China’s Communist party congress: what investors should expect
The 19th National Congress of the Communist Party of China begins on Wednesday. Will President Xi Jinping stick or twist on the country’s economic policy, and what might it mean for markets?
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Craig Botham, Emerging Markets Economist:
The Communist party congress begins on 18 October. It is held once every five years and is closely watched by anyone with an interest in China due to the political and policy changes it can herald.
There has been a great deal of speculation about what we might expect at this congress, given the power President Xi Jinping is perceived to wield in comparison with some of his predecessors. While we are not experts on Chinese politics, we must nonetheless form a view from talking to those who are. Our expectations are laid out below.
Norms to be broken?
A lot of commentary has focused on the importance of certain political norms in China. The two term limit for presidents, for example, would mean that Xi Jinping should promote his preferred successor, to hand over power in another five years’ time. Separately, the 68 year age limit would mean Wang Qishan a key ally of President Xi who has been instrumental in the anti-corruption campaign, would need to step down.
Speculation is rife that both norms may be broken at this congress, in a sign of Xi’s power and his intention to seek a third term. While we would certainly regard this as politically significant, we would note that in fact these two norms are not that well established.
Only Hu Jintao (2002-2012) has strictly observed the two term limit, for example, and former President Jiang Zemin (1989-2002) ignored the retirement age norm by ruling until the age of 76.
Still, there would be domestic political implications from ignoring these and other norms, however short-lived they may be. To date, they have been beneficial to China in creating a more knowledgeable and professional ruling elite.
There is a risk that overriding them destabilises the Party, taking it back to holding elite power struggles as a structure for determining succession, rather than using at least some objective measures of merit and ability.
Reinforcing these concerns is the apparent thrust of President Xi’s agenda for greater centralisation of power as means of shoring up the legitimacy of the Party.
It will be worrying to see the Party become increasingly reliant on its General Secretary. With no checks or balances, the soundness of policy will depend on the character of one man, and we do not know who will follow Xi. This of course is a long term story, rather than one with immediate implications for investors or economic growth.
Economic policy: stick or twist?
As investors, of course, we tend to focus more on economic policy – interesting as political intrigue can be. We sense that hopes expressed earlier this year that the congress would mark a change of policy direction are now giving way to a realisation that little is likely to change.
The first reason for this is somewhat prosaic; these five yearly congress meetings are seldom the place for the nuts and bolts of policies to be specified. Instead, they set out a vision for the next five years, with plenty of slogans but little detail. Specific policies will wait until the National People’s Congress (an annual event) around March 2018.
Growth and stability
There are, however, reasons to think that even in March of next year, little will change. China has already attempted reform under Xi Jinping; the 2013 Third Plenum saw the announcement of a substantial reform package, little of which has been implemented despite the presence of reform-minded individuals like Li Keqiang, Lou Jiwei, and Zhou Xiaochuan. At least two of these will probably depart after this congress.
There are two arguments for why this reform push failed. One is that President Xi values growth and stability above efficiency and reform, and so as long as these main objectives are being met, there is little reason to change course. This would imply a significant deterioration is needed from here to force a serious alteration of policy.
The other school of thought is that Xi Jinping is not so powerful as imagined by the West, and is in fact constrained by internal politics. Should this be the case (and it is impossible to know for sure), then the congress gives Xi the chance to remove the last vestiges of opposition through judicious use of promotions, demotions and retirement, and proceed with a more ambitious reform agenda.
Our own view tilts toward the former explanation: Xi’s history suggests he is a pragmatist rather than idealist when it comes to economic policy.
More of the same
Consequently, our expectations for economic policy in 2018 and beyond are for more of the same. That is: consolidation of power, both political and economic (partly through mergers of state-owned enterprises [SOEs]); an attempt to grow out of the existing debt problem by channelling credit to the consumer and new industries while slowly closing inefficient SOEs; and policy tinkering to keep growth at an acceptable level (probably between 6 and 6.5%).
This approach can probably work a while longer, but on the current path we expect serious concerns to surface around 2020.
Robin Parbrook, Co-Head of Asian Equity Alternative Investments:
It is notable how little publicity the upcoming 19th party congress is receiving both in the press and in the verbiage produced by the Asian stockbroking community.
This is quite a contrast to the last two party congresses when hopes were high of reform and change. We think in this instance the market is correct to view the congress as a non-event (for stockmarkets at least).
We expect the 19th Congress to be all about “control”. In a nutshell: enhanced party control of state owned enterprises (SOEs), tighter control over local government finances and oversight of the banking system especially shadow banking, and more control over the capital account to prevent unauthorised capital outflows.
In practice, if our predictions on “control” are correct then it makes life for investors in China a little bit more predictable and easier (famous last words!).
The Chinese government is now increasingly vocal about the need for large SOEs to be “pillars of the economy”, which in the words of President Xi should be “resolutely” made “bigger and stronger”. This means it is easier than ever to choose to ignore this part of the stockmarket.
The advancement of the state has rarely been good for investment returns in those sectors affected.
On the flip side, if the government does choose to exert greater control over local government finances and the shadow banking system this should have the positive effect of lowering the immediate risk of a financial crisis in China.
The quid pro quo from doing this would be the need to accept a slower rate of GDP growth. This we would view as positive.
To be fair on the Chinese authorities, they have already moved some way to normalise lending rates, thus reducing the worst of the questionable investment excesses in China.
Over the last three years real lending rates have moved up sharply in China, especially once adjusted for the fact that real rates charged by shadow banks in particular are well above quoted prime rates.
The effect has been to sharply reduce investment growth. As a result, the risk of malinvestment (and thus high bad debts) from new loans made in the last two years should be materially less.