04 December 2017 6.00pm
China's Outlook following the 19th Party Congress
Venue: Ashurst, Broadwalk House, 5 Appold Street, London, EC2A 2AG
Sunil Krishnan chaired December’s evening speaker event on China at which the Society was pleased to welcome two experts on the subject – George Magnus of the China Centre, Oxford, and Grant Colquhoun of the CRU Group.
George Magnus began the proceedings with three observations on how President Xi and the 19th Congress will change the way that China operates. First, Xi joins Mao and Deng in having his own thoughts personally embedded in the Party’s constitution. Xi wants his legacy to be China “moving closer to centre-stage”, making “greater contributions to mankind”. Under Xi, politics has become more centralised versus Deng’s desire to create more layers of governance. As a result, there are few opportunities for the development of institutions of constraint. If his policies work, Magnus argues, Xi will be a hero; if they fail, there is nowhere to hide. Whatever the case, Magnus sees China’s politics as more of a headwind than tailwind for the economy going forward.
Second, Magnus argues that under Deng China could be said to have been “hiding its capacities” and “biding its time”. This period is now over – China’s attitude to the rest of the world has changed, broadening its military might and increasing participation in global institutions (such as the IMF and the creation of the Asian Infrastructure Investment Bank). China is the first or second biggest economy in the world (depending on how it’s measured), it is the biggest exporter, a huge importer of commodities, and has sizable investments abroad. Xi’s plan is just as much an economic project as it is a political one.
Third, for the last thirty years the Communist Party’s “principal contradiction” was that China was poor and could not serve its people well – thus requiring growth at any cost (those costs were environmental, social etc). That has, since 2017, changed – growth targets have been abandoned and the intention is that China’s focus will shift to social welfare, income inequality, industrial policy – generally making China work better (albeit not more liberally). Xi’s intention is to raise the dominance of the state owned sector in the economy.
The most immediate issue is whether China can keep the economy stable while simultaneously driving out the recent trend towards riskier financial innovation. When the economy slows, as the crackdown on credit almost certainly suggest it will, will the government be prepared to stick to is policy of deleveraging or will they revert to form in order to stimulate the economy with new infrastructure spending and credit expansion? Magnus concludes that in the event of downside risks to growth emerging the government will capitulate.
Grant Colquhoun tailored his focus towards China’s demand for commodities, also highlighting three areas of particular interest (credit, capacity and pollution). Based on analysis of word counts in official speeches, Colquhoun noted that there has been a sizable shift in emphasis in China towards the Party, politics, military, discipline and the environment – and away from the economy. He argued that this shift is welcome, particularly since in the past growth has been achieved via fiscal policy leading to an unsustainably large budget deficit (13% of GDP).
The flatter profile for housing completions going forward suggests that metal prices (which are significantly influenced by construction demand) could suffer. However, it is important to remember that volumes (if not growth) are still exceptionally high – China is building 10 million homes per year, which compares with just 1.25 million in the US and 200k in the UK.
Colquhoun believes that the auto sector is still well placed to grow thanks to catch-up in car ownership rates. After all, GDP per capita is at a point where typically countries have seen vehicle sales meaningfully accelerate. China is the world’s largest producer of vehicles at around 25 million units per year. The type of production is likely to change, however, with an increased focus on electric vehicles – in turn having implications for metals. The combination of slower construction but a step-up in vehicle production should be negative for steel but positive for aluminium.
The government has forced sizable capacity cuts on the mining and steel sectors – as capacity utilisation rises as a result, this could yet help support steel prices (notwithstanding slower construction demand). Thanks to these policies steel companies have seen improved profitability, thereby improving their ability to pay down debt. As for aluminium, private companies’ capacity is being restricted by the government, with state owned enterprises being allowed to raise production at the private sector’s expense. The state sector is thus becoming less efficient relative to the private sector with negative repercussions for return on assets and economic growth.
Colquhoun concluded by looking briefly at pollution. Airborne particle matter maps of China show PM2.5 concentrations far higher than levels in either Europe or the US, caused largely by the burning of fossil fuels and most evident in the north east of the country. The government may be taking action to mitigate the worse of the pollution, and attempting to improve living standards and quality of life at the micro level. But, Colquhoun argues, it is the symptoms rather than the causes that are being addressed.
For a copy of the slides, please click on the downloads above, and to hear the recording of the meeting click here: