Akash Prakash: China after the Plenum

Beijing has bought itself and the world economy short-term stability, probably at the cost of much greater pain down the road

One thing all investors have to appreciate about the Chinese economy is that politics has totally superseded economic management. Short-term political compulsions are driving economic decision-making today to the exclusion of longer-term economic thinking. The political compulsions of the moment demand economic stability, and will continue to do so till the end of 2017, when we will have the 19th Communist Party Congress. Politburo renewal and many other crucial appointments will be made at this congress. It will also be a test of the current leadership.

Given the political will and resources at the party’s command, it has been able to ensure both the appearance and reality of economic stability this year. We have had three consecutive quarters of 6.7 per cent gross domestic product (GDP), ensuring that the bears have to continue to wait for their bust. While many economic indicators continue to show weakness, and point to economic activity being nowhere near as stable and smooth as the official data indicate, there has been improvement. A renewed surge in credit, investment, revival of the property market and a slowdown in capital outflows have all eased concerns that China is being run by incompetent leaders and about to collapse. Everyone seems to have forgotten the beginning of 2016, when China concerns roiled global markets. The bears were predicting a devaluation of the currency, collapse in economic growth and a balance-sheet crisis in the Chinese economy. Global commodity prices had collapsed as if there was no growth left in China. Those doom-and-gloom outcomes seem to have been avoided, for the moment at least.

 

This determination on the part of the Chinese leadership to maintain stability at all costs is good news for the global economy and markets in the very short term. It is unlikely the authorities will reduce their grip on the economy over the coming 12 months leading up to the congress. The risks of a shock coming out of China in the coming 12 months is that much lower. Given how weak global growth is, stability in China is indeed critical. China even today is contributing more to incremental global GDP than any other country. 

The problem will, however, be in the longer term. For even the Chinese cannot control their economy forever. All the longer-term issues clouding the economic outlook for the country remain. Rising leverage, falling return on capital, need to restructure the public sector, pivot the growth strategy all these issues remain. The longer these issues are neglected, the more painful will be the final resolution. China has bought itself and the world economy short-term stability, probably at the cost of much greater pain somewhere down the road.

The outlook beyond 2017 depends on just how powerful President Xi Jinping becomes, and what does he do with this power? The signals from the 6th Plenum, just concluded, are mixed. Mr Xi was confirmed as the core leader, a designation enjoyed by Deng Xiaoping and Jiang Zemin but not by his immediate predecessor Hu Jintao. However, the meeting’s official communiqué was also full of references to collective leadership. So it remains unclear whether Mr Xi can become a Chinese Vladimir Putin, as he seems to desire, with no checks on his power and tenure, or will he simply complete his next five years and retire like those before him. Sophisticated China-watchers are also split on this issue. It is probably still too early to tell.

As to what Mr Xi may do with the additional power he gathers, the outlook is similarly unclear. His priorities in his first five years were more political than economic. Fight corruption, increase the control of the party over all aspects of society and project Chinese power and leadership globally. The bulls argue that it has taken Mr Xi the first five years to get his people into the top echelons of the bureaucracy and establish his personal authority. In an ever more fractious and complex country (sounds like India!), this was needed before the hard reforms, which trample on vested interests, can begin. The bulls hope that post the 19th Congress late next year, Mr Xi will have gathered the power and authority he needs to move away from his political and authoritarian agenda and address the longer-term economic challenges the country faces. To address these challenges Mr Xi must be willing to sign up for fundamental economic reform. 

Illustration by Ajay Mohanty

The bears argue that while economic decision making in China may come across as confused at times, two key themes are apparent. There seems to be no willingness under Mr Xi to bear short-term pain or accept economic volatility as an inevitable consequence of more freely functioning markets and the capital allocation inherent in a more capitalistic economy. He also seems unwilling to cede any control or role of the state in the economy. These seem to be core beliefs of Mr Xi, not something he is forced to accept due to a lack of authority.

The problem is that greater acceptance of economic volatility and less state interference in economic decision making are both needed if China is to pivot away from an economic model needing ever greater leverage to deliver growth. Deng and Zhu Rongji were both able to cede some state control over the economy despite making no compromises on keeping an authoritarian political system. They were also willing to accept short-term pain as the Chinese economy restructured, to allow it to move into its next stage of growth. They understood that the growth model for the country had to change, and there was a need to kick-start productivity in different sectors of the economy. Millions of jobs were shed by the PSUs in Rongji’s term as an example.

Mr Xi has not shown the willingness to take any risk or intuitive economic understanding that China’s growth model has to change. He has not shown the creativity and flexibility of previous leaders and focus on long-term prosperity that they had. He seems more focussed on establishing Chinese global leadership than putting in place the building blocks of continued economic success. It is unclear if he will take the steps China needs to move into its next growth cycle, even if he has the power to do so. Watch this space as things become clearer post 2017. This shows once again the need for focused and visionary leadership to deliver true economic reform in a large country.
 

The writer is at Amansa Capital. These views are his own