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Paul Doran, Andy Liu
In 2023, the Chinese economy dramatically hit the buffers thanks to the popping of a real estate bubble that shares some troubling similarities with the Japanese slump of the 1990s and the subsequent “lost decade” of deflation and low growth.
As in Japan in the 1990s, the abrupt end of the property boom has led to major commercial real estate investments being frozen, house prices tumbling, and both homebuyers and speculative investors being saddled with enormous debts and assets with declining value.
The real estate crisis also directly affects public finances. Tax revenues raised by local governments have been seriously insufficient for some time and barely cover operational expenditures in provinces and municipalities. To compensate for this, local governments have used their public ownership privileges to sell land to real estate development companies on behalf of “the state.” That source of revenue is now seriously curtailed, as is revenue derived from real estate related taxes, which has shown a sharp drop off in recent months.
Consequently, the ratings agency Moody’s in late 2023 cut its outlook on China’s sovereign credit rating to negative, pointing to the deepening property crisis and a prolonged growth slowdown. Moody’s now predicts that annual economic growth will fall to 4% in 2024 and 2025, before slowing further, to 3.8%, on average, for the rest of the decade. Potential growth will decline to 3.5% by 2030.
These figures present a significant problem for President Xi Jinping, whose vision for the so-called “China Dream” is essentially a social contract that strengthens the Chinese Communist Party (CCP)’s grip on all aspects of power while delivering a prosperous and sustainable lifestyle to the majority of Chinese people (Note though, many China-watchers are sceptical about whether such a contract really exists either in tangible or notional form; they would argue Xi simply maintains the CCP’s grip on power through propaganda, the continually perfected police state and the latent threat of violence against any dissent).
Mismanagement with Chinese characteristics
Although Xi and US President Biden managed to dampen acute Sino-US tensions at their meeting in San Francisco in November 2023, bilateral relations remain sharply adversarial. The US maintains its drive to “de-risk” from China, which essentially means reducing exposure to China particularly in industries deemed critical for US national security such as semiconductors and telecommunications. Tensions with Taiwan – and with the Philippines in the South China Sea – are rising, and although the risk of full-scale war in the region remains small it is real and credible, and vulnerable to accidental escalation.
More pressingly, Xi’s rigid and ideological approach to policy may not provide the necessary flexibility for the People’s Bank of China and other financial institutions to take remedial action in a timely and effective manner in 2024.
Xi Jinping’s “Thought on Socialism with Chinese Characteristics for a New Era,” is an ideological doctrine that combines Chinese Marxism and national rejuvenation. Among the 14 “commitments” of the doctrine include ensuring the CCP exercises leadership over all forms of work in China and following “socialism with Chinese characteristics” and the adoption of a science-based green development.
Undoubtedly, all of Xi’s predecessors had a cast-iron commitment to the political supremacy of the Chinese Communist Party (CCP) but previous Chinese leaders accepted that there was an operative consensus in favour of flexible and pragmatic policy responses to macroeconomic challenges.
However, Xi appears to represent the triumph of political priorities over economic expediencies. While Xi himself might not be completely to blame for the current turbulence in China’s political economy – the excesses of loose credit and speculation predate his accession to power - his Mao-style centralization of power is making many of these problems worse. Xi's obsession with top-down control and his penchant for grand “national initiatives” undoubtedly impede the chances of both short-term recovery and long-term reform.
In short, Xi’s approach may be described as mismanagement with Chinese characteristics. That said, perhaps more positive signs emerged from the Politburo’s meeting on 8 December 2023 to discuss “economic work” and the agenda-setting Central Economic Work Conference of 11 December, both of which emphasised growth and opening up in 2024. There is hope that Beijing’s monetary and fiscal policies in 2024 will be more progressive than they have been up to now.
Opportunities remain
Nonetheless, despite the current macroeconomic turbulence, the impact of geopolitics and Xi’s determination to ensure Party control over the economy and individual companies, there are still reasons for some investor optimism provided this is based on a sound understanding of the pertinent risks.
Decoupling or de-risking have limitations. The commitment of Europe and America to the green energy transition cannot preclude Chinese involvement. Western countries will need to expand their trade deals with both China and the countries in the global south with which China itself has existing deals to secure access to the raw materials of the green transition be they critical minerals such as lithium, or infrastructure such as solar panels and wind turbines, or components for Electric Vehicles (EVs).
Moreover, despite the risks of Japanification, there are some mitigating factors which play to China’s favour. Primarily, the real estate crisis has not been accompanied and exacerbated by a stock market slump as it was in Japan in the 1990s, at least not to date.
And unlike Japan which may be in a demographic death spiral, China will likely continue to enjoy steady population growth in its urban centers even as its overall population declines. Moreover, with a significantly lower GDP per capita, China's economy also arguably has a higher potential growth rate than Japan’s in the 1990s. Moreover, the Chinese economy has shown remarkable resilience in the past largely because of the government’s greater ability to take policy action without reference to or consideration of an electorate.
Finally, while President Xi and the rest of the Chinese leadership are hard-liners politically and unabashedly statist in their economic outlook, they will not completely abandon the market reforms in place since 1979. As one insider recently said, “Xi deeply admires Mao but he doesn’t want to be Mao.”
So, opportunities remain for realistic, clued-in investors in China, those cognisant of both the macro and micro risks, and those prepared to think about longer-term trends and indicators while reacting nimbly to the current difficulties.
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