11/01/2017

General Secretary Xi sets out his blueprint for China

Author: Richard Oldfield, Global Markets Leader  Richard-oldfield

Whichever way you look at it, last week’s 19th National Congress of the Communist Party in China was a triumph for General Secretary Xi. From the beginnings of his days in office it was pretty clear that Xi was a different type of leader for China. A leader with a clear vision who was prepared to move quickly to marshal the resources and consolidate the powers necessary to put his vision into action. The 19th Party Congress has reinforced this, cementing Xi’s grip on power. And with no successor in the wings, he looks likely to be leading China for the next 10 to 15 years. 

While we clearly got the message that we will be dealing with General Secretary Xi for the foreseeable future, what were the messages for business and investors?

In the General Secretary’s words, the Chinese economy–having gone through “deep and fundamental changes”–now stands at a crossroads. On the one hand, between 2013 and 2016 it achieved an average GDP growth rate of 7.2%–but on the other, it faces many challenges and risks. Among them, rising levels of debt, high cost of production, low returns on investment, persistent industrial overcapacity and high levels of pollution. None is easy to fix. But by setting out priorities to pursue supply-side structural reform and a commitment to work harder for better quality, higher efficiency and more robust drivers of economic growth through new industrialisation, better use of technology, urbanisation, and agricultural modernisation, then we can at least now see a clearer direction for future economic growth.

Preventing systemic financial risks has been the focus of attention of the Chinese leadership and many investors around the world. At the National Financial Work Conference in July 2017, General Secretary Xi stressed that China should treat the deleveraging of state-owned enterprises (SOE)–the major beneficiaries of the banks’ easy credit and main source of bad debt–as “the priority of priorities,” adequately deal with the “zombie enterprises”, and hold officials accountable for a lifetime for building up debt at their respective regions.

To address the problems, the 19th Party Congress report calls for “deepening Institutional reform in the financial sector, increasing the proportion of direct financing, and promoting the healthy development of a multilevel capital market”. There are also plans to step up supervision of the financial markets. All encouraging moves.

State-owned enterprise reform has become the centrepiece of China’s economic policy. China has given priority to enhancing SOE competitiveness and efficiency through market-oriented reforms and reducing excessive production capacity. There are signs that SOE reform has gathered pace, starting in August with a partial privatisation deal at China Unicom and with over 68% of central SOEs now involved in mixed ownership reform.

The 19th Party Congress stated that the Party will support state capital in “becoming stronger, doing better, and growing bigger”, and turn Chinese enterprises into “world-class, globally competitive firms”. It also said that the Party will work to consolidate and develop the public sector while encouraging, supporting, and guiding the development of the non-public sector. This is encouraging, however it remains to be seen how SOE expansions will not crowd-out private investment, how to improve SOEs’ returns on investment, and through what mechanisms entrepreneurship and innovation in SOEs are encouraged.

China’s private sector contributes 60% of total GDP, 50% of tax revenues and 80% of employment opportunities. Yet the sector’s growth peaked in 2011 and plunged in 2016 to a low level. The 19th Party Congress report calls for “supporting the growth of private businesses”, and doing away with regulations and practices that impede the development of a unified market and fair competition. While all these measures are in the right direction, time will tell how effective they are.

After rapid growth for over two decades, foreign direct investment (FDI) into China has stalled recently, standing at US$126 billion in 2016. In the first nine months this year, FDI fell by 3.16% year-on-year, according the Ministry of Commerce. There are many reasons for the decline, such as labour-intensive manufacturing companies moving to other low-cost neighbouring countries, but a key reason is the accumulated “promise fatigue”, where many government commitments to further open up to the world and level the playing field are not followed through.

The 19th Party Congress report reaffirms that China will not close its door to the world and will only “become more and more open”. It commits to adopt policies to promote high-standard liberalisation and facilitation of trade and investment, significantly “ease market access”, and “protect the legitimate rights and interests” of foreign investors. “All businesses registered in China will be treated equally”, the report declares. Now that these issues have been given such high political prominence, hopefully the situation will significantly improve in the coming years.

The report also calls for “developing new ways of making outbound investments”, promoting international cooperation on production capacity, and forming globally-oriented networks of trade, investment, financing, production and services. It clearly states that the Belt and Road Initiative will be pursued “as a priority” and investment in these regions is likely to grow further.

So while there were perhaps no real surprises coming out of the 19th Congress, there were for business some encouraging noises and initiatives–the gathering pace of SOE reform, improved market access and fairer treatment for foreign companies, commitment to the Belt and Road Initiative and an increased focus on environmental protection and improving people’s livelihood. Only time will tell which of these initiatives will bear fruit first and when…but time is something that General Secretary Xi does appear to have on his side.

Richard Oldfield leads all market-facing activities, initiatives, and strategy. Prior to his current role, Richard was a member of the UK Executive Board for five years during which he was Head of Clients and Markets and latterly Head of Strategy and Communications.  Richard also led the UK firm’s Banking and Capital Markets Assurance practice and sat on the Assurance Leadership team. Read more

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