Don't Expect China to Change
For all the mystery surrounding who will rise and fall at next week’s big leadership conclave in China, only one question really matters to investors: Will President Xi Jinping, having sidelined any obvious opposition, attack head-on the enormous imbalances and risks building inside the Chinese economy?
Optimists argue that he will. The Economist Intelligence Unit recently wrote, “Xi will find his ability to implement policy substantially reinforced by newly strengthened majorities. After the Party congress, we believe that Mr. Xi will have even more room to pursue a deleveraging agenda.” By this logic, Xi recognizes that the explosion of debt in China following the global financial crisis in 2008 poses an almost existential threat and has only been waiting to clear away internal resistance before moving boldly to address it. Having now amassed all the levers of power necessary to ensure success, he is sure to prioritize economic and financial reform.
This logic is curious, however. It implies that Xi -- already the most powerful Chinese leader since Deng Xiaoping and a man who has swept away thousands of corrupt cadres, imposed far-reaching reforms on the People’s Liberation Army and tightened the Party’s control over virtually all information in China -- has simultaneously been powerless to execute basic economic reforms. The European Chamber of Commerce in Beijing summed up the doubts of many recently when they complained of “promise fatigue.” It seems unlikely that a few changes in the senior Politburo will suddenly unleash capabilities that Xi didn’t possess previously.
We now have five years of data on Xi’s policies and predilections, and very little of it suggests he is deeply invested in a pro-market, reformist agenda. Instead, his economic policy has throughout been marked by a short-term focus on propping up growth, with frequent opportunistic reversals when reforms have gone ahead. There’s been much talk about how determined the government is to maintain stability in the run-up to this month’s congress, when China appoints its new leadership for the next five years. In fact, that same impulse has driven most of the government’s decisions ever since Xi took power in 2012.
Chinese policy makers, for instance, have for years talked about restraining debt growth. Yet despite regular exhortations about the need for deleveraging, the hard realities of sustaining 10 percent nominal growth and real estate prices have dissuaded the government from clamping down too hard. Outstanding mortgage loans are up 31 percent through June, with medium- and long-term loans to households continuing to rise 2 percent a month. Credit is still growing rapidly; by the end of this year, the ratio of total social financing to nominal GDP is expected to have risen from 169 percent in 2012 to 204 percent.
Officials urged Chinese companies to invest overseas in order to gain expertise and improve efficiency -- until they saw the effect of all that outbound investment on the yuan. A little more than a year ago, the government began cracking down on outflows, effectively killing hopes of that the currency might be liberalized. This short-sighted decision may have bolstered the yuan’s value and halted the drain on China’s foreign-exchange reserves. But it comes at the expense of the longer-term goal of promoting the yuan as a global currency.
Plans to implement supply-side reforms, while sound in theory, have suffered from a failure in execution. National operating rates of steel mills in September 2017 averaged 5 percent less than September 2015, even though year-to-date steel materials output is flat, implying net capacity continues to rise significantly. Fixed-asset investment levels in steel remain high, while down from peaks, meaning more capacity is being added and plant utilization is shrinking.
Xi doesn’t seem to view China’s economic problems as so dire that they outweigh the need to promote growth, especially not if they can be managed with constant tweaks. Consequently, economic policy seems likely to continue to focus on controlling rolling asset bubbles, threats to growth and currency problems while avoiding tackling systemic issues.
A go-slow approach, however, can’t keep up with fast-growing risks. New total social financing through August is rising at nearly twice the rate of 2016 and total debt outstanding is growing slightly faster. New capacity in heavy industry continues to far outpace capacity reductions, exacerbating oversupply. Real estate and property development loans are up an eye-watering 24 percent and 18 percent respectively.
Leadership turnovers in every country almost always bring optimism about the direction of economic policy. Prior to Xi’s ascension in late 2012, too, analysts focused on his supposedly pro-market and debt fighting credentials; today, observers in India and Japan confidently predict that their own leaders will double down on big-bang structural reforms once they win re-election. This is an understandable reaction. It shouldn’t overwhelm a sober assessment of the evidence.
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Nisid Hajari at firstname.lastname@example.org