Market Outlook: China’s reform process to accelerate

Ollie Geibel/REX/Shutterstock  China’s government faces various challenges, from dangerously high air pollution to the economic repercussions of the One Child Policy

If you were to ask experienced chemicals company sales and marketing executives who are based in China – and are very often from China – about the market, they would likely tell you not to view China from the perspective of western capitalist market economics. If you do so, you’ll end up once again getting the country entirely wrong – these executives have witnessed several 
cycles of wrong analysis.

Back in the late 1980s, they rightly dismissed the notion that China’s economy was going to collapse as a result of political unrest.

They were equally sceptical of claims that Deng Xiaoping’s economic reforms of the early 1990s – only a gradual opening-up of the economy – could not possibly work. Deng was one of China’s greatest political leaders.

In a post-Cold War world, many western analysts were too quick to assume that only one economic system was viable – outright, unfettered capitalism – because of the triumph of the west over the former Soviet Union.

China instead found its own way to strong, sustained economic growth. This was largely thanks to Deng’s measured opening-up of the economy, with the Communist Party remaining firmly in control.

Today, though, these same executives admit the outcome of China’s current raft of reforms is far more uncertain that in the 1990s. What makes future success so much harder is the scale of the economic, social and political imbalances that built-up in the early 2000s, particularly during the 2009-2013 economic stimulus programme.

MORE, NOT LESS, CONTROL

No matter how you crunch the numbers, China is burdened with debts that have historically always led to economic crises when they have occurred at these levels in other countries. This is mainly the result of over-investment in real estate and manufacturing capacity.

Add to this the challenge of creating a new growth model that is environmentally sustainable, and you really start to worry.

It is widely recognised as being socially, politically and economically impossible for China to carry on polluting its air, water and soil at today’s levels. No country or region of the world has ever faced an environmental crisis on this scale before. There is also the dilemma of how to deal with a rapidly ageing population.

Because of the One Child Policy, China is at risk of becoming old long before it becomes a fully developed economy.

It is thus in a race against time to create sufficient higher-value manufacturing and service industries that justify higher wages resulting from an ageing population.

Wages have gone up rapidly over the last decade as the growth in the working population began to slow down. Now the working population is actually shrinking.

There is another connected problem. China has to raise enough tax revenues to pay for higher health and pension costs that are another consequence of a greater number of elderly people. The only way it can generate these revenues is by successfully moving into higher-value manufacturing and services.

Press Association President Xi Jinping may continue to strengthen his economic reform agenda

Where Western analysts may again have gone wrong is their proposed solution to all of these dilemmas, according to the chemical company executives.

“Just as happened in the 1990s, they are saying that China needs more capitalism and less state control. Too many analysts think that the free market is the answer,” said one of the executives.

“This is somewhat ironic given the mess that the US and European economies are in, thanks to the unregulated capitalism that led to the global financial crisis,” he added.

What instead might prove to be the right formula for success in China is more, rather than less, central government control. And the role that China’s president, Xi Jinping, can play in exerting this greater control could end up being crucial.

Xi has been consolidating power ever since he first came into office in 2013. This has placed the president and his fellow reformers in a position to accelerate economic reforms.

He has boosted his authority partly by sticking with an anti-corruption campaign, unlike his two predecessors who also launched but then quickly abandoned their own anti-corruption efforts, according to a 25 July article in the Financial Times. The anti-graft programme has proved hugely popular.

THE SIGNS TO LOOK OUT FOR

In sticking with his anti-corruption programme, Xi has built-up tremendous popular support. The campaign has also removed from office many of the officials who would have blocked the main phase of his reform programme. Over the last 12 months, Xi has further cemented his position through increasing the influence of “leading groups”, added the same Financial Time article.

These reformist policy-making government groups are said by several commentators to be pushing the State Council – on paper the top legislative body in China – more firmly in the direction of reform.

State media has openly discussed the greater role of one particular leading group – the group that covers financial and economic affairs. Pressure from reformers seems to have been stepped up even further over the last few months.

A 9 May “People’s Daily” front-page article – reportedly penned by Liu He, who runs the leading group on financial economic reforms – included the following comment on China’s debt levels: “A tree cannot reach the sky. Any mishandling [of the situation] will lead to systemic financial risks, negative economic growth and evaporate people’s savings. That’s deadly.”

The “authoritative figure” who officially wrote the article added that China’s economic recovery would be L-shaped rather than U-shaped or V-shaped – and that Xi’s reforms had to be implemented. The 9 May article is seen as important in that it helped warn everybody that more reforms were on the way, while also heavily criticising those who have opposed Xi’s economic vision.

These opponents are said to have been behind both the failed attempt to prevent the collapse of China’s stock markets last year and the sharp rise in bank lending during the first half of 2016.

Too much of this extra credit is thought to have flowed to the real-estate sector, re-inflating the property bubble. A great deal of lending has also reportedly gone to servicing the existing debts of state-owned enterprises (SOEs), where the overcapacity burden is the greatest. Meanwhile, private companies remain short of finance.

It is the private companies that are seen as key to economic reforms, as they are generating more innovation than the SOEs in manufacturing and services than the public sector.

WHAT HAPPENS NEXT?

What should chemicals companies monitor as they attempt to assess whether nor not all the talks of more reforms has translated into firm action? A clear indication that Xi is playing his stronger political hand would be fall in credit growth during the rest of 2016 and into next year.

If evidence also emerges of more lending flowing to private businesses, and less to the SOEs, we will also know that reforms have gathered pace.

Another indication of the willingness to tackle China’s challenges now rather than later would be more job losses through capacity being rationalised in oversupplied industries. This could lead to lower economic growth. Will Xi ultimately be successful? Nobody knows, and so you have to plan for all eventualities.

The problem is that if Xi’s reforms fail, it is hard to see how China can produce an alternative sustainable new economic growth model.

Key facts

SIGNS OF XI JINPING’S REFORM AGENDA

• Fall in credit growth during the rest of 2016 and into next year
• More lending flowing to private 
businesses, and less to the SOEs
• More job losses through capacity being rationalised in oversupplied industries