China Business: Walking the line

David Mahon, managing director of Mahon China Investment Management.

As our ties with China grow but old alliances remain, the issue of trust will come to the fore, says David Mahon.

The threat by an unknown extortionist to contaminate Fonterra products with the poison 1080, unless the Government discontinued its use, had the potential to cripple New Zealand's image as a source of safe food. The calm and discretion with which Fonterra and the Government handled this attempt at economic terrorism resulted in relatively little damage.

Chinese consumer reaction was slight and the subject failed to gain momentum in the press or social media. Fonterra and the government learnt from the mishandled communications around the DCD and C. botulinum false alarms of the last few years.

Astoundingly, hundreds of people in the Government, police and Fonterra investigated the threat for four months without leaks to the media. Despite the problems New Zealand has faced adjusting to the impact of China's influence on its economy over the past three years, the corporate and public sector are showing greater awareness and surefootedness.

The Chinese economy will grow steadily but likely lose some momentum this year, perhaps even falling slightly short of the Chinese-Government-forecasted GDP growth rate of 7 per cent. Influenced by the strengthening US dollar, the Renminbi will probably ease slightly - between 2-3 per cent - against the dollar. This will assist exporters, but the Chinese Government remains committed to regulating its domestic economy more effectively and relying less on exports and unstable economic booms to deliver growth.

The Chinese Government's attempts to balance the overheated housing sector will continue, but it may prove difficult to limit price drops as much as anticipated.

As investors wait to see how much further the market will fall, market sentiment has become a more powerful force than the Government's selected easing of credit policies. Predictions of sectorial collapse continue to prove unfounded, for most Chinese have bought houses with 30-50 per cent deposits until recently, and have the means to meet mortgage obligations.

The recent drop of deposit requirements to 20-40 per cent is unlikely to spur many Chinese buyers to purchase homes they cannot afford.

The damage wrought in China has been less severe than what would have occurred in a sharp downturn in New Zealand and most other developed economies, where residential purchases are more highly leveraged.

Chinese households' urban saving rates also average 40-50 per cent, some of the highest in the world.

Under present circumstances New Zealand exporters can rely on the Chinese economy to retain relatively high and steady growth, but as the slump in dairy prices has demonstrated, New Zealand does need to diversify its exports to China.

New Zealand is working hard to expand its export markets with free trade agreements, such as Anztec with Taiwan and the New Zealand-South Korea FTA. Few countries can or would want to stand outside China's growing economic influence, but India, by virtue of its scale and more impenetrable economy, is the exception.

A free trade agreement with India would be good for New Zealand but harder to negotiate and even harder to benefit from, compared with China's relatively more open and stable market.

New Zealand's strongest trade relationships are increasingly in Asia but its deepest political allegiances still lie with the US, Australia and Britain. New Zealand is respected in China for the integrity of its food and beverage industry (where products such as Manuka honey and brands such as Zespri sell at a high premium), its quality engineering, and the creativity and sophistication of its film industry.

Air New Zealand has even managed to develop a recognised service brand among upper-middle-class Chinese travellers. Recent disclosures of how close New Zealand has remained to the United States and Britain in sharing political intelligence, however, raises a sensitive issue in the future: trust.

New Zealand has been perceived by its Asian trading partners, particularly China, as a relatively non-aligned nation - the country that did not join the invasion, declared illegal by the United Nations, of Iraq. New Zealand's antinuclear stance has been for many New Zealanders a metaphor for the country's nonalignment, and US warships are still not allowed to visit New Zealand ports. It is not about choosing between China and traditional allies, but New Zealand must walk a fine line between its economic interests and its loyalty to those countries with which it shares values of transparency, democracy, and governmental accountability.

China respects loyalty to old friends and is not surprised New Zealand shares intelligence with its traditional allies, but it is suspicious of those who try to contain it.

American aims to contain China have altered little since Nixon brokered an awkward partnership with Mao based on economic engagement and political containment in 1972. New Zealand cannot be a partner to this outdated, quixotic strategy.

China has trusted New Zealand above most other rich, developed countries because of its independent foreign policy.

Despite recent revelations of our role in intelligence sharing, successive Governments have made choices that demonstrate New Zealand makes its own decisions regarding China despite, at times, incurring the ire of its traditional allies.

On the eve of Britain's return of Hong Kong to the Mainland in 1997, resisting intense pressure from Britain and the United States, New Zealand was the first OECD country to recognise the legality of the new Hong Kong Government. New Zealand faced similar opposition by recognising China as a free market economy in 2004.

As the US sided firmly with Japan over the Diaoyu Islands dispute in 2013, New Zealand took the position that it was not the business of other countries to take sides in what is a complex issue, and that any conflict needed to be resolved through arbitration.

New Zealand will not gain by simply siding with China in the region out of crude economic interest, and New Zealand's future choices will be increasingly complex. But China should be given reason to continue to trust the independence of New Zealand's foreign policy.

• David Mahon is managing director of Mahon China Investment Management.