Building Friends Nearby: China’s Economic Relations with Neighboring Countries

China International Studies | 作者: Song Guoyou | 时间: 2013-11-25 | 责编: Li Xiaoyu
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by Song Guoyou[1]


Peripheral diplomacy tops China’s overall diplomatic layout. Economic diplomacy has also increasingly become an important part of Chinese diplomacy. Therefore, it is of important strategic significance to promote economic diplomacy in the surrounding areas. For China, now is a conflict-prone period in relations with its neighboring countries, a sensitive time of American rebalancing to Asia Pacific and a period of development bottlenecks in the peaceful rise of China. It is an important strategic issue for China to figure out how to join neighboring countries to achieve an inclusive growth and symbiotic development, to translate its economic influence in the surrounding areas into political influence, and to better safeguard national interests and improve diplomatic influence.

Economic diplomacy depends on economic policy. China needs a series of economic policy so that it can share with its neighboring countries the dividends from China’s growing economic strength, deepened reform and opening up, and increasing foreign investment, thus forming an overall pattern of mutual benefit and interdepend-ence. Under certain conditions, China can even shape the policy orientation of neighboring countries’ China policy through its economic clout. China’s economic diplomacy in its surrounding areas mainly involves economic policies on trade, investment, free trade areas, monetary and financial matters, and aid. There is not much discussion among Chinese scholars on such specific economic policies. This paper will focus on adjustment and application of specific economic policies in China’s peripheral diplomacy based on analysis of the economic relations between China and its neighbor-ing countries.


I. Trade with Neighboring Countries


China is the biggest trade partner of a number of neighboring countries, and is also the largest source of trade surplus for many countries. Trade with China and exports to China are an important driving force for the economic development of these countries. With the continued implementation of the economic development strategies of the Chinese government such as transformation of the mode of economic growth, expansion of domestic consumption and promotion of international trade, China will import more goods from abroad, and the importance of the Chinese market will become more apparent for neighboring countries.

Generally speaking, the neighboring countries enjoy a huge surplus in trade with China. In 2011, the trade surplus of 23 neighboring countries with China amounted to $115 billion. In this sense, the neighboring countries fully share the benefits of the Chinese market. However, serious imbalance exists in China’s trade with various neighboring countries. First, imbalance in trade with maritime neighbors and continental neighbors. Of the six maritime neighbors, Japan, the Republic of Korea(ROK), Indonesia, Malaysia and the Philippines all have a huge trade surplus with China, and only Brunei has a slight deficit in trade with China. Of the 14 continental neighbors, only Mongolia, Russia, Kazakhstan and Laos have a trade surplus with China, and ten other countries (the ROK, India, Pakistan, Nepal, Bhutan, Afghanistan, Kyrgyzstan, Tajikistan, Vietnam and Myanmar) have trade deficit with China. Second, imbalance between political and trade relations. Some of the countries that have close diplomatic relations and political cooperation with China such as Pakistan and Cambodia have a huge trade deficit with China which accounts for a large proportion of their total foreign trade. Huge trade deficit of these countries has become an important issue in their foreign economic relations and therefore has negative impact on their relations with China. However, some of the countries which are unfriendly to China enjoy a large trade surplus with China.

These imbalances in trade are major reasons for some neighboring countries to be “dependent on China economically but dependent on the U.S. politically and in terms of security”. In this regard, China needs to change the imbalances through optimization of the trade structure. Although a trade surplus or deficit is largely the result of objective economic factors including industrial structure, the trade situation can be optimized through policy measures including tariffs adjustment, customs clearance arrangements, government bulk procurement and corporate guidance. For the neighboring countries having a huge trade deficit with China, China should pay attention to their concerns and take relevant measures to improve their deficit situation. For those unfriendly countries, China can control the magnitude of their trade surplus with China to a certain degree.


II. Investment in Neighboring Countries


As the world’s largest manufacturing country, China is transforming and upgrading its industrial structure on a large scale against the backdrop of fierce international competition, rising cost and transformation of the mode of development. With the transformation and upgrading of industrial structure, industrial transfer has become an inevitable trend and is occurring generally in two ways: transfer domestically and to neighboring countries. With the implementation of the coordinated regional development strategy of the rise of central China and the development of western China, industrial transfer from eastern China to central and western China has become an important option for domestic industrial transfer. Meanwhile, China can also look beyond the border and transfer part of the industries to neighboring countries, and this transfer could be understood as investment in the neighboring countries.

In fact, in terms of non-financial direct investment, neighboring countries have been the focus of China’s foreign investment. In 2011, China’s investment in neighboring countries amounted to $9.188 billion accounting for 28.9%(not including Hong Kong, Macao and Taiwan) of the total foreign investment ($31.74 billion) based on investment flows. Singapore, Russia, Kazakhstan, Myanmar, Pakistan, Mongolia, Cambodia and Indonesia are among China’s top 20 foreign investment destinations in terms of total current investment, amounting to $26.9 billion (not including Hong Kong, Macao and Taiwan). In terms of investment policy initiatives, China has signed bilateral investment protection agreements with all the neighboring countries except Brunei.

Most of the neighboring countries, especially those sharing land borders, lag behind China in economic development, need China’s investment in related industries to promote their economic development. Chinese companies enjoy relative economic and geographical advantages as well as overall economic returns on the whole in transferring certain industries to neighboring countries. Therefore, the Chinese industrial transfer to the surrounding areas can result in a mutually beneficial and win-win situation. At the same time, China’s initiative to invest in neighboring countries helps China move up the value chains of regional high-end industries and gradually produces an industrial division mode with China as a center radiating to surrounding countries. This mode is similar to the “flying geese model” in East Asia in the 1980s, but given China’s geographic location and economic output, it is more influential and can radiate to more countries, promoting economic development in Southeast Asia and even in South and Central Asia.

From the perspective of China’s peripheral diplomacy, there is room for further readjustment in China’s investment policy for neighboring countries: First, adjustment of investment destinations. More investment in countries like Malaysia (Southeast Asia), India (South Asia) as well as Tajikistan and Kyrgyzstan (Central Asia) should be encouraged. As of the end of 2011, China’s total investment in these countries was only hundreds of millions of dollars. Chinese investment in these countries has been too little and failed to produce maximized political effects, incompatible with the economic potential of these countries and their bilateral relationship with China.

Second, adjustment of industries to invest. Chinese investments in neighboring countries are concentrated in resource-based industries and energy-based industries. For example, China’s investment in Russia concentrates on agriculture, forestry, animal husbandry and fishery industry. In Central Asia, China tends to invest in the energy while in ASEAN countries, China mainly invests in electricity and gas industries. Although these types of investment meet China’s economic development needs and are also in line with the comparative economic advantages of neighboring countries, they have been susceptible to such criticism as causing environmental damage or resource grabbing. In the future, China’s investment in the neighboring countries could gradually shift from the resources and energy industry to infrastructure, economic development and manufacturing sectors in order to relatively reduce extraction of local resources and energy and better help neighboring countries achieve a sustainable development.


III. Building FTA in Surrounding Areas


China and ASEAN reached a consensus in 2001 on establishing a free trade zone and signed in the following year the China-ASEAN Framework Agreement on Comprehensive Economic Cooperation, officially launching the free trade zone. In 2008, China and Singapore signed the Free Trade Agreement between the Government of the People’s Republic of China and the Government of the Republic of Singapore. In 2009, China and Pakistan entered into a China-Pakistan Free Trade Agreement on Trade in Services. In addition, the China-ROK FTA and China-Japan-ROK FTA negotiations are under way. In November 2012, the ten member states of ASEAN and China, Japan, the ROK, India, Australia, New Zealand issued the Joint Declaration on the Launch of Negotiations for the Regional Comprehensive Economic Partnership (RCEP), officially setting off the building process of an FTA covering 16 countries.

China currently focuses its FTA negotiations on East Asia. This strategy is understandable given the factors including United States efforts to promote the Trans-Pacific Strategic Economic Partnership Agreement (TPP), Japan and the ROK’s expedited push for FTA negotiations within East Asia as well as the high volume of the East Asian economies. But China has not paid as much attention to Central Asian countries, Russia and Mongolia as to East Asian countries in negotiations over free trade agreements. From the perspective of a greater periphery and building a comprehensive FTA network, neighboring countries like Russia, Central Asian nations and Mongolia are highly complementary to Chinese economy, and FTA agreements with these countries will not only help expand bilateral economic relations but also offer China a better chance in building comprehensive FTAs.

The question of how to further deepen the existing FTAs merits the attention: First, in many FTA negotiations in East Asia, China should focus on a bilateral agreement with the ROK as a way to promote negotiations over the China-Japan-ROK FTA and “10+ 3” FTA (ASEAN plus China, Japan and the ROK). Second, China can sort out its free trade agreement with ASEAN countries (“10+1”): While continuing to push forward the implementation of the China-ASEAN FTA, efforts should be made to create an upgraded version of the “10 +1” FTA by working towards more advanced bilateral FTAs with Thailand, Laos, Cambodia, Indonesia, Malaysia and some other countries. Of course, this does not mean the original “10+1” FTA will be sidelined. Instead, the upgraded version would be based on the existing FTA between China and ASEAN, and China and relevant ASEAN countries could enter into various bilateral free trade agreements according to their respective will and choice in order to build closer bilateral economic and trade ties between them.

In terms of feasibility, the above-mentioned idea is not con-tradictory with the China-ASEAN FTA. The existing China-ASEAN FTA does not forbid China and ASEAN member countries to enter into new bilateral FTAs. In 2008, China entered into an FTA with Singapore and the two sides have since further accelerated the process of trade liberalization and expanded the depth and breadth of their bilateral free trade ties and economic and trade cooperation on the basis of “10+1” FTA.

For China, an upgraded version of the China-ASEAN FTA im-plies more diplomatic options. Under current “10+1” framework, some ASEAN countries can enjoy preferences without distinction in their trade with China in accordance with the existing terms of the China-ASEAN trade pact regardless of the status of their political and security relations with China or what provocative policies they may adopt towards China, and in this regard China’s policy options are greatly constrained. China will enjoy greater flexibility in its policy with introduction of new free trade agreements as an important policy tool to implement the strategy of economic development in China’s periphery.


IV. Monetary Policy Related to China’s Periphery


The objective of China’s monetary policy for its periphery is to expand the scale of the use of RMB in the surrounding areas and enhance the influence of the RMB in the regional monetary system. At present, China’s major monetary policy developments in the surrounding areas include the following three aspects:

First, cross-border trade settlement in Renminbi(RMB). All provinces in China now have access to cross-border trade settlement in RMB, and import and export enterprises can choose RMB as the currency for quoting prices, settling accounts and payment. Settlement in RMB for cross-border trade and foreign direct investment has increased significantly.

Second, bilateral currency swap with neighboring countries. Since the beginning of the international financial crisis, China has taken the initiative or acted upon requests to enter into or renew currency swap agreements with the ROK, Malaysia, Indonesia, Singapore, Mongolia, Kazakhstan, Thailand and Pakistan.

Third, promotion of trade settlement in local currency with neighboring countries. In June 2011, China and Russia signed a bilateral agreement on local currency settlement; China, Japan and South have actively explored trade settlement in local currency. These policies have enhanced the influence of the RMB in the exchange rate regime in East Asia. Currently, seven out of the ten economies in East Asia, including the ROK, Indonesia, Malaysia, Singapore and Thailand are associated more closely with China’s RMB than with the American dollars.

In implementing the monetary policy towards the periphery, China should continue to focus on regionalization of the RMB. Efforts should be made to ultimately turn the RMB into regional public goods by making the RMB remain stable, inflation-proof and adequately liquid, and widely used in neighboring countries. The key for RMB regionalization is to open up and improve the cross-border circulation of RMB with its smooth outflow and inflow. For outbound circulation of the RMB, while implementing and deepening the existing policies, China should formulate the following policy:

First, allow more entities to engage in outbound RMB circulation. Since all provinces now have access to cross-border trade settlement in RMB, the practice should be extended from enterprises to individuals and the pilot programs in cross-border RMB transactions should include individuals.

Second, expand the use of the RMB to cover more areas of business. Currently the RMB is used mainly in cross-border trade settlement. In the future, the focus should be on promoting cross-border direct investment in RMB in neighboring countries, while increasing the use of the RMB in offshore loans, contracted projects and labor cooperation, etc.

While outbound circulation of the RMB has made progress, the inbound circulation of the RMB from neighboring countries is still facing some obstacles which seriously affect the will of these countries to hold a large amount of renminbi. Therefore, it is necessary to broaden the channels to enable inbound circulation of the RMB back to China from the neighboring countries and to promote the balance of the two-way flow of renminbi:

First, increase the quota of RMB Qualified Foreign Institutional Investors (RQFII) from 270 billion yuan at present to a higher level. In addition, inbound RMB circulation could be made smoother by adding more pilot institutions, relaxing the restrictions on investment proportion requirements and expanding channels of investment.

Second, encourage and support the development of offshore RMB business in neighboring countries, including, in particular, setting up a number of regional offshore renminbi business centers in Central and South Asia to make it more convenient for renminbi holders in neighboring countries to invest in China. Hong Kong has been designated as an offshore RMB business center in the process of inbound circulation of the RMB from abroad.

Third, copy the “Model of Qianhai Port (in China’s Shenzhen where innovative cross-border renminbi business is being conducted)” in order to expand channels for inbound circulation of the RMB and to establish innovative pilot areas in other border provinces in China for cross-border renminbi business slated for specific countries and regions.

In addition to RMB regionalization policy, China can choose other monetary policies towards the periphery: first, add more countries for bilateral currency swap arrangement and encourage more neighboring countries, especially those Central Asian countries which have offered to sign currency swap agreements with China, to engage in currency swap, thus expanding the proportion of renminbi in the official foreign exchange reserves of the neighboring countries; second, further promote regional currency cooperation and enhance the autonomy of monetary policy in surrounding countries so as to reduce the influence of the U.S. dollar in China’s periphery; and third, attach importance to coordination with neighboring countries on domestic monetary policy, increase the transparency of monetary policy, and build an image of a responsible country with a major regional currency at a time when the Chinese currency is becoming increasingly influential in the periphery.


V. Financial Cooperation with Neighboring Countries


With economic development, China is growing into a regional financial power, with rising influence in financial affairs and financial organizations in China’s periphery.

China has actively sought membership in regional financial orga-nizations, participated in regional financial governance, and expanded its say on regional financial affairs in China’s periphery. The People’s Bank of China plays a major role in the Asian Development Bank and the Executive Meeting of the East Asia-Pacific Central Bank Governors, and joined two major financial organizations in China’s periphery (the Southeast Asian Central Banks, and the Central Bank Governors Club of Central Asia, the Black Sea Region and Balkan Countries) in 2011.

China continues to participate in East Asian financial cooperation, promote regional financial stability, and expand the size of funds for the Chiang Mai Initiative Multilateralization (CMIM). At the meeting of the ASEAN Plus Three finance ministers, East Asian countries agreed to expand the size of the CMIM funds from $120 billion to $240 billion.

China engages in the creation of a new type of regional financial organizations and plays a leading role in them. Following the founding of the Inter-bank Association of the Shanghai Cooperation Organization (SCO) in 2005, China-ASEAN Banking Consortium was established in 2010. The SCO Development Bank and the BRICS Development Bank are also expected to be established and their commencement will further enhance China’s financial relations with the relevant neighbors.

After the financial crisis, China has enjoyed gradually increasing influence, now more than that of Japan, over financial markets such as the stock market in neighboring countries.

At present, China’s financial activities in the surrounding area focus on inter-governmental cooperation and coordination. In the future China should make more efforts on monetary policy.

First, establish two-way financial institutions. China’s banking sector did not open its first branch in India until September 2011; As of September 2012, Chinese banks have set up eight branches in ASEAN countries. In the future, China should help its financial institutions, such as banking, securities and insurance entities, set up branches in neighboring countries and carry out relevant financial operations. Meanwhile, China should encourage neighboring countries to set up financial institutions in mainland China. The establishment of two-way financial institutions will help forge closer ties between China and its neighboring countries in financial exchanges.

Second, create regional financial centers. With the trend of RMB regionalization, China should take cross-border trade in RMB clearing and settlement as an opportunity to create regional financial centers in China’s border provinces which can radiate to the neighboring countries. Through policy planning, the cities like Kunming, Urumqi and Dalian could be turned into regional financial centers for Southeast Asia and South Asia, Central Asia, and Northeast Asia respectively. By attracting domestic and foreign financial institutions, these regional financial centers are able to provide good service.

Third, provide diversified financial resources. China should expand the linkages between the domestic financial market and neighboring countries, make its financial market more attractive to neighboring countries, provide better financial products and services for neighboring countries, and strive to become important financial resources providers to the neighboring countries. These financial resources include but are not limited to public listing and financing, issuance of bonds, futures exchange and credit support in China by neighboring countries and related enterprises. In addition, China can use two of its policy-oriented banks, the National Development Bank and the China Export-Import Bank, to provide preferential loans and financial support to specific countries and regions in trade, infrastructure construction and other fields according to China’s national interests.

Fourth, build a network of financial mechanisms. China should make full use of its abundant foreign exchange reserve and growing monetary influence to actively work with each neighboring country or group of countries including those in the East Asian region to establish financial stability mechanisms, the exchange rate coordination mechanisms, risk mitigation mechanisms and financial rescue mechanisms in order to form an intense network of regional financial cooperation and to deepen financial ties between China and its neighboring countries through the establishment of those formal and informal mechanisms.


VI. Assistance to Neighboring Countries


It is an integral part of China’s diplomacy towards its periphery to provide assistance to neighboring countries. According to statistics, since the founding of New China, nearly 33 percent of China’s foreign aid has been provided to neighboring countries in Asia. China’s aid to Pakistan, Afghanistan and some ASEAN countries helps build closer diplomatic relations between China and these countries, increase their mutual trust and enhance the level of bilateral political cooperation. In particular, when China now has a pragmatic idea of foreign aid and played down ideology, China’s foreign aid will become more effective. From the perspective of diplomacy towards China’s periphery, China can further readjust its foreign aid policy to better serve the diplomatic service.

First, increase the size of foreign aid. In 2011, China’s foreign aid stood at nearly 20 billion yuan in its national budget, accounting for four ten-thousandths of the year’s GDP (47 trillion yuan), with a significant gap with the United States, the EU and Japan in terms of foreign aid. Although still a developing country with a limited scale of foreign aid, China can appropriately increase the amount of aid to neighboring countries compatible with China’s growing economic strength and the speed of growth of its GDP.

Second, change modalities of aid. While maintaining aid to some countries for strategic and security considerations, China should expand aid to neighboring countries for humanitarian, livelihood, welfare and development purposes to allow the ordinary people of the recipient of the aid to benefit directly from the aid.

Third, emphasize the benefits of aid to the recipient and not to overemphasize mutual benefit and reciprocity or care excessively about economic gains and losses. China’s principle of “not seeking political privileges” in foreign aid can be applied to economic sectors in neighboring countries: China “does not pursue economic privileges”. While promoting the economic development in the recipient countries, China can obtain economic returns through trade and investment.

Fourth, emphasize the flexibility and agility of the funding for foreign aid. In addition to those funds already included in the annual budget for regular foreign aid programs, China can, with sufficient regulatory control and following relevant laws and regulations, appropriately increase the amount of interim aid under special circumstances so as to improve the timeliness and effectiveness of aid to neighboring countries and maximize the positive effects of the economic assistance to neighboring countries.


VII. Conclusion


With China’s rising economic power, the economic ties between China and its neighboring countries are expanding and the economic means can provide China with more policy choices for diplomacy in China’s periphery. Therefore, China should pay more attention to the role of the economic means in China’s diplomacy in the region. Meanwhile, China should strike a new balance in its economic strategy concerning the periphery: In the past, geographically speaking, China put more emphasis on the eastern part of Asia than the western part; in terms of the goal, China emphasized political objectives more than economic targets; and as for the tools of policy, China favored trade over finance. China should instead speed up economic realignment in South Asia, Central Asia and neighboring countries in the north, and give play to the role of financial means in the economic strategy in towards China’s periphery. The building of institutions and mechanisms is essential to the success of economic diplomacy in the periphery. Therefore, China should further strengthen institutional coordination between the ministries responsible for economic policy making and those responsible for foreign policy making, encourage relevant actors to play a more active role, and enhance the effectiveness and relevance of coordination. In addition, China should also strengthen the integration of different economic policies to make them more effective.


Source: China International Studies September/October 2013 p152-166

[1]Song Guoyou is Associate Research Fellow at the American Studies Center, Fudan University, Shanghai, China.