On October 18, China will kick off its 19th National Party Congress. That might sound boring… but for China watchers – and since China is the most important country in the continent that’s the engine of the global economy, pretty much everyone should be watching China – it’s like a state fair, a political nomination convention, Comic-Con festival and Golden Week all rolled into one.
[REITs]That’s because this twice-a-decade Communist Party meeting will determine China’s top leadership for the next five years. And in an economy that is still heavily influenced by the state, the priorities and approach of the guy (and it’s always a guy) at the top is hugely important.
For investors, the Chinese government’s plans can be a blueprint for where to focus your attention – and cash. I’ve often heard Peter say that when the Chinese government makes up its mind to do something (whether it’s building massive new infrastructure projects or hosting the Olympics), it gets done. And, as investors, we can make money by knowing what the government says it plans to do, and getting in front of that wall of money.
China is big
And let’s not forget… with a GDP of US$11.2 trillion, China is already the world’s second-largest economy (it will soon be the largest), and the second-largest stock market. The country will also soon have the world’s largest middle class with over 550 million people by 2022. To put this in perspective: That’s 1.7 times the entire population of the U.S.
China is also becoming a leader in globalisation as the U.S. turns inward. Through its One Belt One Road (OBOR) initiative, China is developing infrastructure across 60 countries. So China will soon have strategic interests across a huge swathe of Africa, Central Asia and Eastern Europe.
So what happens in China matters – a lot – to the global economy, and to investors everywhere.
So what could happen?
President Xi Jinping and Premier Li Keqiang are expected to stay on for their second terms. But at least 11 of the 25 members of the Politburo (see below) could retire due to their ages. And five of the current seven members of the Politburo Standing Committee could retire.
The Politburo oversees the Communist Party. But the real power remains with the senior members of the Politburo Standing Committee. This committee conducts policy discussions and makes decisions on major issues when the Politburo is not in session. In short, the Politburo Standing Committee is the most powerful decision-making body in China.
The Standing Committee used to be nine people – but under Xi it has only been seven. The positive is that it focuses decision making and the ability to get things done. The negative is that it concentrates power in too few hands, leading to less diversity of thinking.
And it’s widely expected that Xi will seize this opportunity to promote his allies into Politburo and Politburo Standing Committee positions. This will consolidate Xi’s power, and allow him to more easily implement his long-term strategies and reforms. (But too much power in too few hands – in any political system – can be dangerous. It also doesn’t promote new or different ideas.)
So what are Xi’s long-term plans? He’ll likely focus on three main things.
Controlling financial risks – and easing the transition
Xi’s overall objective is to maintain “stability” – this covers just about everything – stable economy, currency, financial markets, the banking system and social conditions.
Many analysts believe Xi will focus on China’s systemic financial risks and facilitating China’s transition from a manufacturing to a services economy.
In an effort to keep economic growth up over the past few years, China has taken on a lot of debt. Since 2007, it’s estimated that China has added US$24 trillion in debt at all levels. For comparison, that’s more than the U.S. government’s total debt of around US$20 trillion. (This is a lot… but it’s not going to sink China’s economy, as Peter explains here.)
And note that this is China’s TOTAL debt – public, corporate and household. The U.S. figure is PUBLIC debt… so comparing the two is not comparing apples with apples.
Still, Xi’s primary objective will be to rein in debt by local governments and loss-making state-owned enterprises (SOEs). Reducing the country’s target economic growth rate, below 6.5 percent – which is still astonishingly high for an economy the size of China’s – should also help reduce debt, as the pressure to generate growth has helped fuel the debt load.
We will also see a slow but continuing reform of SOEs, with many smokestack SOEs being closed, merged or wound down… in industries like coal, power, steel, aluminium and cement.
And to help the transition to a more sophisticated economy, Xi will also likely funnel money into the advanced manufacturing, technology and agriculture sectors… while moving resources out of the coal and steel sectors, and other “old economy” segments.
In short, we might see China’s economy continue to slow down in the years ahead (which is in any case a mathematical certainty). In the meantime, investment in China’s advanced manufacturing, technology and agriculture companies could ramp up.
(Part of the puzzle is to figure out who benefits as China leaves behind some industries and focuses on others. One example is in ready-made garments (that is, clothing), where China is by far the world’s largest producer. As labour costs have risen in China, other countries – with lower labour costs – have picked up the slack… like China’s neighbour Bangladesh, which is the world’s second-largest producer of garments. I went there last week to learn more about this incredibly dynamic economy that is practically invisible to the investing world.)
Structural reforms and economic rebalancing
The next item on Xi’s agenda will be focusing on advancing structural reforms in social welfare and economic rebalancing.
Political risk consultancy Eurasia Group (where I used to work) thinks that during his next term, Xi will push policies on healthcare reform, pension reform, fiscal reform (such as tax collection) hukou reform (China’s governmental household registration system), poverty alleviation and other initiatives that help the social safety net.
These reforms should help China’s urbanisation efforts, and also support growing consumer demand.
Xi could also push through reforms to create more transparent capital markets, streamline business approval procedures and lower fees and taxes.
And he could open sectors like financial services and health care to private domestic and foreign capital. This would help Chinese companies access capital and technology. And exposing these sectors to competition could help boost productivity and efficiency.
On a related front, the environment is also a critical issue for China’s policymakers. Pollution isn’t only a question of health – it’s also a political priority.
Selective support of state-owned enterprises
Finally, Xi will likely double down on promoting a strong role for SOEs. Xi has long considered SOEs as “national champions” that advance political objectives. So he’s unlikely to reduce the role of these enterprises. That means that SOEs in the telecommunications, oil and gas, power generation, transportation, railways and nuclear power sectors will continue to benefit from strong domestic positions – and from state-promoted investment through the OBOR initiative.
However, Xi may try to inject private capital into these businesses without ceding state control. And not all SOEs will continue to receive state support. “Zombie” enterprises in the mining, auto, textile, chemicals, cement and steel sectors will continue to have their lifelines slowly removed. The idea is to cut production and make the survivors more efficient and more market oriented.
To sum up, we can expect China to aim, above all, to maintain stability. It’s going to focus on managing its debt – while continuing its transition to a services economy – with social and fiscal reforms in the years ahead. This should lower the risks of China seeing a recession. It also means China will continue to invest in its SOEs and infrastructure and technology sectors.
Good investing,
Kim Iskyan
Publisher, Stansberry Churchouse Research
