- President Xi has consolidated his power. This move came as no surprise to anyone, though the details suggest that we will have to keep guessing for at least a couple more years who his successor is going to be. The Politburo Standing Committee (PSC), the highest echelon of power within the CCP, features five new people—in addition to Premier Li Keqiang and President Xi—who have worked closely with the president in the past and are aligned with him. But the tradition of bringing in the next generation of leaders to the PSC during the last term of the administration has not been observed this time. All PSC members will be above or very close to the unofficial retirement age when President Xi’s second five-year term ends. This means no apparent successor for now, but it also opens up the possibility of President Xi staying in power beyond the typical two five-year terms. This is not our baseline scenario, but regardless, President Xi’s “thoughts”1 are now written in the party constitution at par with those of Mao Zedong, which means their shelf life will extend well beyond his presidential term. The party’s remaining arms (i.e., the Politburo and Central Committee) have also been churned up with 75% new entrants, which would further cement Xi’s power within the CCP.
- President Xi has redefined how China views itself and what it will aspire to become. Since 1981, the “principal contradiction” facing China has always been between “the ever-growing material and cultural needs of the people and backward social production.” President Xi declared that this “principle contradiction” has evolved into “unbalanced and inadequate development and the people’s ever-growing needs for a better life.” What is the big difference, you may ask? A seemingly subtle one, perhaps. But we believe this new “contradiction” will translate into policies that will prioritize better quality of growth (i.e., one that is more enduring and environmentally sustainable) rather than just higher growth; more equitable income distribution; and an emphasis on poverty reduction. This “thought” is enshrined in the party constitution as the guiding principle of policies at all levels of the party and the government. And it is what we believe will align the policies of local governments throughout the country with those of the center. In the past, local governments adhered to the mantra of “growth above anything else” based on the previous “contradiction” despite efforts by the center to reign in their excesses. Now, quality of growth becomes the priority. The longer-term aspiration is to build a prosperous, modern, socialist society by 2050 (the centenary of the founding of the People’s Republic of China) and achieve “the great renewal of the Chinese nation.” In short, President Xi wants to “make China great again.” This may sound awfully familiar, but the notion of a “Chinese renewal” is actually different when you look at details. Policies to address the new “contradiction” and achieve the Chinese dream will focus on supply-side structural reforms and innovation; support for the rural sector and regional development; the development of socialist market mechanisms; and further market liberalization. A big overarching theme is the international reach of this aspiration that is reflected in the Belt and Road Initiative (BRI)2 as well as in China’s increasing role in international fora and as a promoter of international trade.
What Does This Change Mean for China’s Short-Term Policies?
Until 2020, which is also the centenary of the establishment of the CCP, the emphasis will be on containing economic and financial risks, poverty reduction and environmental protection. More specific details will likely be ironed out at the National People’s Conference of the party in March 2018, but in the meantime, we believe these policies will translate into more financial sector deleveraging (as a result of tighter and better coordinated regulatory policies); an extension of mixed-ownership reforms to more state owned enterprises (SOEs) to increase their productivity and reduce their leverage; and more capacity reduction both via closing zombie SOEs but also through stricter enforcement of environmental regulations. Housing policies are also likely to stay tight to discourage speculation, although we are less certain about their effectiveness in the long run, without allowing other venues for households to diversify their assets—and without broader land and tax reform. Broadly, we expect these policies to moderately slow real gross domestic product (GDP) growth to about 6.4%-6.5% next year, down from about 6.8% this year. These policies are still in line with the target of China’s leadership to double nominal incomes by 2020. But the party leadership skipped a reference to an explicit growth target this time, thereby suggesting some tolerance for slower growth, should it contribute to deleveraging and result in a higher quality of growth. Here are more details on our expectations:
- We believe financial deleveraging will continue gradually. The tightening regulatory measures on financial sector leverage, especially via wealth management and other so-called “shadow-banking” products, are already delivering some results, and we expect this trend to continue. Over the summer, President Xi elevated the priority of containing financial sector risks to a matter of national security and the government’s institutional machinery has been upgraded to ensure better coordination across regulators, with increased powers to the People’s Bank of China (PBOC) for macro-prudential policies. In terms of monetary policy, we expect the PBOC’s tightening bias to continue with increasing use of a slew of liquidity facilities to manage excessive volatility while at the same time ensuring adequate credit flow to the real economy.
- We expect SOE reforms to accelerate somewhat and produce more winners in the “new economy.” There are three key elements to these reforms: the extension of production and capacity cuts beyond steel and coal sectors to other “dirty” sectors such as aluminum and cement; the restructuring of zombie SOEs; and mixed-ownership reforms at selected SOEs. We expect the first element to support commodity prices as production cuts in steel and coal sectors did in 2016. How much genuine restructuring of “zombie” SOEs will take place is yet to be seen. However, perhaps the more important element of the SOE reform agenda is the mixed-ownership reforms that have been piloted since 2015 and will be extended to other sectors. Make no mistake, although these reforms will for the first time give a role to the private sector in managing these companies (in return for new technology and production upgrades), the CCP’s control of SOEs will remain essential. The ultimate goal is to improve efficiency of “national champions” to make them globally competitive and facilitate overarching national priorities such as the BRI. Hence we expect the state and private capital to be even more aligned by the CCP leadership’s goals. To prioritize environmental concerns, mixed-ownership reforms are likely to favor sectors that include providers of natural gas, water and waste treatment, soil remediation, and renewable energy. As a result of these reforms, we expect slower debt accumulation at SOEs, but not a fast decline in leverage that could become disruptive. We also expect China’s fiscal policy to mitigate any substantial effects of these policies on dislocated workers and on regional growth.
- These are positive developments, in our view. We believe there is no reason to be concerned over a gradual slowdown in China, because this new era has the potential to put China on a more sustainable growth path and is good for global economic stability. Going forward, we believe that two factors—the further liberalization of Chinese markets; and the continued rebalancing of its economy away from investment-driven to productivity-driven growth, and from savings toward consumption—will support global trade and growth.
Long live the Chinese dream!
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