During this week’s quinquennial congress of China’s reigning Communist Party, Xi Jinping was elevated to the same glorious level of leadership as Mao Zedong after adding the catchy sounding “Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era” to the Party’s constitution. Although reading the Party’s tea leaves is as difficult as guessing who will become the next pope, it seems that Mr. Xi has consolidated power and his leadership might last longer than the customary two terms. By being listed in the constitution, it may be impossible to challenge Mr. Xi’s views or actions. This was already difficult enough after Xi purged his enemies in the name of eradicating graft (remember Bo Xilai?), but now he seems to become as powerful as Mao was in his time whilst at the Standing Committee. We, of course, are curious to understand what Mr. Xi plans to do with his new unconstrained mandate, especially in respect of economic policy.

Thinking alike…?

In this blog, we already raised a few times the unsustainable course that China’s economy is taking by chasing growth (6.8% in 3Q17) fueled by ever-rising mountains of debt. At the end of 2016, China’s sovereign and non-financial private sector debt equaled 254% of GDP according to IMF, on par with the U.S. IMF expects debt to be in excess of 290% of GDP by 2022, assuming no material change in the growth trajectory. Apart from the high level of debt, the rapid growth of debt is worrying. The credit-to-GDP gap (a simple measure to identify the risk of a banking crisis: a reading of 10% or more is a warning sign) for 2016 was 24.6%, according to the BIS. Because of this prolonged and rapid credit growth, S&P lowered China’s credit rating to A+ last September (following a similar downgrade by Moody’s in May). Corporate debt levels are stratospheric. Bank of America Merrill Lynch reports that, as of 31 December 2016, China’s high yield issuers had average leverage ratios of 9.4x (up from 8.9x in 2015) compared to 3.0x for all EM high yield issuers. We also see rising debt levels of households, putting to rest the myth of the prudent Chinese saver. Household debt increased fourfold over the last 10 years to 45% of GDP and is now 75% of disposable income (using IMF data). All this debt is finding a “home”, literally. China is experiencing a property bubble as private investors load up on apartments in the belief that house prices cannot collapse (or else, Mr. Xi surely will order measures to reverse the price decline, the “Xi put”). Many of these apartments, maybe amounting to one-third of the housing stock, are vacant.

We are led to believe that the government will take steps to reform the economy, from exports to consumption and from industry to services (mining to dining). Credit would be tightened and overcapacity addressed. Indeed, government officials have given public warnings that China’s economy must change track for it to remain sustainable. In May of last year, an “authoritative person”, widely believed to be Liu He, said that relying on debt to fuel economic growth could lead to a crisis. More recently (smartly timed, just before retirement), the People’s Bank of China governor Zhou Xiaochun warned that the country could face a “Minsky Moment”, triggered by the use of debt to make speculative investments. However, despite these warnings, the debt pile still is growing. In respect of rebalancing the economy, not much progress is made either. Of course, China has its own technology champions, like Alibaba and Tencent, and service sectors generally are expanding. However, old-style manufacturing is still the workhorse of China’s economy with new capacity coming on stream in sectors like coal mining and steel production. Excess capacity is generating oversupply, once again. Measures to cool house prices are ineffective, have been reversed or have stalled (like, for example, the much-debated property tax), making large Chinese cities the most expensive on earth based on affordability.

Mr. Xi’s new-era thoughts, unfortunately, do not give much guidance on how he wants to address China’s imbalanced economy. Surely, we will hear more official mutterings about the need for economic reforms in the coming year, but we have second thoughts about Xi’s ability and willingness (given the pledge to double the size of the economy between 2010 and 2020) to implement these reforms. The longer he waits, the bigger and longer the inevitable economic slowdown that eventually will befall China.