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Party Congress opens a new era for China

Progress on structural reform in China looks set to accelerate and be more far-reaching given the new composition of the leading seven-member politburo in the wake of the 19th Communist party congress and the First Plenum.

Progress on structural reform in China looks set to accelerate and be more far-reaching given the new composition of the leading seven-member politburo in the wake of the 19th Communist party congress and the First Plenum.

Six out of the seven members were as I predicted in my July report (Exhibits 1 and 2). The politburo now includes six reformers (Exhibit 2), adding to my conviction in July that structural reforms, including efforts to cut debt, will advance faster and deeper than many anticipate.

Exhibit 1: Prediction of the composition of the new politburoChina

Source: BNP Paribas Asset Management (Asia), as of 30/10/2017

Exhibit 2: The new politburoChina

Source: BNP Paribas Asset Management (Asia), as of 30/10/2017

The reform party in China has begun

Crucially, President Xi Jinping’s ‘core’ leader position was affirmed by congress with his political ideology – ‘Xi Jinping thought on socialism with Chinese characteristics for a new era’ – being written into the party’s charter. This has put his status on a par with those of Mao Zedong and Deng Xiaoping, the only other two leaders who enjoyed similarly distinctive recognition. It also suggests that Mr. Xi had garnered enough party support to carry out the structural reform mandate to achieve his ‘China dream’.

Mr. Xi indeed used the party congress to set the stage for extending his power in the years to come as he broke convention by not naming a successor. He does not have to remain as president after 2022 (the constitution bars him from doing so) to retain control. He could arrange an extended tenure in his positions as general secretary and chairman of the army, which would allow him to exert power behind the scenes.  Note that Deng Xiaoping did not retire from all his positions until he was 85 years old; Jiang Zemin served as general secretary for 13 years and as the army chairman for 14 years.

I do not agree with the view that none of the five new faces in the politburo would be young enough to serve as the next president. Mr. Xi’s protégé Zhao Leji is only 60. Another Xi supporter, Wang Yang, is 62. One of them may still be chosen as the next president even though they would not have 10 years of experience in the politburo (which is another convention for choosing the country’s president).

Mr. Xi has already broken some party conventions, so why not break this one also? Exactly how this will play out is uncertain. But it is clear that the party has endorsed the reversion back to ‘one-man rule’.

Implications for the economy in China

More reforms and debt reduction efforts will come at the cost of slower GDP growth. However, to achieve the goal of doubling per capita real GDP by 2020 from its 2010 level, China’s economy will have to grow by an average of 6.3% a year between now and 2020. Any downside risk of undershooting 6.0% growth would likely be met by a strong policy easing response.

Growth targets will become less important for China after 2020 as Mr. Xi’s ‘new normal’ growth policy focuses on quality rather than quantity. But the trend of industrialisation migrating inland (Exhibit 3) to exploit untapped resources should generate enough momentum to keep GDP growth at around 6.0% for longer than most observers currently expect.

Exhibit 3: Industrialisation migrating inland represented by Gansu, Guizhou, Qinghai, Shaanxi, Guangxi, Sichuan, Yunan, Henan, Hubei, Hunan, Jingxi

ChinaSource: BNP Paribas Asset Management (Asia), as of 30/10/2017

State-owned enterprise (SOE), fiscal and financial reforms, including debt reduction, all rank high on the policy agenda. The policy details will be finalised at the Third Plenum in late 2018, but we should not expect big-bang changes.

The state will continue to direct the marketisation of the system. There will not be much privatisation as Mr. Xi’s reform platform seeks to strengthen ‘state capital’ and increase SOE efficiency through capacity reduction and mixed-ownership programmes.

Creative destruction and debt reduction look set to intensify under the new politburo. Beijing has already started allowing zombie firms to exit in a manageable way. Systemic risk is expected to remain low under these circumstances, but localised financial risk and bankruptcies at the sector and firm levels could well rise.

Why no big-bang changes in China?

In my view, Mr. Xi’s power is still not as strong as most people see it. He failed to install his protégé Chen Min’er (and another reformer, Hu Chunhua) or keep Wang Qishan (his die-hard supporter) in the politburo. He kept the buro's size at seven instead of reducing it to five, as widely speculated. He also did not name a successor. All this, and other anecdotal evidence, might reflect Mr. Xi’s inability to negotiate with the elders to get his way.


Some observers argue that the lack of an heir-apparent indicates Mr. Xi’s strong hold on power as he has not ceded any of his authority. This may not be the case. In my view, it may reflect strong resistance to Chen Min’er being ushered into the politburo and naming him as Mr. Xi’s successor. What happens after his second term in 2022 has not been settled in advance. This is a medium-term political risk.

There is also a key-man risk. With no successor waiting in the wings, Mr. Xi’s sudden illness or death would risk systemic upheaval. Meanwhile, he has significantly increased the level of censorship. This could make it more difficult for China to change course should it become necessary.

A ‘Goldilocks’ state

Overall, the outcome of the politburo changes is positive for China’s structural reforms, in my view. By consolidating his power, Mr. Xi has improved the alignment of reform incentives between the core leadership and other officials. But he has also struck a balance by operating within the bounds of many party conventions and by trying to strengthen the party system. Moving too far towards strongman rule could risk political instability. China may be entering a ‘Goldilocks’ state by simultaneously seeking to maintain stability and make progress on reforms.

Written on 30/10/2017

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