A new era has begun in China. Gauging the economic outlook requires thorough understanding of the new leadership under President Xi Jinping. He has received overwhelming endorsement of his authority from the 19th National Congress (NC) of the Communist Party. Four out of the seven members of the Standing Committee of the Politburo are his long-time allies, alongside 11 out of 18 new members introduced to the 25-person Politburo. Most importantly, the new members in the Standing Committee will be too old to be eligible to succeed Xi in the 20th NC in 2022. Xi, in all probability, will lead China for another decade and beyond. The orientation of macroeconomic policies will focus on improving the well-being of the economy in the long run.
All decisions to be made by Xi will easily be endorsed by the Standing Committee and the Politburo. Thus, it is fair to assume execution of economic policy will be faster, particularly in the fiscal space pertaining to urbanisation and those related to the Belt and Road Initiative (BRI). The likelihood of state-driven investment becoming the prime economic growth driver in 2018 and beyond is high.
Investment-led growth to resurface
The orthodoxy of developing a consumption-led economy is unlikely the sacred goal for China at this juncture. Improving the livelihood of the Chinese people requires per-capita income to rise sustainably over the long run.
This requires investment in the right places now to generate decent returns in the future. Consumption rises only when incomes do. That is indeed the path of development followed by many Asian economies. China clearly does not want to be cursed by the “middle income trap”. The authorities know well that artificial wealth creation via inflation of the property bubble is a precarious route.
How to make the right investment decision? The textbook answer is to allow free movement of interest rates to reflect the risk premium. In China, this represents only a small part of the investment decision process. What matters more now is the fact that local governments’ investment plans are absolutely synchronised with the goals of the central government. All state-owned enterprises (SOEs) must follow the decisions made upstream.
Centralisation will be ‘new normal’
Centralisation of control will be the “new normal” pertaining to SOEs reform. Experimentation of mixed-ownership reform will continue. But when it comes to important decision-making, the state will prevail. The state has been increasing its control over newly-merged SOEs by including Communist Party committee members in the board of directors. Management is encouraged to seek direction from the party committee member before making major decisions. Many SOEs are also merging the role of company chairman with that of the party secretary.
These new policies reflect consolidation of political control over core strategic industries. It is a complete departure from the thesis of separation of political control from the enterprise management. The central government has zero tolerance for corruption. Compared to the past, fiscal wastage will likely be minimised. And it has big plans to spur the next phase of urbanisation and scientific innovation (the China Manufacturing 2025 initiative). These areas are unlikely to be affected too much by the “deleveraging” process.
Urbanisation is about facilitating cooperation among various provincial governments to hone their strengths and mitigate their weaknesses. These provincial governments had been hindered by vast differences in political interests in the past. Now, these hurdles are gone after the 19th NC meeting. There will likely be some real progress on this front in 2018. For example, Beijing-Tianjin-Hebei is to be integrated with the Xiong’an new district, and Hong Kong, Macao, and Guangdong province will be integrated as the Greater Bay Area.
This is not to say the share of consumption in China’s GDP, which currently stands at 60 per cent, is going to drop sharply. The growth momentum in 2018 will likely be spearheaded by investment. If these new investments are executed well, they will consequentially ramp up consumption.
Industrial policy matters
As far as the agenda to push for scientific innovation is concerned, industrial policy clearly matters. China will spur technological innovation by boosting research and development expenditure at universities and SOEs in artificial intelligence, manufacturing robotics, and Big Data mining. Meanwhile, the state would seek opportunities to become a shareholder of successful tech companies in the private sector. The process however risks being characterised by initial rapid growth followed by overcapacity later. Here is the usual sequence:
1. The state identifies a few key industries to invest in.
2. Everyone follows suits, due to easy and quick regulatory approvals.
3. Easy loan support from state banks.
4. Foreign suppliers benefit from strong import demand.
5. As time goes by, oversupply sets in, collapsing margins.
6. To save them from bankruptcy, state subsidies are provided.
7. Export overcapacity to the rest of the world.
Many industries such as solar energy, medium- and high-value steel, aluminium, semiconductors, home appliances, and hydropower engineering went through this cycle. This time round, the leadership may change the sequence by limiting entry at the earliest stage. This strategy is equivalent to establishing oligopolistic market power for certain strategic industries right at the beginning.
Industrial policies will intensify to sharpen the export competitiveness of the following strategic sectors: railway equipment, electric vehicles, manufacturing control systems, maritime engineering, and biomedicine. China will continue to embrace free trade that suits her mercantilist favour. Trade conflict with the US is set to rise. Against this backdrop, 2018 growth, buoyed by a new phase of urbanisation and state-driven investment in strategic sectors, may surprise on the upside, conditional upon the magnitude of deleveraging.
Gradual deleveraging to continue
As far as the monetary side of the economy is concerned, the persistent decline of M2 growth from 11.3 per cent YoY in January to the latest reading of 9.2 per cent in September is often cited as evidence of deleveraging. But data on total social financing (TSF) has consistently been pointing to very strong loan demand since the beginning of Q317. New TSF came in at RMB1.82trn in September, up 6 per cent YoY.
Contraction of money supply amidst strong credit demand jets up refinancing costs. The aim is to mitigate the explosive growth of wealth management products (WMPs) seen in recent years. Onshore benchmark 5-year government bond yields shot up to almost 4 per cent after the NC meeting.