Xi Jinping’s Infinite Rule

Tue 06 Mar 2018

Things have been looking up for China recently, as market sentiment towards the world’s second largest economy has finally started to take a positive turn. Since 2015, when the country’s stock market sold-off sharply and the Shanghai Composite Index crashed 45% in under two months, investors have understandably been wary of China. Redemptions in Chinese equity funds totalled $9 billion in 2016, following outflows of $21 billion in 2015. The potential for capital flight, a surging debt pile and slowing economic growth have added to investors’ list of worries including political intervention in the currency, shadow financing and corporate governance issues.

Despite all of this, China has come back strong with the MSCI China index posting gains of 51% last year, the second best performing emerging market, beaten only by Poland. The consensus view among today’s investors is one of renewed optimism for the country. An optimism which is in part owed to a much more stable economy and currency, attributable to President (and head of the Communist party) Xi Jinping.

Xi came to power in 2012 with a view to overhaul the country and pave the way for it to become a global powerhouse. He has made some decidedly risky moves, however these have largely paid off for the country. One notable example is the supply-side structural reform, designed to close excess capacity and return the industrial sector to profitability again. Despite being mapped back in 2015, the reform only started showing signs of its success last year. The sector has since exited deflation and is finally growing again, suggesting that Xi’s efforts have not gone to waste.

Additionally, Xi has made significant moves towards reducing the country’s rather intimidating debt pile. With estimated debt-to-GDP of 270% it’s no wonder many are scared off by the amount of leverage that is looming ahead for China to pay back. However, broader credit growth has fallen to a new multi-year low. Additionally, the majority of China’s debt is in fact state-owned, where state-controlled banks have lent money to state-controlled firms. Of course these obligations will come due in the future, however the government can easily manage the situation. Therefore the widespread opinion is not one of a credit crisis in the short term.

The People’s Bank of China regularly announces total social financing (TSF) figures which are separate to its monthly data on bank loans. The TSF information includes channels predominantly linked to shadow finance activity. Impressively, January’s figure marked the smallest total in three years. Furthermore, outstanding wealth management products (WMP), another measure of shadow financing, shows how much the government has managed to reduce this activity having only grown 1.7% at the end of 2017, compared to a growth rate of 24% one year earlier.

When you look at it from this perspective, the President appears to be fulfilling the promise set out at the beginning of his tenure. However, many are concerned that an announcement made at the end of February proposing a change to the constitution to allow Xi to continue his Presidency indefinitely could bring China’s recovery to a halt. There was speculation that this would happen back in October when no clear heir to Xi was chosen in the new line-up of the top governing body during the 19th National Congress of the Communist Party of China. However, Sunday’s announcement made Xi’s intention clear.

Under the current system, put in place by Deng Xiaoping during the 90’s, Xi would have had to abdicate by 2023. The clause was introduced to avoid a repeat of the turmoil endured during Mao Zedong’s era and the Cultural Revolution during which up to 2 million people were killed. Xi is therefore doing away with the very thing that has cemented the peaceful transfer of power from one generation of leaders to the next.

Many are asking why, and this is a good question. Xi is already head of the party and the military, two posts both more powerful than the presidency and without term limits. Therefore some are speculating that this move is a further grab for power, with Xi trying to give himself even more scope to aggressively declare territorial rights in the South China Sea and Chinese political and economic influence in Asia and beyond. Xi will be able to suitably enforce his domestic political and economic agendas as well as his foreign policy ambitions.

The proposal to change the constitution has been somewhat overshadowed by President Trump’s recent trade war rhetoric, which has seen him announce 25% and 10% tariffs on imported steel and aluminium respectively. As an advocate of global trade, it will be interesting to see how Xi reacts in the weeks to come, however at present we are still positive on China and do not see Xi’s move towards infinite rule as breaking China’s stride just yet.