China – UK Trade: The Effects of Brexit

By Jake Liddle

The UK’s lengthy process of leaving the EU is set to begin by the end of March 2017. While reaching a positive partnership with the EU is an immediate priority for the UK, as China is one of the UK’s biggest trade partners, the prospect of a free trade agreement with China is becoming more and more of an issue.

The last British government worked hard to foster a good relationship with Beijing, but the conservative attitude of the present government – displayed by Prime Minister Theresa May’s protectionist stance on Chinese investment in ‘sensitive’ infrastructure projects – poses a threat to the so-called ‘golden decade’, enthusiastically evoked by former prime minister David Cameron.

Already, doubts over the approval of the UK’s Hinkley Point C nuclear station in Somerset had arisen because of the UK government’s suspicion about Chinese investment, which dampened trust with the Chinese. Indeed, the UK will have to work harder to warm relations with China.

Impact of Brexit

London was viewed as a gateway to the EU market, and China’s interest in the city was shown when China issued its first overseas sovereign RMB bond there. But when the UK departs from the EU, London’s status as a gateway will vanish, with the city providing access to a market of 65 million as opposed to 500 million.

As the UK’s economy deteriorates, so will the value of China’s investments made in past years. There are many more significant trading partners on China’s list than the UK, particularly as the UK will not be a feasible option as a ‘back door’ to the EU for China. Further, the EU will most likely enforce rules of origin to stop Chinese imports entering through the UK.

Trade prospects

Despite this negative outlook, there is still hope for the UK’s trade prospects with China. China – EU trade has lagged in the past few years, and with the UK depending more and more on China in the future, this will present a new opportunity for trade. Furthermore, China sees the UK as a political partner and a leading voice for granting China market economy status.

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According to the UK Balance of Payments 2015 Pink Book, China is the UK’s seventh largest export market, accounting for 3.6 percent of the UK’s overall exports. Services and goods are largely unbalanced, with a surplus of the former, and deficit of the latter.

Meanwhile, China is the UK’s third largest source of imports, accounting for seven percent of imports. Overall, the UK had a trade deficit of around £19.6 billion with China in 2015. The following table details China-UK trade volume over the last 10 years.

As a country with the world’s largest population and fastest growing consumer market due to increasing disposable income, China represents a key market for British exports. Trade volume has been rising at a steady pace, and though there has been a dip in the recent years, if there is a trade agreement reached between the two countries in the future, this growth is sure to continue.

The UK exports a myriad of products to China, representing a cross-section of British industry and services. In order of volume, the largest export categories are:

1. Machinery/electrical products
2. Road vehicles
3. Metals
4. Transportation services
5. Travel services
6. Business services
7. Raw materials
8. Precision instruments
9. Pharmaceuticals
10. Chemicals
11. Plastics
12. Financial services

The UK’s share of the Chinese market has fallen to around one percent, and the reason the UK underperforms in regard to export performance in China is that its more successful exports are not in line with China’s current demand. Other EU countries have stronger trade relationships with China, and competition in the Chinese market is very tough.

The sectors that provide the greatest income include machinery, fuels, metals, transportation services, business services, and travel services. However, the volume of UK exports to China is not exactly aligned with the rate of China’s market growth.

As China’s economy transitions from heavy manufacturing to a service driven economy, the balance of demand across the varying industries will shift. With services coming to the forefront of demand, the UK’s greatest goods exports in terms of value to China (such as machinery, electronic products, precision instruments, and metals) will be less in demand.

These shifts in China’s calibration should be monitored by UK-based businesses in order to align offerings with China’s demands, especially as the UK already excels in its service exports.

Looking forward

The IMF predicts that China’s import market will be worth over £3 trillion (US$3.6 trillion) by 2020. This presents a huge opportunity for the UK, and if trade patterns are identified and acted upon accordingly, the UK could close the gap with its European competitors in China.

While the UK will prioritize its negotiations with the EU, it will need to work significantly in rethinking its trade relationship with China in the future in order to come to a successful trade agreement. Britain’s relationship with China goes back centuries and includes stewardship of Hong Kong until 1999, when the territory initially developed as an international financial services hub.

Moves for the UK government to instigate free trade agreements and enhance existing double tax treaties are highly likely. Britain already has a double tax treaty with Hong Kong, and is expected to be enhanced in the financial services sector. The UK also has a double taxation agreement (DTA) with mainland China, though this is in need of updating as it does not sufficiently cover new IT technologies. Either way, there will be diplomatic and trade efforts to be put in by both sides.

For British enterprises looking to export to China, understanding the details of tax treaties and the regulatory environment can be the difference between success and failure when competing. Our firm, Dezan Shira & Associates keeps track of the trade and investment policies between both regions and enjoys an extensive, 25 year history of involvement in UK-China Trade and Investment. A background to our firms involvement with British business investing in China can be viewed here.

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