Podcast

Luke Bartholomew  00:06

Hello, and welcome to Macro Bytes the economics and politics podcast series from abrdn. My name is Luke Bartholomew, and today we're talking about China. And in particular reflecting on the 20th Party Congress, which is just finished, and looking forward to what it might mean for political and economic developments in China. So I'm delighted to say, I am joined by Robert Gilhooly, who is our senior economist at Aberdeen covering China, and Neil Thomas, who is a political risk analyst at Eurasia, covering China. So, gentlemen, thank you very much for joining us today. Now, I have to say recording here in the UK after the several months of, dare I say 'political noise' that we've been through, the contrast with China's party congress does seem exceedingly striking right now, given what at least seems to an outsider to have been a very well managed piece of political theatre. But Neil, perhaps before we go into the substance of what this party congress delivered, it may be helpful if you could just give us a little bit of background in terms of the role of the party congress within China's political system and way in which this particular 20th Party Congress might have been different from the previous structure.

 

Neil Thomas  01:30

So the 20th Party Congress is the most important event in the Chinese political calendar. There's a congress like this held every five years, and we see a reshuffle in the top leadership. So the Congress elects a new Central Committee. That's the top 370 odd leaders of the Chinese Communist Party then right after that Congress, that new Central Committee selects its new General Secretary. So the leader of the whole Communist Party currently Xi Jinping, and a new Politburo and other kind of main leadership bodies. The Congress is also important because it's at the opening of the Congress that the incumbent General Secretary delivers a report on behalf of the outgoing Central Committee. And that report is the most authoritative statement we have of the party's political worldview and its policy priorities going forward. At the end of the Congress, the party also amends its constitution. So the policy changes and political ideologies that make it into that updated version of the Constitution, have a particular resonance, in how the party is going to operate for the years ahead. So it's basically the equivalent to the Olympic Games in China watching. It's when the most attention comes on our particular esoteric expertises. And, you know, the shift of the leadership really is an important thing that gets all the attention. But some of the more important policy signals actually come in the report and the constitutional amendments that get made. In terms of how different this Congress was to previous ones, it really was quite a departure from the norm in one really important way, which was that since the early 1990s, there's been an understanding that some considered a norm that the General Secretary, the leader of the Chinese Communist Party, would serve for two five year terms in between congresses, and would then step down and hand over power to a successor who'd be designated at the Congress before the incumbent stepped down. And this year, that didn't happen. So there was no new leader, Xi continued for a third five year term as General Secretary, and there was no designation of successor. It didn't happen five years ago, didn't happen now, so we're getting towards a strong base case assumption that Xi plans to rule indefinitely. So that's the the major departure from the previous norms of what we saw at party congresses.

 

Luke Bartholomew  04:11

Well, a gold medal for that excellent description on your Olympics analogy, there. But you, as you said, there, that sort of the work report is where the main substance of the Congress comes through. So maybe you could talk a little bit about what the key signals were from that work report, and I guess sort of Xi Jinping speech around that gave us something of a summary albeit still rather lengthy. So sort of the main things that came from that speech, then, as you say, Xi Jinping staying on without a designated successor, what signals we should take from that as well?

 

Neil Thomas  04:47

The first big message from the speech was that we're going to see an even stronger role for Xi and the Communist Party in Chinese policymaking. So the report described the new era of Xi's leadership as a milestone in all of Chinese history, going back 1000s of years.  It was, you know, his thought as a new horizon in Marxism, and it now has its own kind of worldview and methodology, things that were traditionally only associated with Marxism, not even, you know, Mao Zedong thought. And there are key kind of elements of this theoretical innovation that Xi Jinping has achieved in the party's reckoning. Something that slipped under the radar, a bit of a lot of the coverage is this idea of systems thinking, which was in the report for the first time. And that's this idea in Xi's mind that kind of everything is interconnected and interdependent in a kind of more complex policymaking environment, where all of these difficult economic, social, and political reforms that Xi's trying to do to kind of shore up the party's long term rule and the sustainability of China's growth model, really involve very difficult series of reforms to balance all these competing vested interests. And there's a phrase out, you know, 'pulling one hair moves the whole body', which I think refers to things like the common prosperity campaign triggering big market reactions, the made in China policy, kind of precipitating this move by the West to cut China out of advanced tech supply chains. So for Xi, the solution to this more complicated policymaking environment is that the party needs to enhance its oversight of all elements of China's society, economy, politics, and introduce many more kind of systems to manage and coordinate the country's overall development. That's a key theme across the rest of the report as well. There's a huge number of new systems, for example, macroeconomic adjustment that were mentioned really for the first time. So it's of a piece of the trend of increasing party control over the last 10 years, but it was expressed more formally, and perhaps in a more kind of organised manner than done previously. So that stronger role for the party is one of the main key themes. I think a second key theme is the rising perceptions, at least among Xi and the party, that there are more domestic and external risks facing China's rise. So the CCP previously saw China as in being in a period of strategic opportunity, where there's a favourable environment, domestically and externally for the leadership to focus on growth and development. But Xi changed that two decade old view of the world to one in which there is strategic opportunity, but that coexists with risks and challenges. And he mentioned that for the first time as well, that all sorts of black swan and grey rhino events could occur at any time. So there's a much darker outlook on the world and on the challenges that China is facing. And, you know, again, that kind of pushing a shift towards, you know, more policy, more politics and policymaking. And there's a move, you know, from kind of focusing primarily on development, to balancing development with security. So that's political security, but also security from financial bubbles, from western geopolitical leverage, from internal domestic reforms, like, you know, property-addicted growth model. And so, you know, Xi basically thinks that these kinds of security concerns and awareness needs to permeate every aspect of Chinese governance, so there's a new section on the report, dedicated to national security and having systems that respond to that. So it's really kind of a key rising priority and kind of part of that is also an even stronger focus on indigenous innovation of science, technology and human capital, the new chapter on that, so kind of seeing a very strong term towards focusing on domestic production and, and you're self-reliance in these key technologies. And just quickly on economic policy and in foreign policy. On economic policy and some of the, you know, the spirit of market oriented reform, but you still animated parts of the report five years ago, really is absent this year. So even things like supply side structural reforms, financial deleveraging, destocking property inventory, cutting excess capacity, those references have been omitted completely this year. And we have instead kind of stronger focus on the state sector playing a bigger role. And you know, guidance of the non-public sector, this language about increasing the activity of party organisations in corporate governance and financial firms, as well as in the non-state sector generally. And in foreign policy, you know, Xi has declared that, you know, China is now pursuing its task of national rejuvenation using Chinese style modernisation - look a really strong assertion in my view that Xi is going to steer his own course, the party's own course, even if that involves strategic competition with the West. And we had the clearest statement yet in a party report that this national rejuvenation goal for 2049 means that Xi wants to transform China into a country that leads the world in comprehensive national power and international influence in his words. So this is likely to inform a stronger role in global governance, a more assertive Chinese diplomacy that we've been seeing in the last few years, and a likely continuation and likely intensification of US / China strategic competition. There's a lot in the report, but I think those are some of the major themes that I noticed.

 

Luke Bartholomew  11:04

Brilliant. Thanks, Neil. So Bob, just bringing you into the conversation. I know Neil was talking there about how the focus of the Party Congress in the work report, in particular, is on long-term challenges, long run development, but it seems to me at least that one very glaring elephant in the room that wasn't addressed there, and potentially quite a good example of one of the ways in which China is going its own way to use a phrase of Niel's is around zero COVID policy. So what are our thoughts around how that might develop from here and how the policymakers are thinking about those kind of questions?

 

Bob Gilhooly  11:40

Yeah, I mean, it was interesting in terms of zero COVID, the People's Daily and other state media had effectively kind of like a mini campaign, to emphasise the importance of sticking with zero COVID strategy ahead of the Congress. And that effectively removed the chances of any sort of exit strategy being being revealed. I mean the latest market rumours have actually just come out today are that we could see a reopening committee being set up, potentially that could tie him in with some easing after the two sessions in March, that would at least allow potentially the political process to be largely completed clearing the kind of one hurdle to changing strategy. But personally, I find it quite hard to believe that they're actually going to move so quickly, only about 67% of the elderly population, have actually had the booster shots for the COVID vaccines. And we know that that that does have a very marked improvement in reducing, improving efficacy, so reducing risks of death and serious illnesses. We also know that rural areas typically have certainly worse health care provision, they also have a slightly higher share of the vulnerable unvaccinated elderly population. And as you alluded to there, you know, there wasn't much that you could point to in the work report or in zero COVID. But President Xi did emphasise improving the emergency response mechanism for health care. I think that does at least kind of speak a bit to a slightly more delayed exit. And I guess alongside that, that this kind of need to improve medical facilities, roll out booster shots. The slower move away from zero COVID also gives time to stockpile the COVID pill. You know that it's got the advantage of it doesn't have the kind of same baggage that Western vaccines seem to have within China. But you know, it's quite uncertain. But we still think that's going to take some time to manufacture in significant quantities to use as part of their kind of therapeutic solutions. You know, overall, you're we're still pencilling in a change maybe not happening until kind of autumn next year. So essentially, we'll have had four years of China being locked away from the rest of the world.

 

Luke Bartholomew  14:00

Brilliant. And turning back to you Neil. We've talked a lot about Xi and to coin a phrase his thinking. But of course, we also had a new Politburo Standing Committee appointed. So is there anything to learn in the composition of that committee and the particular backgrounds that the individuals that were chosen have come from around where China's policymaking might go from here?

 

Neil Thomas  14:22

The most important thing about the backgrounds of the new Politburo Standing Committee members is that they are all political allies of Xi Jinping. So Xi 'sweeps' the Politburo Standing Committee to use a sporting term. And he really has consolidated a position at the top of Chinese elite politics that we haven't seen since the Mao era. I mean, if we look at the factoral composition of every Politburo Standing Committee, going back to the earliest years of the reform era, no paramount leader has this preponderance of people who are clearly 'theirs' in a political sense. So the main message from the composition is that Xi really is large and in charge in China's internal politics in a way that is only increasing. So these kinds of rumours and analyses that have emerged in the last couple of years. And there's different pushback from premier Li Keqiang or other factions associated with former leaders, like Hu Jintao or Jiang Zemin really is no longer credible. And we had an account in Xinhua, the state news agency about how the new leadership bodies were selected. It's done through a system of interviews and investigations, it's led by a Xi Jinping that happened five years ago, and that helped him consolidate his power to an extent at the 19th Party Congress. But unlike five years ago, this time, Xi did not talk to any party elders as part of the process and there was a much smaller circle of people he consulted. So he did 30 interviews himself rather than 57, five years ago. So that the message really is that Xi is at an even greater level of power than he was previously. And I think the message for policy there is, and in some sense not completely negative in the sense that we're unlikely to see that many surprises in terms of strong policy pivots to what's expected. Whether those policies that are existing the moment are good is a different question. But continuity in Xi's agenda, at least is the overarching theme, if you like of the 20th Party Congress from a policy perspective.

 

Luke Bartholomew  16:44

So outside of those overarching themes, I guess, one interesting little side story was that the Q3 GDP report sort of went missing in action in the sense. It was released rather later than was expected. So, Bob, firstly, is there any signal to take from that delayed report? And then I guess the other thing to say about it was not only was it delayed, but it was potentially a little bit stronger than most analysts were expecting. So if I might put this bluntly, should we believe that report at all?

 

Bob Gilhooly    17:15

Yeah, I mean, you could potentially think of this delay to GDP as being a little bit emblematic of GDP growth, kind of falling down the list of priorities. But I think the real reason for the delay, is the authorities just didn't want it as a distraction to the Congress, after all, it was basically guaranteed to show that the government's growth target of around about five and a half percent for the year was not going to be met. And even after the strong Q3 figure for GDP, it's like the annual GDP for 2022 is going to be about two percentage points short of target. And there's just simply no plausible sequential quarter on quarter growth rate for Q4 that can actually get you to the growth target there. In terms of do I believe that Q3 number? I mean, yes, it was very strong. If I was to pull my punches slightly, I'd probably say it was on the high side of plausibility, if not actually, somewhat beyond it. Of course, you know, refuting the figure published by the NBS is effectively almost impossible. Those constructing alternative measures are of course, relying on figures published by the NBS and other Chinese government agencies, which kind of raises the question of why do you believe some figures over other figures? One approach, though, is to consider the distribution of indicators adjusting their average rates to match GDP. And then you can kind of see whether the mass of these indicators is centred on, above or below GDP. And at the moment this and slightly more complex methods, such as principal components, would suggest that Q3's recovery was less impressive than the headline kind of official GDP number would have you believe. So I'm a bit of a sceptic, for this quarter.

 

Luke Bartholomew  19:03

So looking beyond just sort of the quarter to quarter, whether this particular report was more or less credible, and in terms of China's growth over the next year or so - we've talked about zero COVID being one of the elephants in the room that didn't get a huge amount of attention at the party congress, I suppose the other big elephant is what's going on in the Chinese property sector at the moment and the attempt to de-risk that sector? So I guess the question is, even if the authorities can succeed in de-risking that sector without any sort of systemic crisis, can they still rely on it as an engine for growth over the next couple of years in a way that it perhaps has been recently?

 

Bob Gilhooly    19:44

Yeah, I'm thinking that near term it's going to be pretty hard to avoid a drag from the real estate sector. The pipeline of activity has fallen very dramatically. New starts are down around about 45% on a year ago, land bought by developers is around about 60% down. So that kind of pipeline of new builds shrinking so rapidly will weigh on growth by the flow of investment, given lags between construction breaking ground and then housing completing. A bigger question was probably kind of more of a long run one. And I think here, it's increasingly hard to believe that the fundamental drivers of real estate are going to remain as strong as they have in the past. So on the one hand, your urbanisation process, upgrading the housing stock, should imply demand should remain reasonably robust, if not quite as strong as it has in the past. Chinese urbanisation rate should be able to rise about 10 or 15 percentage points. It's also been estimated by the UN that kind of your slum housing maybe makes up around about 25% of urban areas. To put another way, that's a lot of knocking down and rebuilding still to come within China. But on the other hand, and you know, while there's a lot of uncertainties about the Chinese economy, the data and the state of the real estate sector, we do know that demographics are shifting and these trends are largely baked in. 2022 is actually the first year of population to climb and demand for new housing will eventually trend down and ultimately turn negative as the population decline accelerates over the course of this century. I mean, there is, of course, always a risk of taking any snapshot out of context. After all, there are many ghost cities, which have subsequently been filled up in China. But you know, our modelling implies that housing inventory probably began to accumulate quite at an alarming rate after 2010. By 2021, the housing stock may have stood around about 560 million, I suppose 60 million higher than our model of housing formation would have implied. You know, that's roughly equivalent to the entire expected household formation out to 2045. Taken to the extreme, you could read that, as seeing developers entirely front run the urbanisation process. I think that's probably too extreme a reading though. Some degree of vacancy should be expected, the excess vacancy rate's probably likely to be much more modest. But I think it still implies that to stop vacancies exploding, new starts, and therefore real estate activity, real estate's contribution to GDP, need to continue to slow and we think new starts will probably half over the next five years to kind of stop that balance from widening.

 

Luke Bartholomew  22:31

So the big policy shift on housing was one of several significant regulatory shocks we saw from China over the last few years, and  also in the education sector and technology sector. So Neil, turning back to you and given everything we've said about the consolidation of power around Xi does that make the sort of big regulatory shocks more or less likely? And the sort of the way I'm coming at that question is, in one sense, if there's this consolidation of power, maybe it's less opaque the decision making process, and he's been very clear about his thinking around everything that we've talked about so far. But then equally, if there are very, very few sort of checks and balances to use that American phrase on policy making maybe that means that there's more scope for sudden and dramatic, violent shifts in policies? So how should we think about the consolidation of power in that sense?

 

Neil Thomas  23:23

I think on balance, this new maximum Xi orientation of Chinese politics does increase political risk across a few dimensions. So you know, Xi's views and preferences at the top are less likely to encounter substantial pushback, or, you know, even discussion, perhaps, and, you know, top decision making bodies that he now dominates are just full of his loyalists. Because I mean, the message emerging from the Congress really is that supporting Xi's leadership, and his policy agenda is what matters for your career as an official in the Chinese system. So we're unlikely to see a repeat of the slightly more pro-growth messaging for example of Premier Li earlier this year, whilst he was implementing Xi's zero COVID policy. And now Xi's decisions are also less likely to be reversed, in my view, you know, as policies that are passed or increased identified with his leadership and his power, there's not really a fall guy that Xi can pin things on. He has to start targeting his allies if things get wrong. He can't point to Premier Li anymore and say that economic growth is his responsibility. So if things are going wrong, you know, blame him. It's going to be more difficult to turn around the ship and I think zero COVID policies are perhaps a good current example of that. And you know, we've seen turnback before. The proposed property tax trial was shelved late last year, financial reforms that ended up disrupting the domestic market in 2015/16 were wound down and changed. So those types of adjustments are probably going to become not impossible, but less likely going forward. And then the other kind of more immediate concern, perhaps is that the loyalists that Xi is putting in some of these top jobs say, Li Qiang the new Premier has a lot less experience especially with central government positions than their predecessors. So the experienced economic managers that Xi's had in top administrative positions in his first two terms, that kind of team of technocrats is gone. There are still a lot of technocrats at the top in the Politburo, but the people who are likely to hold the top economic policymaking decisions so Li Qiang as Premier, Ding Xuexiang a key Xi aid in as the Executive Vice Premier, no experience in the State Council or economic policymaking He Lifeng the new Liu He on as Vice Premier on the State Council, on the Politburo, he's a local party boss, basically he's a politician. He's not the economic expert and technocrat that Liu He previously Xi's top economic adviser was. So there's this range of different factors, you know, less pushback, less walkbacks, and less experience at the top. And I mean I think the overall quality of economic governance is likely to decline. But in terms of the potential for kind of overnight crackdowns, like we saw on the education sector, last summer, that kind of started the common prosperity era, I think that's going to remain more of an outlier than the norm. I think there was some learning in the system at just how disruptive and counterproductive that was. And Xi's made the point very strongly to the tech sector, and really, to the private sector more generally, that the party is in charge. And if you want to make money in Xi's China, you have to toe the line on his major policy priorities. So I think, you know, less shocks, but overall, it's still not a good news story.

 

Luke Bartholomew  27:13

So Bob, one final question for you then. And we've talked how China is potentially coming, a bit more insular. But it would be helpful, I think, to put China in a global context at the end of this conversation. And we are of course forecasting a global recession next year. So what scope is there for China, both itself to use policy levers to push back on any spillovers from a global recession? And then in turn,  how much should the rest of the global economy expect Chinese policy easing to boost global growth?

 

Bob Gilhooly    27:51

Yeah, I mean, I guess the kind of good news here is that unlike much of the rest of the world, in particular, in the US and Eurozone, China's inflation remains very low. So you know in that sense, it won't be constrained in its ability to deploy timely counter cyclical policy. There's also a few features of its economy such as its financial system remaining relatively closed, which you know should help insulate it from worsening global financial conditions and largely state owned banking system. So it provides that very strong policy lever to pull should the authorities really want to ramp up stimulus very aggressively. I mean, so we do still think though the sequential growth in China is going to take a knock, we don't think they can avoid technical recession. So that's two negative quarters of growth, which will probably hit many other economies around the world. You know, it's a difficult one to know how much this kind of global shock is going to hit China. Modelling spillovers from other countries recessions is always tricky. For one thing, China's undergone massive structural change over the last 30 years, which modelling may fail to fully capture. Models also implicitly embed a policy reaction within them and China pulled out all the stops after the global financial crisis. There's a risk here that models may have actually kind of erroneously assumed spillovers are largely offset this time too, but given all the policy debate we've been having today, we seem to place a bit less emphasis on growth and more on kind of mitigating risks. I think this suggests that China's reaction to global recession is going to be much more tempered. They're going to be wary of building up the sort of financial stability risks that were associated with their massive credit policy after global financial crisis. And as a result, I just don't think we should be expecting China to bail out the rest of the world by launching a massive stimulus as they have done in the past.

 

Luke Bartholomew  29:59

Brilliant. Thanks. Bob so that is all we have time for today. If you enjoyed the podcast please do subscribe and like us on your podcast platform of choice. And all that remains is for me to thank Neil and Bob for their excellent contributions today and thank you all for listening. So thanks very much and speak again soon. 

 

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for informational purposes only, and should not be considered as an offer, investment recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication, and do not necessarily reflect those of abrdn. The companies discussed in this podcast had been selected for illustrative purposes only, or to demonstrate our investment management style and not as an investment recommendation or indication of their future performance. The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested. Past performance is not a guide to future returns, return projections or estimates and provide no guarantee of future results.