Evaluating the New 2022 China Trade & Supply Chains

May 18, 2022 Posted by China Briefing Reading Time: 8 minutes

Adapting to the new China and its supply chain realities, as China JV partners will be looking at Central Asian markets

By Chris Devonshire-Ellis

Western media again has tended to portray China business and trade in negative terms, most recently in terms of Q1’s export data. Headlines stating that China’s export slowdown ‘is the end of an era’ and that China trade is dramatically reducing are noisy and consistent. While China’s ‘Zero-Covid’ policy has attracted plenty of criticism, its application, at least in Beijing’s eyes makes complete sense. This is because while it doesn’t make sense in terms that its neighboring countries do not have such strategies in place and means that China’s defenses will always be breached, it does make sense on a localized political level. All these issues are affecting China supply chains, and more.

Beijing wanted to minimize infection risks during the Beijing Winter Olympics, Hong Kong is going through a political and economic transition (a new Chief Executive was appointed last week), and the 20^th National People’s Congress, a hugely influential and important event at which 2,300 delegates descend on Beijing, together with all their assistants and deputies and so on, is being held in November. Nothing is being permitted to interfere with this. Consequently, China will remain locked down in various stages until the year end. We expected this would happen at the beginning of 2022 and adapted our business plans accordingly.

Here is where it pays to listen to China advice being given from China as opposed to from the United States or Europe, who always impose additional negative political angles on China’s policies. We highlighted these exact China lockdown expectations and warnings in our China Briefing publication in December last year, in the article China 2022 Outlook: The Economy, Covid, Business, and Regulatory Landscape. The intelligence and the knowledge are out there. Make sure you have your China ear to the ground connected to China-based sources as opposed to Western media opinion, even if they ‘used to be’ in China. It’s a fast-moving country and advice needs to be sourced – from the source.

All this – and the Russia-Ukraine conflict – has impacted upon China’s supply chains. But not as often reported. What has actually happened is that while there has been an overall slowdown in China exports in the first four months of 2022, this has largely been the result of both China’s Zero-Covid strategy shuttering ports, but also the impact of the Russia-Ukraine issue where the expected normal transport flows of container ships ended up with the required vessels not being where they were needed. The EU closed its ports with Russia, leaving ships, rail, and millions of containers stranded, and will likely take until June-July to resolve. It is these two events that have resulted in a China export slowdown. Both are temporary.

What China has done during 2022 to mitigate against a slowdown is to release a new ‘Negative List’– a document that identifies areas of foreign investment either off limits or partially restricted to foreign investors – which this year is its most liberal yet. The China domestic market in 2022 is the most open to foreign investment it has ever been.

Other liberalization has just occurred in China’s financial services industry, where for the first time, foreign financial services firms will be able to access mainland China’s estimated US$3 trillion worth of private wealth via the various ‘Wealth Connect’ schemes being operated between China and Hong Kong. Far from Hong Kong being dead, it is being repositioned. China’s massive private wealth needs foreign expertise and investment help, and Hong Kong is being structured to allow foreign financial firms registered there and with the correct backgrounds to access that market. Additionally, China has just released laws concerning Futures and Derivatives, and is again providing market access to international firms to access this sector.

While it is true that the previous business model of sourcing from China and importing into the United States has long run its attractive profit margin course (the majority of the China tariffs imposed by President Trump in 2018 have still not been removed under the Biden administration), US businesses still sticking to this model will be suffering some pain. But opportunities to source from elsewhere in Asia, such as a booming Vietnam and elsewhere also exist. At Dezan Shira & Associates, we cover all these bases with multiple offices throughout Asia.

So, what is the future for China as concerns foreign investors? Despite Western media grumbles, its actually looking pretty rosy. China is changing from being an export-driven economy to being a consumer-based economy, meaning that (coupled with the liberalized ‘Negative List’ I mentioned above) foreign investors should be looking to sell to China. The country has a middle-class consumer base of some 600 million and this is expected to reach 1.1 billion by 2030. Selling to China will involve some marketing challenges, and possibly investment into manufacturing. But that has already been incentivized. The China-ASEAN Free Trade Agreement that came into effect in 2009 means that goods can be sourced or manufactured in ASEAN – which includes Cambodia, Indonesia, Malaysia, The Philippines, Thailand, and Vietnam – and sold to China duty free. The benefit? ASEAN’s production costs are lower than China’s.

China has also become part of the Regional Comprehensive Economic Partnership (RCEP) Free Trade Bloc from January 1 this year, which also includes all the ASEAN countries, Australia, New Zealand, Japan, and South Korea. Q1 2022 trade data has shown that China trade with these countries grew by 6.9% over 2021. The message is clear: use Asia and China both as sourcing, manufacturing, and sales markets to boost your own exports.

The Russia-Ukraine conflict

The unexpected development affecting all businesses globally is the Russian issue. While the reasons for this occurring are complicated, and the violence and destruction abhorrent, the fact remains that businesses have to adapt. While in Europe the result has been a pull-out of the Russian market and intense levels of sanctions placed upon Russian exports, in Asia, the conflict is seen as a European issue. This has resulted in changes in attitudes and supply chains. Businesses affected by these now need to factor these in and decide how to behave.

The Russian market

The exit of European exporters from Russia has led to consumer gaps appearing in the country. While the country is energy-wise and agriculturally self-sufficient, the middle-class consumer market is now available. Numerous countries in Asia, including China and India among others, are now examining these opportunities. The Russian middle class consumer base is about 60 million and worth about US$260 billion per annum. Not surprisingly, Asian exporters wish to service that. Chinese auto manufacturers are looking to JVs in Russia as the Europeans and others have exited. There will be many other examples, and Chinese investors will want to access them. Is your China JV prepared for this and the sanctions risk possibilities? It might be time to consider the issue.

The Asia markets

With Russian exporters barred from Europe (and the United States), they are now having to fast reinvent themselves as suppliers to Asian markets. Russia has several trade platforms to accelerate this, not least the Eurasian Economic Union (EAEU) and the Commonwealth of Independent States (CIS). The EAEU is of particular importance as it has free trade agreements with Vietnam and is negotiating FTAs with India, Egypt, China, Turkey, and several other ASEAN nations, including Indonesia. The Ukraine issue may need to settle down before it is politically agreeable to enter into these deals but as and when they do, the Russia bilateral trade impact will be significant. China will be a beneficiary.

Supply chains

As Russia has effectively been cut off from European access, this has meant that the rail supply chain routes from China, across Central Asia, Russia, and Belarus to the EU have ceased. Given that some 50,000 freight trains used that route in 2021, the impact has been huge. Replacements exist. There is already the Suez Canal option, although this is expensive, time consuming, and has had problems (readers may recall one ship blocked the entire canal for three weeks last year). An alternative exists along a southerly route, which is partially operational and upon which infrastructure work is being carried out at a rapid pace. This route extends from the Southern European Ports in Italy, Greece, Bulgaria, and Romania and heads east to either Turkish or Georgian Ports on the eastern Black Sea coast. From there, they travel overland (via rail and road), typically to Azerbaijan’s Baku Port on the Caspian Sea, a distance of some 693 km.

From Baku, several onward options exist (in both directions heading East and West):

Kazakhstan to China

Maritime shipping from Baku to Kazakhstan’s Caspian Aqtau Port, then by rail direct to other destinations in Central Asia and China.

Russia

Maritime shipping from Baku to Russia’s Caspian Sea Lagan and Astrakhan Ports, giving access to Russia’s Volga River heartland. Eleven cities with population of 1 million lie along the Volga River.

Turkmenistan to Central Asia

Maritime shipping from Baku to the Caspian Sea port of Turkmenbashi, then via road and rail to Uzbekistan and potentially, Afghanistan. It is also possible to link through to China via Kazakhstan to the North. Uzbekistan is an important Central Asian market and will impact upon its neighbors as it has an increasingly liberal trade and investment environment and possesses significant trade agreements with the EU. Concerning Afghanistan, all regional nations including China and Russia wish to see the country settle down, while the Shanghai Cooperation Organisation, a regional security and trade entity (not unlike NATO) will be keen to underpin this. That could, in turn, transform Afghanistan into a Central Asian transit and trade hub. Afghanistan, landlocked, linking to Turkmenistan’s Caspian Sea access and via Pakistan to ports at Gwadar could yet become a Central Asian success story in the next two decades – as long as peace and security can be sustained.

Iran to the Middle East, East Africa, and South Asia

This route exits Baku and leads south to the Iranian Caspian Sea Ports at Anzali, where road and rail connectivity runs south to Iran’s Persian Gulf Port at Chabahar. From there, maritime access leads on to East Africa, the Middle East, Pakistan, and India and beyond. Known as the International North-South Transportation Corridor (INSTC), this route was originally conceived as a way to reconnect Indian and Iranian trade, which has been segregated since partition of India in 1947. (Pakistan now sits between the two countries). This route has now taken on far greater significance given the Russia situation.

It is operational, although the Iranian rail connectivity will not be completed until 2023. The INSTC route from Asia to Europe however has advantages – it is less time consuming than the Suez option and is cheaper. Meanwhile, India-Iran trade is set to recover sharply from its Covid-impacted downturn and allows improved India access to EU markets and vice-versa. As both the EU and UK sign off on trade agreements with India, negotiations for which are ongoing but accelerated, the INSTC will become significant.

Summary

All these new routes affect all of the Asian-European connectivity relationships, and all impact upon China, if not directly in trade, then certainly in market development (Russia) and regional outbound investment (Belt and Road Initiative project financing) This indicates where future investment opportunities lie. Big winners are likely to be Azerbaijan, with the Baku Port now a key critical piece of connective infrastructure, Iran (although US sanctions remain an issue the EU will need to discuss), Turkmenistan, developing as a Central Asian transit hub, where Chinese investors are already investigating opportunities, and markets in Uzbekistan with its EU and other regional trade agreements also of immense interest to China. This means that the Foreign Investor management part of Sino-Foreign JVs may need to be buying atlases of Central Asian markets as supply chains change and new opportunities arise.

To summarize, taking care of your China business investment requires an understanding of the regional geopolitics and understanding how those can lead to opportunities – or disaster. A partial role of any business investor is to be aware that the original business model, especially in turbulent times, may need adjustment. Meanwhile, there is plenty of noise out there, much of it with underlying US and EU vested interests. They may not always help you understand what is going on in the minds of Chinese and Asian investors. If you want to understand China, or Asia, you need regional resources.

Chris Devonshire-Ellis is the Chairman of Dezan Shira & Associates and Publisher of Asia Briefing. He has had a 30 plus career in Asia, building his business up from a three-person office in one city to a business employing hundreds throughout Asia. For the very latest China and Asia updates, a complimentary subscription can be obtained from the Asia Briefing website here.