China in the global fragmentation game

Globalisation benefits fade

Since 2020, China has been moving toward a new economic development strategy emphasising “domestic circulation” as opposed to “external circulation”. It is not that China no longer considers that exports are an important driver of economic development, but only that it aims to avoid excessive reliance on exports.

China’s decades long, labor- and energy-intensive, export-oriented model has benefited from globalisation. Since the economic reforms and opening up in the 1980s, China has increasingly integrated with the world economy. Its exports as a percentage of GDP have grown from 5% in 1980 to 36% at their 2006 peak.

World trade slumped to 26.5% of GDP after the Great Financial Crisis and then oscillated between 27% and 30%, save for a brief slide during COVID-19. However, China’s external trade as a percentage of GDP declined steadily to around 20%, far below the global level.

In the global fragmentation game

China seeks to play a bigger role in multilateral economic institutions of the prevailing international economic order established by the United States after the Second World War. China has pushed its officials to high positions in these institutions, such as Deputy Director General at the WTO, and proactively seeks reform of the WTO to ensure its voice is being heard and its interests addressed.

China recognises the hegemonic international economic and financial order created and defined by the US and has been acting mostly within its frameworks in its drive for economic development since the 1980s. As its national might grows and strategic competition with the US intensifies, China is looking to displace the American order, not entirely, but selectively and regionally.

This is similar to the strategy in the Asian board game of Go, in which winning does not mean eliminating the opponents’ playing pieces, but placing your pieces on the appropriate intersections to secure more spheres of influence. China has been investing in relationships with selected countries in key geopolitical regions with the aim of controlling key resources, blunting American influences and building China’s own influences. While continuing to embrace globalisation and the benefits that it brings about, China pursues to augment the globalised order in its favor, with an additional layer of bloc-building and alliance formation.

To hedge its position as well as to pursue strategically advantageous positions, China is actively seeking to establish bilateral agreements and regional ecosystems to secure access to markets for its products, and more importantly, the supply of key resources which are vital to the Chinese economy, as well as increasing its sphere of influence for national security considerations. China launched the Belt and Road Initiative, alongside the China-centric Asian Infrastructure Investment Bank and the New Development Bank in 2013. It has accelerated the signing of numerous bilateral and regional free trade agreements since 2015. China has also actively sought to sign bilateral currency swap agreements to push for the use of the renminbi (RMB) in its external trades, reducing its own reliance on the US dollar, as well as its trading partners’ use of the dollar.

Meanwhile, in pursuit of strategic competition with China, the US has fragmented the globalised order that it created to deny China access to some advanced technologies, investment, capital and markets, as well as to face higher tariffs and other trade barriers.

China marches West to secure energy supplies

After not going overseas for more than two years due to the pandemic, President Xi visited Central Asian countries Kazakhstan and Uzbekistan in September 2022, Saudi Arabia in December 2022, and Russia in March 2023 and received a visit from the Iranian President in February 2023.  During Xi’s visit, China and Saudi Arabia entered into a large number of trade, investment, technology and infrastructure agreements. Xi also calls for Saudi Arabia to accept the renminbi in settling crude oil trades. China has also recently brokered the restoration of diplomatic relations between Saudi Arabia and Iran. China is building ties to the Middle East to secure its crude oil supply and in the process blunting American power marginally in the latter’s traditional sphere of influence.

The location of Central Asia is key to China’s Belt and Road Initiative and an important source of crude oil and natural gas. The land-locked region used to be within the sphere of influence of Russia and most of its pipelines are still going to Russia. As Russia is busy at war and in need of China strategically, China is expanding its economic power in Central Asia.

Financial fragmentation

In spite of embracing globalisation in the past few decades, China has a firm grip on its currency, capital account and banking system. China has strict control over cross-border capital movements and a currency tied to a basket of currencies of major partners. Its banking sector is dominated by majority-state-owned banks.

China ring-fences its financial system from external financial shocks and uses its banks to channel funding to the corporate sector and local governments to finance economic growth and policy initiatives. While the US regional bank woes and the Swiss bank saga weighed on the share prices of US and European banks, listed banks in China are less affected, as they are relatively insulated from those shockwaves. Nonetheless, China’s banks have their unique issue of having to heed the People’s Bank of China’s window guidance to lend in accordance with Beijing’s policy initiatives. Chinese banks are often in a far different credit cycle stage than the rest of the world at any given time and their operating environment is outside of the global financial system.

In March 2023, China announced setting up new apparatuses directly under the Chinese Communist Party to take over from the government the policy settling and oversight of the financial sector in a move to centralise and tighten the ideological grip over the financial sector.

Technology and data fragmentation

In pursuit of self-reliance in technology amid restrictions imposed by the US on access to advanced technology, China is establishing a central science and technology commission under the Chinese Communist Party to mobilise nationwide resources and efforts across multiple government entities to advance technological innovation and scientific discovery.

Often acclaimed as the new oil for the information economy, data is a key strategic asset that China strives to insulate from the rest of the world. China also prohibits its population from accessing numerous overseas websites.

Investing in fragmentation

As China makes headway on providing infrastructure construction for Saudi Arabia recently and potentially with other resource-rich Gulf countries and Central Asian countries, it may be worthwhile to monitor some leading companies in the infrastructure space, such as China State Construction, Nari Technology and China Energy Engineering.

For additional inspiration, investors can look at Saxo’s China Consumer and Technology equity theme basket and China’s Little Giants equity theme basket for lists of companies that are exposed to China’s boost in domestic consumption and technology.