When Chinese President Xi Jinping arrived in power in 2012 he was going to progressively liberalise the Chinese economy and integrate it more fully into global markets. However, the reformer has now secured a powerful grip over the communist party apparatus and has made clear his wish to be the dominant governing force for years to come. That is not quite what his western fans had in mind when they praised him in his early days. Is it time to reappraise the apparent reformer?
There’s no doubting the scope of Xi’s ambition for his country. He wants to lead China away from the industrial and export-led model of growth he inherited, with much more emphasis on services and consumption. Like his predecessors, he is keen to acquire the best technology from around the world, and has the money to buy some of it, but the US still thinks China “cheats” over intellectual property.
President Xi wants Chinese living standards to rise at a decent pace, and has adjusted expectations down from 10% growth to around 6% growth without any obvious difficulties. This is still a good pace of improvement, given how much larger and richer the economy now is. He has led a big drive to improve the Chinese environment, which has been much damaged by the rush to industrialisation.
The new silk road
His long term vision is the Belt and Road initiative, which has been dubbed the Silk Road Economic Belt. China is making a series of investments, alliances and partnerships half way around the world from the east to the Middle East and on to Russia. The country is also busily acquiring a lot of scarce and important mineral resources, and gaining strategic positions in important transport hubs. At the same time, China is expanding sandbanks and atolls in the China Seas into islands that extend Chinese territorial controls. The country has embarked on the construction of a much more powerful military, capable of acting well beyond China’s borders.
However, there remains an issue with democracy. When Xi first came to power there was talk of some greater introduction of democracy, with a possible greater choice of candidates for local elections. That strand of thinking is no longer popular. President Xi has, however, moved some way to free the market in the yuan and in Chinese shares, with the two-way interconnector from the mainland markets into Hong Kong. Later this year, a connector is expected to be introduced between the London-Stock Exchange and Shanghai, trading a limited amount of shares. This means a little bit more of corporate China has been exposed to global price formation and criticism.
The reform programme and the sustained growth has been a sufficient backdrop to sustain a bull market in Hong Kong shares, which have done well again over the last year. As more of Chinese industry gets a listing, and as the links between the mainland exchanges and Hong Kong get stronger, so more international investors are likely to overcome their objections and see China as a regular part of their investment portfolios.
The path to such liberalisation will not always be smooth, given the nature of the regime. We saw how managed capitalism in China can be badly mismanaged with the gyrations of the domestic stock markets in 2015. The authorities encouraged a bull market by telling people to buy shares, only to undermine them when they thought it had gone too far. A frothy bull market was turned dramatically by curbing speculation and banning broker loans to clients. The government lost control of the market in both directions, disliking the extent of the rise and then worrying about the speed of the fall.
The events of the last few years have shown that President Xi is indeed a talented and capable leader in a new mould. But markets now have to adjust to the truth that he has gained more power than his predecessors and has now displaced the ten-year period in office with its planned succession system in the leadership. For the time being, he may well be at the height of his powers and able to get more right than he gets wrong.
However, his actions have increased China investment risk quite considerably. We are relying on his judgements, and the leadership team around him is likely to be more sycophantic and less challenging and collaborative than under the old system.
Trump trade wars
Meanwhile the stage is set for a further chapter in the story of how President Xi gets on with President Trump. So far, Xi has seen off US flirtation with a more independent Taiwan by being very firm, and has taken the edge off US anger over trade by being helpful over the value of the Chinese currency. This is all about to be tested more with the US report into alleged intellectual property theft. Mr Xi will want to be a successful advocate of no new trade restrictions worldwide, whilst keeping as much of China’s special deal as possible.
China is now in a dominant position in many sectors, including the now topical steel and aluminium markets. China produces half the world’s steel and is the main producer of aluminium. The new strategy is showing that, like the US, the country can exploit the new digital technology through the huge growth of companies such as Alibaba and Tencent.
President Xi came to power wanting to move China away from producing cheap industrial materials and products for export into a more rounded and richer economy, with more coming from services and higher-value-added activities. This was given greater urgency by a political imperative. Chinese air quality had fallen to very low standards in many of the cities, as coal home boilers, combined with huge industrial plants and more diesel vehicles, cloud the air with dangerous particulate matter. From 2014 onwards the Chinese authorities have been making air-quality improvement an overriding priority.
This winter, new curbs were introduced to cut the particles. Construction was stopped on many urban sites. Steel and aluminium, bricks and pottery plants were closed for the winter or permanently. Gas replaced coal in some power stations, and people were put under pressure to stop using coal boilers in their homes. There is evidence that the last four years of a tougher environment policy has registered a material improvement in air quality in major cities.
Cleaning up its act
China is trying to eliminate substantial surplus and dirty capacity in steel and aluminium, two areas targeted for special tariffs by the US. Doubtless there will be more closures. There is also quite a programme of new plants going in at the same time. China does not wish to cease being the world’s main producer of these industrial sinews, and has a strategic view that it needs control of resources like steel and aluminium for weapons production amongst other things. The country is moving over to coastal location larger more modern plants, whilst closing smaller older dirtier plants in cities.
The Chinese government needs to shut old capacity at a pace people find acceptable. Air quality gives them their best reason to do so whilst keeping many more people onside for the job losses and disruption this causes. It will need to allow the markets to tighten and prices to rise for these products to contain the US trade retaliation. It is possible the regime can tread this difficult path in the months ahead as it has successfully done in the months past. It is going to get more difficult, as it looks as if the US pressure is about to go up. This is probably a negative for Chinese shares, which on the Hong Kong exchange have just had a great year. Only when the skies are reliably and truly blue over Chinese cities will these trade clouds lift.
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