China’s Internal Circulation Model Forging Ahead August 2020 Photo from Sina China's latest manufacturing PMI index was at 51.1, an increase of 0.2 from the previous month, which is now five consecutive months in the expansion zone, signaling that China's economic recovery continues. In the sub-indices, production, new orders, main raw materials purchase price, producer price grew, while new export orders and imports contracted, dragging down the overall PMI. New orders index was 51.7, which increased 0.3 from June, which represents an expansion of 3 consecutive months. Comparatively, the production index was at 54, 2.3 higher than the new orders index. This indicates that while production has recovered strongly, external demand and exports remain relatively weak. Since China manufacturing PMI’s inception in August 2016, structural supply side and taxation reforms have optimized and recalibrated the structure of the Chinese economy, which coincided with 27 months of continuing expansion for the manufacturing PMI. The structure of the Chinese economy at present remains reasonably resilient, even after the initial wave of COVID-19 pandemic and the resulting contraction in economic data. By implementing strict social distancing and rigorous testing policies, China was first in and first out of the COVID-19 recession and was among the earliest countries to resume production and economic activities. Amid the global recession, relying on exports to drive GDP remains a challenge. Therefore, policies have been implemented by the government and PBOC to drive domestic consumption and infrastructure investment. Internal Economic Circulation Faced with the global demand shortfall and geopolitical tensions, China promoted the idea of ‘Internal Economic Circulation’ in May 2020. With increased emphasis on self-sustainability in areas such as production, connectivity, capital allocation and consumption. Economic self-reliance is pursued to form a ‘Dual Circulation’ model of growth. Since China’s historical reform and opening-up policy, the Chinese economy has gradually grown more influential and embedded in the global economic system. With rising global pushback against China, the export-driven growth model is becoming more challenging each passing day. Therefore, it is important for China to leverage the strength of its huge domestic market to adapt in these testing conditions, even though potential challenges to the domestic-driven economic model remain. Good in Theory, but Real-life Challenges Remain With a population of 1.4 billion, a large labour force is an important component for the ‘Internal Economic Circulation’ model to succeed. Efficient production and labour allocation are the main elements that drive domestic consumption. Other than traditional infrastructure projects, infrastructure for the ‘New Economy’ is a new priority to drive productivity and technological gains. Infrastructure for the ‘New Economy’ represents crucial building blocks that can enable greater use of technology, these include 5G infrastructure, UHV power transmission, high-speed railways, EV charging piles, data centres, Artificial Intelligence and Industrial Internet of Things. These projects involve industries such as communications, industrial, transportation, digital etc. Investments in these key strategic areas should important drivers for economic growth under the ‘Internal Economic Circulation’ model. In June 2020, Premier Li pointed out that China has 600 million people living on a monthly income of 1000 yuan. China’s huge wealth inequality, as well as expensive property prices could be a potential drag on the domestic-driven economic model. In addition, China benefitted from overseas transfer of technology and foreign capital since the initial reform. Relying on an internal circulation model would reduce the exchange and cooperation on technology between China and other countries, which could complicate China’s innovation and progress on new technological development. Faced with external and internal challenges, China’s economy continues to forge ahead. Since February 2020, China manufacturing PMI 5-month expansion fully demonstrates China cultural and economic advantages. We believe this new direction of ‘Internal Economic Circulation’ is an important policy shift, with long term benefits and challenges to China’s economic development.