The real estate game is all about “location, location, location.” The economic reform equivalent of this old maxim is “timing, timing, timing.”
It’s here where economists worry Chinese President Xi Jinping may have erred. His bold moves to regulate sectors from technology to education and end China’s reliance on real estate are looking spectacularly ill-timed.
That, combined with power shortages, surging oil prices and fresh Covid-19 risks, is turning the tables on the 2022 China planners likely expected.
The year ahead is crucial to Xi’s top-line plan to secure a third term as Communist Party leader, a first for China. The odds very much favor Xi securing that legacy. Odds are, too, that retail sales trends in China are robust enough to produce faster growth than the US and Europe.
Yet Xi’s dueling clampdowns are generating headwinds at the very worst moment.
First, the bull case on Xiconomics. As Bank of America strategist Ajay Kapur points out, there were times in the 1980s and 1990s when it seemed Beijing’s reform drives were going awry.
That includes then-Chinese leader Deng Xiaoping’s modernization push of the late 1970s and early 1980s. It includes former Premier Zhu Rongji, who shook up state enterprises.
It was Deng who opened the economy; it was Zhu who tuned its engines to compete in the globalization age. China’s No 2 official from 1998 to 2003, Zhu guided Beijing into the World Trade Organization. He accompanied that accession with a forceful reckoning for the bloated, inward-looking state sector.
The putsch shuttered some 60,000 state companies and eliminated 40 million-plus jobs. Though Xi’s crackdowns on tech, education and other sectors aren’t yet causing mass unemployment, it’s the most aggressive shock to the system since Zhu’s time controlling the wrecking ball.
The plot thickens
The question, says BoA’s Kapur, is whether history looks back favorably on this 2020-2021 period as a once-in-two-generations economic restructuring. “If so, the data flow from China could confound even the pessimists, and we are on guard for that scenario unfolding,” Kapur says.
Economist Dan Wang at Hang Seng Bank notes that the fact China’s “slowdown is predominantly policy-driven” thickens the plot somewhat. Beijing, he says, may be “willing to make the trade-off” between rapid GDP and retooling to put the economy on a more productive path.
It’s entirely possible, says Zhou Hao, economist at Commerzbank AG, that “the fourth quarter of this year and the first quarter of next year might be the bottom of the current economic cycle.”
This, not surprisingly, is the take at the People’s Bank of China, despite the China Evergrande Group default drama preoccupying world markets.
As Zou Lan, a director at the central bank, puts it, financial liabilities from the globe’s most indebted property developers make up less than one-third of its total liabilities, “and the creditors are diverse.”
The bottom line, Zou notes, is “individual financial institutions are not at high-risk exposure to Evergrande. Its spillover risks on the financial industry are overall controllable.”
Yet what if China’s slowdown is less controllable than hoped? Economist Lu Tong at Nomura, for example, thinks China’s gross domestic product (GDP) will fall to 3% in the current quarter and enter 2022 at a similar pace.
Though comparatively better than most other major economies, that’s half the pace Xi’s men targeted for this year. It’s quite a ways from the growth rates needed to create tens of millions of jobs to maintain social stability. And it’s a long way from the 8% the International Monetary Fund (IMF) expects from the No 2 economy.
Worse, says economist Shen Xinfeng at Northeast Securities, China might right now be sliding toward “quasi-stagflation” as imported price increases collide with slowing growth and weakening employment conditions.
All this makes for quite a difference from March, when Premier Li Keqiang assured the globe that growth would end 2021 “above 6%.” Even that level, of course, was a concession to markets. For years, businesspeople, investors and national leaders abroad had counseled Xi’s party to grow better, not just faster.
A structural shift
The last 24 months saw Beijing prioritizing just that. Xi’s men began with moves to tighten limits on leverage and rein in China’s $10 trillion shadow banking system. Efforts to convince the globe that China was championing financial stability and environmental sustainability over runway growth were paying off.
During that time, says analyst Lauren Gloudeman at Eurasia Group, it became clear “credit is undergoing a structural shift in composition, from shadow banking growth to loan growth and from property sector loans to small business and ‘common prosperity’ agenda support.”
Gloudeman notes that “if property risks, low consumption growth and lackluster local infrastructure activity further undermine economic growth in the coming months,” the central bank “will likely push through a stronger easing package.” In general, she adds, the emphasis has been on policy restraint.
Then came the Covid-19 crisis. China did a solid job containing the pandemic and then generating a recovery. Yet Xi may have botched the endgame by launching a highly disruptive crackdown on China’s biggest tech tycoons.
The inquisition started with Jack Ma’s Ant Group. In early November 2020, the Alibaba Group founder’s fintech giant was about to pull off history’s biggest initial public offering. The $37 billion listing was scrapped. In the months that followed, Alibaba, Tencent Holdings, Didi Global, Baidu Inc and myriad other tech firms also were getting called in for a talking-to.
Diana Choyleva at Enodo Economics puts it well when calling this “an unprecedented economic transformation” as Xi pursues a “common prosperity” doctrine the world is struggling to fathom. The bottom line, Choyleva says, is “we recommend betting against well-off urban consumers. They’ll be hit hard by Xi’s drive against inequality” and any resulting losses in popular wealth management products.
The odds are, things will get worse before they get better, says analyst Kelvin Ho at Fitch Ratings.
“We expect regulatory risk in China’s internet sector to continue to evolve and remain high, as the Chinese government has made antitrust enforcement a priority in its new five-year plan,” Ho says. “In addition, we expect more government intervention in various internet segments to rectify what it considers unhealthy content and behavior on the internet.
“New and tightening regulations will squeeze the sector’s revenue and profitability. Compliance costs may increase, too.”
All this has left all too many foreign investors aghast – and grasping at possible explanations both for Xi’s game plan and exit strategy.
This uncertainty was already spooking markets when supply-chain disruptions tripped up global growth. And it collided with surging energy prices fanning inflation and imperiling China’s recovery hopes.
Plans to implement power rationing are sure to hit GDP. Strict maneuvers, Barclays Research analysts argue in a recent report, could reduce economic growth by anywhere from 1 to 3 percentage points.
Coal and carbon emissions
With less than three months left before year end, “we think it will be very difficult to achieve the ‘dual-control’ target this year,” they write. “We think the government is likely to adopt a more flexible approach to its targets especially given already slowing growth and a potential for a colder-than-usual winter.”
It remains to be seen if there’s a silver lining to the energy price surge. Increasing coal supply indefinitely isn’t an option. Not with virtually all governments agreeing on the need to reduce carbon emissions.
That, argue analysts at Morgan Stanley, means China and the rest of Asia must ramp up investments in renewable energy. As of August, the bank says, China was routing roughly 69% of all investment in electricity generation investment into wind and hydropower.
“Hence,” Morgan Stanley analysts argue, “we anticipate that investment in renewables will continue at a steady pace in the coming years. The recent emergence of shortages should provide an additional incentive for local governments to accelerate their plans.”
There’s also the risk that US-China relations will deteriorate further. President Joe Biden has been slow to remove the trade tariffs implemented by predecessor Donald Trump.
In his new book The Wires of War: Technology and the Global Struggle for Power, Jacob Helberg argues: “The spoils of this war are power over every meaningful aspect of our society: our economy, our infrastructure, our ability to compete and innovate, our personal privacy, our culture, and subtle daily decisions we make based on information we interact with online.”
In Xi’s case, there’s concern that a top-down campaign on tech, on top of the trade war, will stymie the development of innovation from the ground up too as promising startups avoid the limelight. And that the timing of this disruption is creating even more headwinds at the very worst moment.