Investment Talks, Climate Change in the Spotlight at Xi-Obama Meeting

1 October 2015

Negotiations for a bilateral investment treaty (BIT) between China and the US are set to ramp up, leaders from both nations said late last week, following high-level meetings in Washington that touched upon a range of key issues in the Sino-American relationship. A series of climate-related announcements also resulted from Chinese President Xi Jinping’s state visit to the US capital city, with the Chinese leader confirming plans that Beijing will launch a national carbon market in 2017.

The potential for news on the long-running BIT talks had been one of the key areas in focus ahead of the state visit, given both the expected economic impact of such a deal as well as the recent exchange between the two sides of revised negative lists, which once finalised would be a key component.

Under a negative list approach, all industry sectors are open to investment except for those specifically deemed closed.

“With respect to our economic relationship, we agreed to step up our work toward a high-standard bilateral investment treaty that would help level the playing field for American companies,” Obama confirmed in remarks to reporters on Friday, with his Chinese counterpart affirming that assessment.

A joint fact sheet issued by the two sides referred to the BIT talks as a “top economic priority” for both countries, with a focus on reaching a deal that demonstrates commitment to non-discrimination, fairness, transparency, and easier market access.

“In light of the progress made in the BIT negotiations and both sides’ improved negative list proposals in September, the United States and China commit to intensify the negotiations and to work expeditiously to conclude the negotiation of a mutually beneficial treaty that meets these high standards,” said the joint fact sheet.

Furthermore, the fact sheet confirmed, the two sides have committed to limit the scope of their national security reviews regarding foreign investments to just those areas that actually involve national security concerns. The two sides will not “generalise the scope of such reviews to include other broader public interest or economic issues,” they affirmed.

This national security review would only apply to new investments following the set-up of this review process, and the two sides will work to address any identified security risks first through mitigation, instead of prohibiting those investments, “whenever reasonably possible.”

Neither the leaders’ remarks nor the joint fact sheet referred to any specific timeline for possible next steps on the BIT, however, though comments made by some trade officials prior to the event indicated that more work needs to be done for reaching agreement on negative lists and a deal text.

Just days before the Obama-Xi meeting, US Trade Representative Michael Froman told participants at the CSIS Asian Architecture Conference that China’s revised negative list offer did indeed show improvement over the original version. However, he qualified, these changes are not sufficient in the US’ view, telling participants that the two sides are still at “a substantial distance from the kind of high standard agreement necessary to achieve our mutual objectives.”

Calling for a Chinese negative list that is “limited, narrow, and represents a substantial liberalisation of the Chinese economy,” the US trade official also highlighted the importance of reaching an agreed text for the BIT that “addresses critical concerns about China’s investment environment.”

Froman also stressed the importance of the BIT as one way for Washington to engage with Beijing on the latter’s domestic reform efforts, particularly in light of concerns regarding a Chinese economic slowdown and greater volatility.

The US and China began negotiations for a bilateral investment treaty in 2008, only for the talks to lag until they were relaunched in July 2013. (See Bridges Weekly, 18 July 2013) Should these talks be successful, some analysts say, it could yield significant openings for increased bilateral trade and investment, with some suggesting that the BIT could potentially serve as a precursor to negotiating a future trade deal between the economic giants.

In 2012, according to US statistics, US foreign direct investment (FDI) in China reached US$51.4 billion, marking a 7.1 percent decrease from the year prior. Meanwhile, China’s FDI in the US hit US$5.2 billion in the same year, a 38.2 percent increase from the year before.

On the US side, direct investment in China is primarily made up by manufacturing, wholesale trade, banking, finance, and insurance sectors, while for China this investment is focused mainly in banking and wholesale trade.

China carbon market

Among the climate announcements made during last week’s state visit was a confirmation that China will put in place a national emissions trading scheme starting from 2017, with this system covering sectors including iron and steel, power generation, chemicals, building materials, paper-making, and non-ferrous metals.

Once in place, analysts predict the scheme will become the world’s largest carbon market, surpassing the EU’s Emission Trading System (ETS).

The news comes just months ahead of this year’s UN Framework Convention on Climate Change’s (UNFCCC) annual Conference of the Parties (COP), which is scheduled to be held in Paris, France from 30 November to 11 December. During the Paris meeting, UN member states are aiming to finalise a new global climate deal that would be in place from the end of the decade. (See Bridges Weekly, 9 September 2015)

Beijing had initially aimed to put in place an emissions trading scheme at the national level by 2016, having already started a process of establishing seven regional pilot schemes in 2011. Indications had already been given about the possible sectors for inclusion in a nation-wide system, which had been welcomed by some analysts as a sign of China’s interest in using market-based tools in helping meet mitigation goals. (See Bridges Weekly, 18 September 2014, 27 November 2014, and 9 September 2015)

Other commitments by Beijing outlined in the US-China Joint Presidential Statement on Climate Change include the promotion of low-carbon buildings and transport, as well as the completion of “next-stage” fuel efficiency standards for heavy-duty vehicles by next year with a 2019 implementation date, as well as continued support to tackle the issue of hydrofluorocarbons (HFCs).

On the US side, Washington confirmed that it will finalise a federal plan that would implement carbon emissions standards for power plants in those states that have chosen not to design individual implementation plans under the Clean Power Act. Other developments promised by the US for 2016 include improved fuel efficiency standards for heavy-duty vehicles, which would be implemented in 2019, as well as finalised standards for methane emissions from landfills and the oil and gas sectors.

These commitments, leaders said, are in tandem with the joint plan they announced last November that focused on both slashing emissions, as well as outlining new post-2020 climate targets for the two major economies. (See Bridges Weekly, 13 November 2014)

“When the world’s two largest economies, energy consumers, and carbon emitters come together like this, then there’s no reason for other countries – whether developed or developing – to not do so as well,” Obama said on Friday, referring to the preparations for the upcoming UN conference in Paris. “And so this is another major step towards the global agreement the world needs to reach in two months’ time.”

IMF special drawing rights

Another key question going into last week’s meetings was what the US might say regarding China’s bid for the Renminbi to be included in the International Monetary Fund’s (IMF) international reserve asset, known as the “Special Drawing Rights” (SDR) Basket. Should China be included, analysts say it would boost the use of the currency substantially.

The SDR basket determines its value based on four major currencies, which are currently the US dollar, the euro, the Japanese yen, and the pound sterling. IMF member economies can exchange SDRs for one of these “freely usable” currencies, a requirement that the Renminbi would need to meet for inclusion.

Under the Fund’s Articles of Agreement, a freely usable currency is defined as “a member’s currency that the Fund determines (i) is, in fact, widely used to make payments for international transactions, and (ii) is widely traded in the principal exchange markets.”

The IMF’s SDR review takes place every five years, with the next one currently slated for the end of 2015. In August, the Fund confirmed that the current SDR basket would be extended from 31 December 2015 to 30 September 2016 to help the system continue to operate smoothly. The IMF also noted that the extension could be useful should a new currency be added to the existing basket.

In the joint fact sheet issued following the leaders’ meeting, the US said that it “supports China’s commitment to implement further financial and capital market reforms, and accordingly the United States reiterates its support for the inclusion of the [Renminbi] in the SDR basket provided the currency meets the IMF’s existing criteria in its SDR review.”

On Beijing’s side, the Asian economy noted the importance of “meeting the transparency standards of other major reserve currencies” with regards to internationalising its own currency successfully.

Along with a currency being “freely usable,” inclusion in the SDR basket also requires that the four currencies involved are issued by those members or currency unions that meet a specific export criterion – namely, that their goods and services exports over the previous five years are of the largest value.

In May of this year, the IMF deemed the Chinese Renminbi to be “no longer undervalued,” in an announcement that was seen as having potentially positive implications for the currency’s eligibility in the Fund’s SDR Basket. (See Bridges Weekly, 28 May 2015)

The surprise devaluation of China’s currency in August sent shockwaves through the global economy, however, though officials explained at the time that the move was actually in response to market dynamics. The move was ultimately welcomed by the Fund, for those reasons.

“The new mechanism for determining the central parity of the Renminbi announced by the [People’s Bank of China] appears a welcome step as it should allow market forces to have a greater role in determining the exchange rate,” said an IMF spokesperson at the time, who noted that its actual effect would depend on implementation.

“Regarding the ongoing review of the IMF’s SDR basket, the announced change has no direct implications for the criteria used in determining the composition of the basket. Nevertheless, a more market-determined exchange rate would facilitate SDR operations in case the Renminbi were included in the currency basket going forward,” the spokesperson added, reiterating the Fund’s position that China should aim to establish a floating exchange rate system in the next two to three years.

The issue of the devaluation was raised by reporters during the leaders’ press conference on Friday, with Xi explaining that the fluctuation in the Renminbi was the result of factors such as financial market turbulence and the earlier strengthening of the US currency.

The Chinese president added, however, that “there is no basis for the Renminbi to have a devaluation in the long run. At present, the exchange rate between Renminbi and US dollars is moving toward stability.”

ICTSD reporting; “White House declares truce with China over AIIB,” FINANCIAL TIMES, 27 September 2015; “China’s renminbi creeps closer to global reserve status,” FINANCIAL TIMES, 28 September 2015; “U.S., China Make Progress Toward Trade and Investment Deal,” WALL STREET JOURNAL, 25 September 2015; “Devaluation Strengthens China’s Hand at IMF,” WALL STREET JOURNAL, 2 September 2015.

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