn, Beijing needs London not just for trade and investment, but as a financial gateway to Europe.
Thriving trade, soaring investment
In the past half decade, UK exports to China have doubled to $25.8 billion, which makes the mainland one of Britain’s largest markets. From London’s standpoint, the trade potential remains huge.
As the UK economy is coping with substantial economic challenges, PM Cameron is eager to take advantage of the perceived China potential. In China, the role of net exports has been halved since the onset of the global crisis, but is vital to Chinese manufacturers.
In 2012, the Sino-UK trade increased to more than $63 billion at 7.5 percent growth year-on-year. Yet, it accounts for just a part of the full bilateral economic relations. Last year, Chinese investment in the UK soared by 95 percent, which makes Britain the top recipient of Chinese investment in Europe.
During his October visit to China, Chancellor George Osborne pledged to open the doors to inward investors, especially to Chinese banks that seek to open branches in London.
What makes the bilateral relations so important to both London and Beijing in the coming years is the proposed role of London’s City as China’s financial beachhead in Europe.
A balancing act
As reflected by China’s nascent financial deregulation, Shanghai’s free trade zone and the central government’s impending reforms, Beijing seeks to build a more advanced financial system. Resting on a fully convertible renminbi, that system is needed to support more sustainable growth and a rudimentary social model to Chinese people.
These reforms require the increasing sophistication and internationalization of the Chinese financial sector, which is vital to support the mainland’s shift toward consumption. When ordinary Chinese feel more secure about their social welfare, health services and education, they are also likely to consume more.
When the UK offers to treat Chinese banks operating in Britain as branches, which are subject to Chinese regulation, rather than subsidiaries, which are subject to British regulation, both Chinese banks and UK economy can potentially reap great benefits.
As PM Cameron’s government is encouraging China to develop financial institutions with light regulation, it sees itself as supporting Chinese reforms, preparing the mainland for increasing access of foreign investment while facilitating the internationalization of the renminbi.
On the other hand, the critics argue that British policymakers may be more eager to encourage Chinese banks’ risk-taking, when it benefits the financial markets, than to protect Chinese financial flows, which should benefit Chinese savers.
For all practical purposes, the internationalization of Chinese banks is a balancing act in which opening-up policies are likely to be coupled by adequate control.
As future prospects in the U.S., Europe and Japan remain haunted by soaring sovereign debt, the sooner China can exploit the renminbi’s potential as an international reserve currency, the faster institutional investors worldwide can diversify their portfolios.
In the ideal scenario, the mainland’s government debt is positioned to become a critical global benchmark asset.
A shorter version of the commentary was published by China.org on December 1, 2013