A predictable but clarifying moment for China

By Stéphane Monier Chief Investment Officer Lombard Odier Private Bank

 

Homin Lee, Macro Strategist Asia

China moves on from the brute pursuit of economic growth.

Most market observers would characterise the 19^th Party Congress of the Chinese Communist Party¹ (CCP) as a predictable affair – but such predictability was a significant political feat in itself. The process for determining the leadership of the world’s most-populous country is obviously an enormous political and logistical undertaking given the scale of interests at stake. Meanwhile, this year’s event witnessed the largest turnover of CCP senior leadership in decades, and came on the heels of an unprecedented overhaul of the country’s two-million strong armed forces. The general calm that has followed these two sweeping political changes indicates that there is now a distinctly stable governance framework for the country to pursue its long-term national strategy.

Clearly, President Xi Jinping will be leading that journey. In addition to having successfully influenced a historic turnover of the party elite, Xi punctuated the gathering by enshrining his ideology in its charter. The unveiling of a new Politburo Standing Committee – the country’s ultimate decision-making body – lacking in any obvious leadership heir was another signal of Xi’s political dominance.

“Socialist modernisation” by 2035 through Xi’s strategy

The contours of Xi’s strategy were reflected in his three-and-a-half hour opening speech to the Congress, as well as the CCP’s new charter. Xi set a new goal for China to “realise socialist modernisation” by 2035, which is the mid-point between the CCP’s twin centenary goals of making China a “moderately well-off society” by 2021 and building “a modern socialist country that is strong, prosperous, democratic, culturally advanced, and harmonious” by the centenary of the republic in 2049. The key message is that China has already entered a new era under Xi’s leadership, which carries the implication that the national strategy, against this backdrop, will be substantially different from the previous two eras under Mao Zedong and Deng Xiaoping.

Politically, the focus remained on the maintenance of ideological discipline in the CCP and the military – the two pillars of the current party-state framework – but corruption was cited as the biggest threat to the party’s success.

This focus on control naturally spilled into the broader economic vision in which Xi made it clear that there was no plan for the country’s convergence towards the western model. While there were a few references to the ambitious economic reform agenda of the third plenum of the Central Committee (2013), the importance of the state-owned enterprises and the role of the government were also highlighted. The logic was clear: China is confident that its own model of development will serve it well in the future, as it has thus far.

China as an alternative to the Washington consensus

The direct challenge to the Washington consensus was one of the most intriguing developments in the Congress. Xi promoted China as a model for “other countries and nations who want to speed up their development while preserving their independence”. The sentiment was confirmed in the charter, where “One Belt One Road” (Xi’s signature multi-lateral trade and investment initiative, see chart below) was enshrined. To place itself in direct contrast to Trump’s protectionist agenda, Xi characterised China as a defender of the global system and free trade agreements. The implicit message was that the international system will begin to exhibit “Chinese characteristics” with more countries following its leadership.

Focus on better life and the quality of economic growth…

The distinctly political nature of the Congress meant that there was relatively little for the market to get its teeth into in terms of near-term policy measures. Still, there were strong hints about the direction of economic policy in favour of growth sustainability and domestic demand. The party’s key challenge will be to balance the population’s desire for a better life with the various imbalances and inadequacies of rapid economic development. The message was echoed in Xi’s citation of the policy priorities from the five-year plan as outlined in 2016:

1. cuts in over-capacity and deleveraging in inefficient industrial sectors,
2. nurturing of high tech industries,
3. reduction of pollution and environmental protection,
4. stronger social safety net, and
5. fighting inequality between regions and communities.

Along with the removal of specific numerical economic targets for 2035, these messages suggest that quality of growth and sufficient improvement in living standards will be the party’s priority, not a brute pursuit of economic growth.

… with a bias towards financial stability

On the issue of the macroeconomic policy mix, many speeches by Xi himself before the Congress and by the retiring People’s Bank of China (PBoC) Governor Zhou Xiaochuan (who warned of a Minsky moment) hinted that the stability focus would logically translate into the “twin pillar” approach of prudent monetary policy and robust macro-prudential controls. It is rumoured that the PBoC will play a crucial role in the new “Financial Stability and Development Committee”. Furthermore, two of the four likely candidates to replace Zhou as the PBoC governor currently serve China’s financial sector regulators. Their appointment, if confirmed, would be indicative of China’s increasing focus on financial stability, a stance that is consistent with tighter monetary policy and the stable renminbi.

Realising the Chinese dream

Many investors compare China’s current economic challenges to that of Japan in the 1990s. Indeed, some of the similarities are striking. The country faces a rapidly aging demographic (which surpasses Japan’s in speed²) after three decades of breakneck economic growth3. It also needs to cope with the fundamental challenge of liberalising its financial system and reforming its economic institutions while rising domestic leverage threatens its stability in the medium term.

The key difference is, of course, China’s politics. Instead of the rotating premierships that marked the first 10 years of Japan’s Lost Decade, China will likely remain under the extended rule of Xi and the CCP – thus delivering policy continuity. China also endeavours to set its own pace of market liberalisation and even create a new trading ecosystem to which the pressure from Washington will no longer apply. The redistribution and policy implementation will improve, but with the condition that ordinary stakeholders in the system fully support the CCP’s leadership. This is an interesting variation that could still work, if Xi manages to balance the conflicting political and economic needs of his party states adroitly. The result of this experiment will have repercussions far beyond China’s borders.

Should Xi’s government effectively manage this transition and deliver on its ambitions, we believe that within as little as a decade, China will enjoy a significant rise in global dominance, realistically rivalling the US as the world’s leading economic power.

Key takeaways

As the main political event is behind us, we expect to see the emergence of a more stable China both economically and politically in the near future. 
This will be positive, not only for the local China shares (A- and H-shares) but also, more broadly, for emerging market (EM) equities overall. 
This scenario echoes our positive stance on EM assets.