China’s rise has an outsized impact on all of us. With a growing chance that the worst effects of the pandemic are behind us, China is now the single biggest risk factor, for financial markets as well as for the world economy. That is why three turning points affecting China need close watching, as each of these will have major consequences.
The first is China’s relations with the US, as a summit meeting between their leaders nears. Another turning point is in domestic politics, where the sixth plenum meeting is about to extend President Xi Jinping’s dominance. And the final turning point is the economy, where additional headwinds are emerging which could precipitate a sharp slowdown unless appropriate policy measures are taken.
A Biden-Xi virtual summit meeting should be announced imminently
After prolonged talks to prepare for a virtual summit meeting between President Joe Biden and President Xi, word is out that the meeting will be held next week. In recent months, the impression has grown of two big powers constantly at loggerheads, with the two leaders and their senior officials making tough and uncompromising comments against the other. The relationship is indeed troubled but we should see these recent developments in context: the heated rhetoric and actions partly reflect the posturing needed to assure their respective domestic bases that their leaders will not be weak in dealing with the other side. Each side is also probing and testing the opponent, trying to assess the other side’s vulnerabilities and to strengthen its bargaining position.
Indeed, since each side will want to tout the outcome of a summit as a success, the confirmation of a summit probably means that China and the US have already come to a broad agreement in some areas. Indeed, the two sides have been sending positive signals in recent days. Xi and Biden just exchanged letters in which each expressed the desire for their countries to work together.
In a recent interview, US National Security Advisor Jake Sullivan also chimed in with comments that would be seen as reassuring by China. He indicated that the US wanted to establish a framework which would allow co-existence between the two nations. Even as competition with China intensified, the US, he said, did not want to contain China or to bring about a fundamental transformation of the Chinese system as some in China fear. His comments on Taiwan, a highly charged issue between the two countries, were also nuanced and carefully worded.
Thus, we believe that the summit could produce relatively good news, at least for the near term. There could be agreement to work together for the common good in areas of mutual concern such as climate change. Given the sharp rise in China’s trade surplus with the US, we might see China agreeing to ramp up its imports from the US which have lagged behind what it promised in the January 2020 trade deal. The US could sweeten the mood by rescinding a few of the Trump-era tariffs on Chinese exports. The two leaders will probably agree to disagree in areas where the differences are too deep to be resolved soon, such as Taiwan and the South China Sea.
However, the test of the summit will be whether the two men will agree informally on a framework to manage their relations, so that frictions do not escalate into a serious clash. We believe that such an outcome is likely. After all, given their domestic preoccupations, the last thing the two leaders want is a distracting external crisis. Xi has the all-important 20th Party Congress next year to focus on, while Biden needs to get his domestic programmes approved so that he can reverse the slide in his approval ratings. All in all, then, we expect a good outcome from next week’s summit.
Communist Party plenum will give Xi what he wants, empowering him to push his agenda more aggressively
All the indications are that the Sixth Plenum of the Chinese Communist Party’s (CCP) 19th Central Committee will endorse Xi’s agenda, and in particular, his desire for a special party resolution on its history.
There have been only two such resolutions in the Party’s 100-year history. The first, in 1945, was used by the founding father Mao Zedong to push aside opposition and anoint him paramount leader. Deng Xiaoping, the leader whose bold reforms transformed China, initiated the second one, in 1981, to settle the Party’s view on the disastrous Cultural Revolution and Mao’s role in it. The resolution that Xi aspires to will cement his position in the CCP’s history and elevate him to a level of prestige close to that accorded to Mao and Deng. The wording of the resolution will probably be such that any challenge to Xi’s strategies and views would be made tantamount to a challenge to the Party’s ideology, thus further strengthening Xi’s already firm grip on the Party and nation.
In addition, it is likely that Xi will use the informal sessions around the main meetings to signal his preferences for the wide-ranging personnel changes he will want to engineer in the Central Committee and the Politburo Standing Committee at next year’s crucial 20th Party Congress.
The practical impact of this highly consequential plenum will be to embolden Xi. How this affects China’s long-term political development is a moot question. But in the near term, it could make it easier for Xi to undertake policy reversals that might be needed such as the Zero Covid policy or the unrelenting push to deleverage the economy, both of which are slowing economic growth. It could also mean that Xi would be more confident in pressing ahead with structural reforms in areas where he has been hesitant — such as liberalising the hukou regulations which restrict what migrant workers in urban areas can do or in implementing a much-needed nationwide property tax.
Economy under pressure as more headwinds appear
A third turning point is the economy. GDP growth slowed sharply in the third quarter, with investment actually contracting over the previous quarter. Consumer spending has also decelerated. So far, external demand has supported growth, with exports surging 27.1% in October after expanding 28.1% in September. While global demand is poised to recover and help boost China’s exports, we are also likely to see a shift in spending in recovering economies, away from imported goods to homegrown services — that might mean that China’s export growth could slow as we get into 2022. This is why the emergence of two fresh headwinds is of concern.
- The first is the emergence of the La Nina weather syndrome which caused early snowfalls and plunging temperatures in many parts of China. The China Meteorological Administration had earlier warned that low temperatures and snow could hurt energy supply, agriculture and transport infrastructure this winter season. This is going to place added strain on power generation in China. Although better coal supply has allowed an improvement in the power situation, it has not improved sufficiently for China to meet the higher demand arising from very low temperatures.
- A further headwind is the increase in China’s Covid-19 infections to a multi-month high. The infection rate is miniscule compared to the rest of the world, but even small outbreaks are met with draconian measures that impose a toll on the economy. Part of the reason for desultory consumer spending is the frequent lockdowns which depress confidence and cause people to stay at home.
These new challenges are hitting an economy already suffering from policy-induced difficulties. Much as government efforts to overcome longstanding structural weaknesses are necessary for long-term sustainability, they may have increased the risk of the economy tipping over into a much greater slowdown than the leadership would like to see. Its policies to force deleveraging and reduce the reliance on the property market are an example of such well-intentioned measures which cause short-term damage. Now we see additional headwinds appear.
- The recent data for the property sector is an example of this effect: Property sales of the top 100 developers fell 32.2% y-o-y in October 2021, after declining 36.2% in September 2021. Local governments are struggling to carry through with planned land sales — in September, 86.4% and 55.1% of land put up for sale in auctions in second- and third-tier cities respectively were unsold. Revenue from residential land sales — which is a critical source of funding for local governments — declined 37% y-o-y in the third quarter.
- The slowdown in investment could be another victim of policy. Note that the slower overall investment came about even though some areas of high technology and the green economy are still seeing massive inflows of new funding. Xi’s attacks on big technology companies and his calls for “common prosperity”, which might entail higher taxes and government pressure to step up charitable donations out of profits, are worrying entrepreneurs who have already seen a higher level of state intrusiveness in private-sector affairs.
Conclusion: What does this all mean for policy changes?
Chinese leaders are fully aware of the drags on growth but have judged that they should not rush into a stimulus, for two reasons. One is that they fear that a hurried stimulus will undo their efforts to promote deleveraging and reduce the economy’s over-reliance on the real estate sector. Another reason is the leadership’s changed emphasis on the quality of growth, rather than on achieving numerical growth targets: So long as job growth continues and so long as unemployment continues to fall (as it has), they do not feel they need to act urgently.
However, it does look as if the downside risks are accumulating to the point where some stimulus measures will be needed. Once the sixth plenum is over and the Biden-Xi summit is done, Xi can use the forthcoming Central Economic Works Conference in early December to announce a number of easing measures. These are likely to be administrative support measures that will be targeted at sectors in difficulty or additional subsidies for areas which the government is keen to promote — such as the creation of massive urban agglomerations and the more rapid development of strategic industries such as semiconductors. Judging by recent pronouncements, it does not seem likely that the central bank will cut reserve requirements so that money can be injected into the financial system. If that happens, it is more likely to be done in early 2022 rather than this year.
The question is whether this will be sufficient. One of the puzzling issues in Chinese macro-economic policy today is the unusual tightness of fiscal spending. Central government spending has been extremely restrained this year despite the many obstacles the economy faces. Recent data on local government spending has been patchy, but what we have seen also shows a reluctance to spend at a time when the economy sorely needs such spending. Our view is that the most important policy change needed is a loosening of fiscal policy, not monetary policy.
In short, the downside risks to China’s economy have grown. Policymakers will eventually respond with some stimulus measures, but there is a concern that the additional support to the economy will come late and be too small.
Manu Bhaskaran is CEO at Centennial Asia Advisors
Photo: Bloomberg
