INSIGHT: China politics raise global concerns

21 September 2012 16:33  [Source: ICIS news]

By John Richardson

China waits for political handoverPERTH (ICIS)--Politics dominate China at the moment as the country prepares for its once-in-a-decade leadership transition. 

Beijing is so wrapped up in the leadership issue that it doesn’t have the time and/or legitimacy to adequately deal with major economic problems, suggest some commentators.

“Because China’s current senior politicians are about to step down, they don’t feel able to take any major policy initiatives on behalf of their successors,” said an Australian-based resources consultant.

It would be comforting to believe that the political handover will soon be completed.

But an early August meeting of party leaders at the Chinese seaside resort of Beidaihe reportedly failed to resolve differences over who should hold power.

This could mean a delay to the completion of the handover process well into next year.

"The current political malaise is likely to carry on for another 6-7 months, maintaining uncertainty among investors," added the resources consultant.

It would be equally comforting to believe that the reformers will win control of China, resulting in a smooth rebalancing of the economy away from investment towards domestic growth and higher-value and more sustainable manufacturing.

But what if this doesn’t happen, given that politicians, executives at state-owned enterprises, and other well-connected individuals, have allegedly done remarkably well out of the status-quo?

For example, in February this year the Hurun Report, the magazine which publishes China’s “rich list”, estimated that the wealthiest 70 members of China's legislature added almost $90bn to their bank accounts in 2011.

If China fails to rebalance, there is a risk of a lot more wasteful investment, which would increase bad debts and cause more damage to the environment.

In reality, nobody really knows what China’s direction will be post-handover because of its opaque political system. As The Economist wrote in its 14 September issue, politics in China "remains an intricate and frustrating puzzle to be tackled with crude techniques and unreliable sources".

The other big political issue at the moment is the China-Japan dispute over ownership of islands in the East China Sea, which, say commentators, is connected to the leadership handover.

“China’s government is trying to deflect attention away from weak economic growth by allowing demonstrations against Japan,” said a chemicals industry executive

“I think that one of the underlying causes of the expression of anger against Japan is the sense among working-class people that they have lost out during China’s economic boom,” he added.

“The gap between the rich and poor has widened since the 2008-2010 economic stimulus package, and the cost of living for the average worker earning around $200 a month is a major issue. Property in China’s big cities remains way too expensive for most people.”

The executive worries that a miscalculation by either Japan or China could lead to military conflict.

“The US is obligated to side with Japan, and I think that most other Asian countries would take sides with the US.”

Meanwhile, while politics dominates, economic problems for China seem to get worse.

Manufacturing activity did, at least, stabilise in September after hitting a nine-month low in August, according to the latest HSBC manufacturing purchasing managers’ index (PMI). The PMI improved to 47.8% in September compared with 47.6% in August.

But a reading below 50 still represents a contraction and Qu Hongbin, HSBC’s China chief economist, said in a statement accompanying the release of the PMI: “Manufacturing activities remain lacklustre, thanks to weak new business flows and a longer than expected destocking process.”

“This is adding more pressure to the labour market and has prompted Beijing to step up easing over the past few weeks.”

Rising consumer-price inflation, and manufacturing deflation, might, however, make it hard for China to further reduce interest rates and bank-reserve requirements.

Concerns are also growing over the problems that the US Federal Reserve’s QE3 programme, and the European Central Bank’s bond-buying policy, could cause for China and other developing countries.

The recent moves by western central banks could result in China’s equity markets surging by 10-20%, as they are relatively undervalued compared with the stellar-performing US market, said international investor Marc Faber, in a 14 September Bloomberg TV video.

Faber made the point that the super-rich would search the world for undervalued assets, generating tremendous returns for themselves.

But he added that it was a "fallacy" that western central bank action had already or would in the future benefit the average person in the street.

In fact quite the reverse would happen, as the super-rich became even richer at the expense of everybody else - until the world economy collapsed, warned Faber.

For example, property markets could well take off again in China, as could speculation in chemicals and polymers, as all the hot money seeks strong returns.

China might face a tough choice: Either allow all this hot money to further inflate and distort its economy, or impose restrictions on the flow of overseas funds, said some observers.

Perhaps it might decide to "join the party" by launching a big new economic stimulus of its own, in an attempt to deal with its industrial slowdown, once the political handover is over, they added.

But this would mean living with inflation in excess of 5%/year. This would carry significant political risk - because of increased resentment over an even wider gap between the rich and the poor.

Read Paul Hodges’ Chemicals and the Economy blog
Bookmark John Richardson and Malini Hariharan’s Asian Chemical Connections blog

By: John Richardson
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