Presentation by Toshiya Tsugami, President of Tsugami Workshop, Ltd., at the IAI conference "Xi Jinping’s China: Are Japan and Europe on the same page?" organised in cooperation with the Japanese Embassy in Rome

1. Toshiya Tsugami
November 2017
1
Envisaging China’s future
How will Xi Jinping navigate
his second term?

2. Accelerated growth in 2009~2013 was
largely a result of an investment bubble
Over capacities in industries, dead stocks in real estate sector, inefficient
public infrastructure…Massive amount of non-performing 'assets' were
cumulated and eroded the national Balance Sheet. So is the case on the
liability side. Massive non-performing debts were cumulated on the B/S 2
14.8 19.4 24.1 30.2 36.5 43.7 50.2 55.2 59.7
19.4
43.6
73.7
110.2
153.9
204.1
259.3
318.9
1.51
1.79 1.81 1.81
1.88
1.95 1.93
2.06 2.08
1.0
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
2.0
2.1
0
50
100
150
200
250
300
350
2008 2009 2010 2011 2012 2013 2014 2015 2016
FixedInvestment(unit:trillionRMB)
Investment Boom and monetary easing
after the Four Trillion Package
FixedInvestment(2009~accumulated)
Each
year
source：STATS, PBOC
M2/GDP ratio
（right axis）
319 trillion RMB
≒ 41 trillion Euro
Too much money was
borrowed and poured into
non-performing projects

3. -24%
-22%
-20%
-18%
-16%
-14%
-12%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
22%
24%
YoY
source：National Bureau of Statistics (NBS), Ministry of Finance, China Railway, China Electricity Council
Year on Year and three months moving average
State Enterprise
turn over
Indirect tax
revenue
Electric
consumption
Railroad Cargo
（ton*km）
Real GDP growth
(official)
3
Economic Growth marked
a clear rebound in 2016

4. Producer Price rebounded, nominal GDP
were pushed up to two digits growth
• Producer Price Index (PPI) has continuously declined since 2011, but
rebounded in 2016
• It improved the profit of manufacturing industry, “old economy” such as
material industry in particular. It also pushed up nominal GDP growth
• Current world economy is boosted by “Locomotive China”
4
-7.0%
-6.0%
-5.0%
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35% Industrial Profit and PPI
source:NBS
Industrial Proft
(YoY 3 months
ave. left axix)
Producer Price
Index (YoY right
axix)

5. The rebound was caused by
the govt. led investment drive
• The central economic work conference (Dec. 2015) declared to carry out
“supply side reform”; slashing over capacity and employees, disposing
NPL in 2016, which may bring about slower growth.
• However, what came to reality in 2016 was a massive investment drive,
rather than the “supply side reform”. Premier Li Keqiang praised the
economic rebound in the first quarter, but soon faced “authoritative
insider’s” criticism posted to People’s Daily. 5
5%
10%
15%
20%
25%
30%
Investment (YoY)
source：NBS
Private
Enterprise
Govt.
related
-20%
-10%
0%
10%
20%
30%
40%
50% Real Estate investment (YoY)
Real Estate
Investment Total
source：NBS
Land
Purchase

6. IMF raised China’s growth prospect, but
thinks keeping high growth is a bad idea
• 2016 version: warned the risk of rapid debt increase and advised to
downgrade the growth target to secure more sustainable development
• 2017 version: “China will meet the authorities’ 2020 output target, but
at the cost of further large increases in public and private debt.”
6
5.50
5.75
6.00
6.25
6.50
6.75
7.00
7.25
7.50
2014 2015 2016 2017 2018 2019 2020 2021 2022
IMF’s Growth Prospect
出典：IMF ARTICLE IV CONSULTATION
STAFF REPORT（2017/8）
2017 forecast
2016 forecast

7. The price of high growth :
rapid increase of Govt. deficit and total debt
7
-15
-14
-13
-12
-11
-10
-9
-8
-7
-6
%ofGDP
Govt. Deficit/GDP forecast by IMF
2016 forecast
2017 forecast
150
175
200
225
250
275
300
325
%ofGDP
Total debt/GDP forecast by IMF
(Govt. + corporate + household)
出典：IMF ARTICLE IV CONSULTATION
STAFF REPORT(2017/08)
2017 forecast
2016 forecast
• As a result of aiming at high growth, China’s govt. deficit (consolidating
local govt. deficits) will maintain two digits level over medium term
• The total debt (Govt. + corporate + household) level will come close to
300% in 2022

8. 50
70
90
110
130
150
170
190
210
230
250
Corporatedebt/GDPratio
Japan
Thailand
Spain
China
USA
source：IMF Global Financial Stability Report 04/2017
This occurs because
-- too much money is borrowed, poured to investments that can’t make cash
-- as a result, debt redemption is slow, in some cases can’t even pay interest
-- If interest-rate level is high, there will also be “snowball” like debt increase
-- more and more newly borrowed money are allocated for refinance of
previous debt (“Ponzi” scheme)
8
IMF warning : rapid increase of debt
will be followed by hard landing (2016)

9. Implicit Guarantees : the reason
why Chinese bubble has yet to burst
9
Chinese Govts. have customarily bailed out
market failures and generated a strong
expectation of “implicit guarantees”
• People recklessly take risks because they
believe the govt. will bail out in case of loss
• People invest in real estates because they
believe the local govt. never let market fall
Investment bubble deteriorates national balance-sheet
(brings about huge non-performing assets & debts)
It is akin to having eaten rotten foods, you will soon be attacked
by vomiting and diarrhea, it is painful, but is a normal
physiological phenomenon to excrete toxin out of body,
In other words, avoiding vomiting and diarrhea means keeping
toxin inside your body, which continuously harm your health

10. 10
General government
（2007：769→ 2016：1170 trillion）
Household and NPISHs
（2007:337→2016:331)
0
500
1,000
1,500
2,000
2,500
100
120
140
160
180
200
220
240
260
280
300
320
340
360
380
400
Debtamount(trillionYen)
Debt/GDPratio
Japan's Total Deb/ GDP
Total Debt / GDP
(left axis)
Non financial corporation
(2007：523→ 2016：496 )
source: Bank of International Settlement
The reasons why Japan has yet fallen into financial crisis; China’s case
(1) capital exporting country (no need to borrow oversees) 
(2) Debts are concentrated onto the resilient central Govt. 
(3) 0% interest rate maintained almost two decades ー
Japan's lesson : debt-driven stimulus;
temporarily sustainable if borne by the Central
Government; but should not exceed bounds;

11. 11
5.8
6.0
6.2
6.4
6.6
6.8
7.0-2,000
-1,500
-1,000
-500
0
500
1,000
hundredmillionUSD
China's capital inflow/outflow and USD/RMB rate
Estimated in /out fow of money(A-B)
USD/RMB rate
source：PBOC、DOC
RMBappreciation
capitaloutflowcapitalinflow
RMBdevaluation
Combating home-made capital flight by
strengthening capital move restriction
 People don’t expect RMB’s appreciation and try to convert their
assets into USD’s, redeem USD denominated debt before maturity
 The government strengthened restriction on capital transaction and
successfullycalmed down the speculative move (for the time being)
 Once China fails to keep currency rate stable, its shock wave
may hit global economy more than China itself
Oct. 2016 : RMB
employed as SDR
basket currency

12. 12
An alternative view (warning)
by UCSD Associate Professor Victor Shih
• FOREX purchase for FDI and foreign debt
redemption has peaked out, but the
purchase for foreign travel or children’s
study abroad (by individuals) is still large
• Recent recovery in foreign reserve seems
supported by oversees short term
borrowing including Hong Kong
• The outstanding oversees borrowing incl-
uding Honk Kong exceeds 1.2 trillion
USD, more vulnerable than thought
Source: FINANCIAL INSTABILITY IN CHINA Mercator Institute for China Studies mericskgjwvjiuzm.devcloud.acquia-sites.com

13. • Chinese economists expect moderate slowdown, but no evident sign to date
• The impact of the slowdown will be bigger in the rest of the world than in China
• “Growth target will not be declared after 2020”…what is the implication? 13
47
48
49
50
51
52
53
54
55
56
PMI index（NSB and Caixin）
NSB manufact. index
NSB service index
Caixin service index
Caixin manufact. index
Will Chinese economy slow down?

14. 1.5
2.0
2.5
3.0
3.5
4.0
4.5
Long / short term interest rate change
Govt. bond (5 years) yield
Inter-bank over night rate
Tightrope walking
China can’t tolerate Ponzi financing
but also needs to avoid hard landing
• Providing too much liquidity helps asset bubble grow further and
zombie companies survive
• But hastily reducing liquidity may lead to rapid hike of interest rate
and eventually hard landing 14

15. Bright Aspects
of Chinese economy
• New Economy is growing fast
• China’s “ IE B” industries
• I ：IT technology
• E：Electric Vehicles
• B：Big Science
15

16. 16
Mobile-phone based “Apps” in which fintech, sharing
economy, scoring system, GPS are integrated, provide very
cost-efficient, small-business friendly biz platform
• QR code payment: service fee = 0.1% of pay
• No need for advertisement if you get high score
• Two way rating system: ex. driver and passenger rate
with each other
'New economy in IT industry' is growing fast

17. “The End of Privacy, Part 2: Scoring Pro-Social Behaviour” Joseph Heath
http://induecourse.ca/the-end-of-privacy-part-2-scoring-pro-social-behaviour/ 17
Overcoming the problem of “asymmetric information”,
reducing the risk/cost of transaction with stranger by
using digital technology
'New economy in IT industry' is growing fast
transaction risk/cost Business opportunity
small-scale societies every body knows each other : Low few
mass-scale societies dealing with stranger is too risky : high many
Alibaba, a huge BtoB and CtoC online trade platform is
also providing online micro-financing service in which
lending decision is made instantly by AI (Artificial
Intelligence). It is only possible when the system can
access and refer to the applicant’s track record saved in
the trade database

18. Huawei : used to be a manufacturer of server and cell phone,
is now ICT device manufacturer as well as ICT
service/solution provider with annual turnover 60 bn USD
DJI : an 11 years old drone manufacturer with 70% of global
share (consumer drone)
'New economy in IT industry' is growing fast
18

19. “Digital Leninism”？
“One party rule powered by digital technology”
• Alibaba is establishing personal rating App which gives incentive
/disincentive for good/evil deed. The incentives are increasing
• Chinese govt. also plans to create a “social credit” system, with a
rating for all individuals – like a credit score, which eventually
include all sorts of information about a person
• Such a future may remind us of G. Orwell’s hideous ”1984”, but can we
totally deny such a system if it is effective and powerful enough ?
• Current laws & regulation for taxi service by Govt. can be replaced
by Apps (two way rating) with far lower cost and higher efficiency
19

20. Ambition to lead EV dissemination
and reverse the industrial inferiority
20
In 2016,
• annual EV sales exceeded 500 thousand (YoY 50% increase)
• exceeds 50% of global EV sales
• amounts 1.8% of total sales of vehicle in China
• Govt. plans to ban sales of petrol/ diesel cars in future
“Man made market”

21. 21
• China’s R&D expenditure exceeded
1trillion RMB (150 bn USD) and 2% of
GDP in 2013
• Govt. funded R&D expenditure also
exceeded 600 bn RMB (94 bn USD)
and 4.3% of total Govt.
• Research outcomes have been
enriched in tandem
Big science is taking off

22. 22
Lunar Exploration Program
• China’s research outcome is evident in the area of big science,
in aero/astro nauticis in particular.
• Though it started from imitating Western or Russian technology,
China’s progress on R&D is undeniable
Big science is taking off

23. Has Xi Jinping
strengthened his power?
• Quite contrasting between;
Foreign relations or Defense area and
Economic policy
23

24. 1. overwhelming PLA reform
• 300 thousand troop cut, abolish 7 military regions and reestablish 5 theaters
• Dismantle powerful departments (General Staff, Political, Equipment,
Armament, Logistics) and reshuffle them into 15 functional bureaus
• Establish Joint Operation Command (JOC) and rectify previous overemphasis
of army and improve Army-Navy-Air Force interoperability
2. diplomatic maneuverability was enhanced
① South China Sea
After PCA’s ruling in July 2016, previous assertive stance was rectified.
China tries to appeal that territorial dispute can peacefully be resolved
between claimants and no need for third party’s intervention.
For this sake, appeals “self restraint” on issues like Scarborough shore
② North Korea
Tries to “revise” traditional narratives on NK (a sense of taboo which
arises from the memory of the “war dead”), views NK as risk, liability
rather than asset. By doing so, tries to enlarge the room for strategic
maneuver
Xi Jinping’s strengthened power
well observed in Foreign relations or Defense area
24

25. Economic policy: Dutch rolling
reform orientedinvestment led
high growth oriented 2013
2014
2015
2016
2017
Likonomics
Dec. “supply side reform” advocated
← May. Authoritative insider’s criticism
June. Stock bubble busted
Aug. RMB devaluation incident
1Q economic rebound
Li Keqiang “a good start”
Aug. “New Normal” came on stage
Financial turmoil 2013/6/20
real estate price surge,
leveraging up
Dec . “New Normal” taken up officially
24
← Oct. curving real estate bubble
Interest rate hike

26. How to live together with
economic giant China?
• Matters of concern;
① Lotte case (a Korean company in China)
“Coercing” other country by using economic might
② Hambantota Port case (aid loan for Sri Lanka)
Aid loan for developing country’s unviable project
which the recipient country is unable to repay
③ “Belt & Road” Issue
26

27. • An important ally to protect free trade
• The biggest beneficiary of existing free trade order such as WTO
• It is helpful that its President Xi Jinping opposes protectionism
• There are also tendencies which make us unease
① Coercing other country by using economic power (boycott)
• “Boycott” has long been a tool for Chinese to protest against
other country. When China was weak, there was no other way.
But China today is a second largest, powerful country
• Recently a Korean company “Lotte” faced severe Boycott in
China and was forced to withdraw their China business.
• It was because Korea recently agreed to introduce US anti
ballistic missile system (THAAD), and Lotte transfer its land for
the deployment upon Govt request, which invited China’s anger
• China and Korea reconciled on the issue but simultaneously
Korea undertook to deny further deployment of THAAD
How to live together with
economic giant China?
27

28. • Though lender’s right and interest should be protected, they
should refrain from giving loan to country that is unable to
repay. It is particularly the case when it has something to do
with territorial concern
• Int’l community should look at such issues and draw China’s
attention (Don’t leave Sri Lanka alone to face this challenge)
How to live together with
economic giant China? (2)
28
• This is a “coercion” and conflicts with the multilateral trading
order, China’s market opening commitments are damaged
• A multilateral effort to draw China’s attention is essential
② Aid loan for developing country’s unviable
project and acquire compensation that has
territorial implication (“Hambantota case”)
• China has provided billions of loans to Sri Lanka
but Sri Lanka couldn’t repay it
• Recently Sri Lanka has signed a $1.1bn deal for
a 99-year lease on the Hambantota port

29. One Belt One Road:
Real image vs. Virtual image
[Real Image]
• China’s “Belt & Road” like projects started since around 2000
• Major financers are not AIIB or Silk Road Fund, but are the
State Development Bank or China EXIM Bank.
[In 2014]
• Xi Jinping’s endorsement with a new name “Belt & Road” has
brought about a “fever”
• But judging from actual activities, China seems cautiously choose
bankable projects, much 'prudent' than three years ago when we
first heard => Why?
• strong unease and resentment in China’s public sentiment
has been growing against massive foreign aid commitments of the
Government.
• Cautiously examining candidate project is for the benefit of all,
By doing so, both sides can avoid another “Hambantota” 29

30. Asian Infrastructure Investment Bank (AIIB):
A good partner of the WB/ ADB?
 With Europeans, AIIB was substantially upgraded
With Canada, member countries will reach 90
 Collaboration with World Bank and Asian Development Bank
The two banks seem actively offer AIIB chances of collaboration
For the time being, more than 2/3 of AIIB's lending will be joint
lending with WB or ADB, through which AIIB can cumulate experience
and track records
The two banks can also be benefited from the collaborations with AIIB
by mitigating their undercapitalization (kind of 'resuming leverage'),
This might be a way of peaceful co-existence
 Still unclear whether AIIB really becomes an 'international
development Bank’, but so long as China goes along with
internationally recognized order and practice, there is a
good chance. 30