Article / 31 January 2017 at 13:00 GMT

China's crash course in the anti-establishment mantra

Former managing editor, TradingFloor.com / Saxo Bank
Denmark
  • China has watched global anti-establishment wave with considerable concern
  • Beijing keen to keep lid on protest in run-up to leadership transition in late 2017
  • Authorities have become better at managing volatility — Wei Li
  • Stock-market implosion of 2015 a crash course for China in markets — Wei Li
  • Shift to consumer-led from investment-led economy hampered by growth targets
  • Beijing balancing shift in 'two steps forward, one step back' process — Wei Li
  • Controls of capital flight aimed at preventing devaluations like August 2015
l  The rise of anti-establishment forces means Beijing can never truly relax, even when its people are engaging in one of their favourite pastimes on Shanghai's Nanjing Lu. Photo: Shutterstock

By Martin O'Rourke

It's not that often that China's ruling classes find common ground with the western liberal elites but the anti-establishment angst that dominated the thoughts of the urban classes through 2016 has been felt almost as keenly in Beijing.

China's leaders fear the anti-establishment mantra sweeping the globe perhaps more than anything. Forget the election of Donald Trump (although he himself is a by-product of that same wave), the battle for resources in the South China Sea or even its rivalry with the old enemy Japan. Nothing strikes harder at the core of the Chinese system than the fear of political upheaval on the domestic front.

"They are paying a lot of attention to this which is why there is so much focus around the upcoming leadership transition, firstly around the consolidation of Xi Jinping’s power base," says iShares Wei Li.

President Xi has spent much of his first term since his election in 2012 establishing his power base and, where necessary, ruthlessly dealing with rivals to create a centralisation of power that is probably as absolute as anyone since Deng Xiaoping's tenure from 1982-87. With the next leadership transition set for November, it is a crucial year for Xi and his clique.

"Given the global wave of populism, the leadership are very focused on what this means for a tightly controlled population such as China," says Wei Li, in interview with TradingFloor. "People demand more, including a healthier environment and better living standards."

"That inevitably means ebbs and flows for the new Chinese economic model as they adapt to the need for transition and the need to cater to the well-being of the people."

One step beyond

The much-documented shift from an investment-led model to a consumer-led economy has sometimes fallen victim to those competing elements as China tries to keep to the 6.5-7% GDP growth/quarter range that has been the envy of the globe for the best part of three decades.

"It's a one-step forward, two-steps back process," says Wei Li. "There is always an ongoing trade off between reform and growth, because if you grow too fast, inevitably you are not doing enough reform as you are relying on the old growth engine and visa versa."

"If you reform too quickly, then you take out some of the powerful but old traditional drivers of growth and then you may get a growth correction that can not be stomached smoothly by the market. It’s a very fine balance."

L
 Keeping China's middle classes happy is essential to Beijing. Photo: Martin O'Rourke
 
"In terms of the growth, we’re not calling for a V-shaped recovery, we’re looking at an L-shaped stabilisation which as far as sentiment is concerned, may well be good enough in terms of calming down fears of a China hard landing around the corner," she says. "China has other issues which centre around the high leverage debt to GDP ratio – we’re talking about 260% of debt to GDP including the private sector – and that number could quite easily go to 300% especially if they were to keep up with the rather ambitious growth targets."

"China has been trying to swap some of the debt to make it a bit more sustainable and also to try to help companies that have sensible business models by helping them roll over their debt on a selective basis," she says. "A hard landing is an issue for later down the line, but for this year it is sustainable to the point that growth is still holding up." 

Wei Li points to the leverage issue as a massive obstacle ahead for China but does not think it is insurmountable.

Pricking the bubble

"There are ways they can soft engineer a decrease of the bubble rather than pricking the bubble in a way that results in it bursting so to some extent, the fact they have been more stringent around lending to specific parts of the economy that may not have a very robust model is evidence of them becoming a bit more selective in terms of letting the bubble grow. "

Credit ratings agency Fitch warned last week that China was running out of time to manage credit bubbles while keeping growth targets intact and enabling the transition to a consumer led economy. The imperative to wean China off its heavy industry is powerful, says Wei Li, but adds that the authorities are making progress in this direction.

"The state-owned enterprises with poor return on equity like the big steelmakers and the coal miners represent the inefficient part of the economy," she says. "But we have seen defaults both onshore and offshore last year and so the fact that they are allowing some to selectively default means that they acknowledge the issue is there."

Their preponderance nevertheless explains why China's pollution dominates the news agenda with much of the country's northeast, for example, overwhelmed by a severe case at the start of this month. That particular episode left approximately 400 million people to endure a pollution reading level of more than 500 micrograms per cubic metre on January 1.

The World Health Organisation recommends a safe level of 10 µg/m3 .

The trade off is a simple one. For now, prosperity continues to be the priority among China's middle classes and for that, they are willing to accept life-threatening pollution levels (some 4,000 people a day are estimated to succumb to the insidious killer) as the necessary payoff. 

Property and the ability to own your own home remain key.

"The property market has started to get a bit softer from where it was 18 months to two years ago, but tier one and two cities (the distinction is based on wealth and the likes of Beijing and Shanghai qualify as tier one and Chengdu and Nanjing are typical tier two cities) have benefited enormously from the stimulus that went into the property sector," says Wei Li. 

"All of this means that the middle classes are not feeling quite as deprived as you might think in terms of the assets they hold." 

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 This isn't false modesty, it's a very real reaction to fatal pollution levels. Photo: Shutterstock

Faustian pact

How long that Faustian pact with the authorities will remain in place is difficult to say, particularly when various food-poisoning scandals like the deliberate contamination of milk supplies in 2008 which accounted for 300,000 victims, are thrown into the mix. Wei Li, nevertheless, believes that time is on the authorities side for now.

"When they set in motion the agenda for transitioning to a consumer-led economy; they set themselves a decisive target of achieving this transition by 2020 so the leadership does have time to manoeuvre and juggle the balls in the air without dropping the big one."

One of those balls of course is the value of the currency and, after the devaluation shock of August 2015 followed by the short-circuiting crisis of January 2016, the Chinese have had something of a sink-or-swim immersion on just how volatile markets can be.

"The Chinese have learnt rather painfully that any mishap in communication and political risk could derail the market," says Wei Li. "The revaluation of RMB at the start of this year – USDCNH shifted from just below 7.0 to sub-6.8 in two days – confused markets and it caused a lot of concern in terms of funding squeeze, and how the government might be propping up the offshore market to make sure RMB does not devalue too much."

"They actually have reacted reasonably well in comparison with the same episode last year," she says, referencing China's $20bn injection on January 5 to bolster the currency aftertheshort-circuiting crisis as opposed to the equity market performance that has so far held up in 2017. "The direction of travel may have been different but the suddenness is equally surprising."

China drew $40bn out of its reserve in December. "We have seen double that in the past and close to $100bn," says Wei Li. "This is within the normal course of business as they engineer a smooth path for RMB against dollar and also against a basket of currencies."

"The devaluations of August 2015 and January 2016 were lessons and important ones," she says. "It is all part of the reiterative process."

China is of course currently swotting up on the Trump module as it tries to discern how much of what the new US president should actually be taken literally.

"There are a lot of details that need to be ironed out to see how this relationship will pan out but it's hard to see the level of rhetoric continuing on the same scale," says the Chinese native. "There are unexpected things with the Trump administration and there are no doubt a great many people paying more attention to what happens on Twitter at 2am in the morning."

For Beijing, it's just one of the many juggling balls. An important one, nevertheless.

k
 Is China marching forward to a better future? Photo: Shutterstock

Martin O'Rourke is managing editor at Saxo Bank

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