All is not well in the Chinese economy

Sascha: [00:00:00] More from Equity Mates media. This is the dive. I'm your host, Sascha Kelley. We can expect to hear a lot about China and Xi Jinping next week on the 16th of October. This coming Sunday, as we're recording China's Communist Party, Congress is taking place. This once every five year event will be monumental because President Xi is going to attempt to do something that hasn't been done in decades. He's attempting to secure a third consecutive five year term as leader. And if he's successful, he'll be the most powerful Chinese leader since Mao. But all is not well in the Chinese economy.

Audio Clip: [00:00:39] Chinese businesses are warning of the severe impact of Shanghai's prolonged lockdowns.

Audio Clip: [00:00:44] Evergrande teeters on the edge of default. Collapse would have grave consequences for hundreds of thousands of property buyers and retail customers.

Audio Clip: [00:00:53] The GDP growth is a big mess, but we always know there is a margin of uncertainty. Let's put it our way around such number. But this number basically means this year something 5% growth is out of water, 4% is still very challenging. [00:01:06][13.7]

Sascha: [00:01:07] So to set the scene and provide the context, Fergie's unprecedented tilt. At a third term, we wanted to explore the state of the Chinese economy. It's Friday, the 15th of October. And today, I want to know what's going on in China. To do this, I'm joined by my colleague here at Equity Mates is Darcy Cordell. Darcy. Welcome to the Dive.

Darcy: [00:01:28] Thanks, Sascha.

Sascha: [00:01:30] Now, Darcy, as President Xi prepares to deliver his address at China's Communist Party Congress, he's facing a lot of issues after enjoying explosive growth since the 1980s. China is slowing, in fact, for the first time in 30 years. China's growth rate will be slower than Asia's as a whole.

Audio Clip: [00:01:49] It expects the Chinese economy to grow 2.8% this year, nearly half of what was previously forecast.

Darcy: [00:01:56] It will, Sascha, and that's really big news. The World Bank projects China will report 2.8% growth in 2022, but the projection for East Asia and the Pacific, excluding China, is for growth of 5.3% in 2022. And many South East Asian countries, including Indonesia, Vietnam, Thailand and Malaysia. They're really picking up the mantle and becoming the growth drivers of the Asian region. 

Sascha: [00:02:20] And this is a real paradigm shift for this part of the globe. Since the 1980s, China has averaged around 10% GDP growth per year, and in those 40 years, China has lifted almost 800 million people out of poverty. It really has been the economic story of our times, and it seems we might be turning the page on this chapter.

Darcy: [00:02:43] Yeah, there's no doubt China's growth is slowing. Earlier this year, China set a GDP target of five and a half percent this year. And that in itself would have been a 30 year low. But in the last six months, the World Bank, as we said, revised its forecast to 2.8% growth, down from over 8% last year. And that is the headline challenge that Xi Jinping is facing a decade ago, he inherited an economy growing between 7 to 10% a year. And he now has an economy that's projected to grow less than 3% this year.

Audio Clip: [00:03:14] What's funny, how we've gotten so used to China being the leader and the strong growth figures coming from there.

Darcy: [00:03:21] And in that context, he's trying to convince the Communist Party leaders to give him a third term as leader.

Sascha: [00:03:26] And there's really two important drivers of this economic slowdown. Firstly, China's slow moving property collapse. And secondly, their ongoing COVID zero policies.

Darcy: [00:03:36] These are the two driving factors, and they kind of go hand in hand a little bit. China is facing a developing property crisis.

Audio Clip: [00:03:43] To us, the most important factor outside of the zero COVID situation is actually the housing. As you actually already mentioned, the housing right now is in a pretty dire situation. And if we don't have a strong recovery in housing sales from here onwards, yeah, that's that's going to be a challenge.

Darcy: [00:04:02] About 70% of household wealth is tied up in property and the industry is worth a fifth of China's total GDP.

Sascha: [00:04:09] 70% is just enormous. 

Darcy: [00:04:11] It's crazy. In fact, China's real estate is the world's single biggest asset class. An estimated market value of 55 trillion USD. And the cracks in this market. They started to appear late last year when Evergrande, China's second largest property developer, defaulted on its debt. It couldn't pay it back, and the Chinese government had to intervene to bail them out.

Audio Clip: [00:04:32] The collapse of Chinese property giant Eva Grand and holds shares in the highly indebted company have fallen 80% this year and analysts fear the crisis could spread throughout China's property sector.

Darcy: [00:04:44] So, Sascha, since the Evergrande drama began last year, the housing market has slumped into this massive hole, dragging the economy down and even causing small outbreaks of social unrest. The frenetic pace of house building. It used to be emblematic of China's rise as a global power. But now confidence in the sector has just completely collapsed. In July this year, the value of new home sales fell by 29% compared with a year earlier.

Sascha: [00:05:10] So housing is Xi's first big economic challenge and for years he's had the line. Housing is for living in, not for speculation. But that certainly didn't stop the frenzy of the past decade. And now Xi is trying to prevent a crash and protect developers, homeowners and investors because this has extended beyond an economic problem to a political one.

Darcy: [00:05:33] I mentioned that stat before that jumped out to you. 70% of China's household wealth is tied up in property. So collapsing property prices and activity, it really hurts the material wealth of Chinese people. In some parts of China, this stress is actually turning into unrest.

Audio Clip: [00:05:49] Well, they are fresh signs of trouble for China's embattled property sector, not only a home buyers refusing to pay their mortgages, developers bonds are plummeting.

Darcy: [00:05:58] Mortgage holders have threatened to stop repaying their loans if construction doesn't resume and homes that they're already paying for.

Sascha: [00:06:04] So slowing growth can partially be explained by China's collapsing property market. And the second reason is just as important continues to zig when the rest of the world zags. He's committed to this COVID zero policy.

Audio Clip: [00:06:18] In many parts of the world. Most COVID restrictions are gone. But in China, this remains the strategy. Lockdowns such as this one in Shanghai. And any change, of course, is being resisted.

Darcy: [00:06:29] The zero tolerance approach to COVID. It has prevented a lot of deaths and long term infections, but it's come at a high and growing cost to the Chinese economy. China's COVID zero. It's meant extensive and sporadic lockdowns across the country for the last couple of years. Just recently, the city of Chengdu, with 21 million residents was put under a strict lockdown. And that was following the two month lockdown in Shanghai earlier this year, which affected nearly 30 million people. So obviously, these intermittent lockdowns, they shut down manufacturing and building in many cases, but they also just stomp on people's confidence. If you're expecting a lockdown every couple of months, it's hard to. It's hard to confidently invest in something.

Sascha: [00:07:08] Or make any kind of plans with your money or otherwise.

Darcy: [00:07:12] And then you've got the closure of the country's borders to international travelers, which means foreign investment in China has stalled during the pandemic. Companies and investors, they've shifted their attention to other countries that they can more easily access.

Sascha: [00:07:25] So she is facing a real economic challenge as he gets ready for his legacy defining party Congress. Why don't we take a break? And then I want to discuss how China watchers think he will respond and what he's going to say next week.

Darcy: [00:07:48] The Communist Party's twice a decade, Congress determines political succession and sets the tone for China's policy direction for the next five years.

Sascha: [00:07:57] Welcome back to the Dive. We've been talking about the deteriorating state of China's economy. And this takes us to what's happening on the 16th of October. China's Communist Party Congress will begin with an address from Xi, and it will provide us with clues for what the future holds for China and their business with the world. Darcy What can we expect?

Darcy: [00:08:18] We can expect at least a couple of hours of Communist Party ideology. Sascha His address at the start of the last party Congress in 2017 lasted over 3 hours. But buried within that, there's going to be some important information about the direction Xi wants to take China. One of Xi's favourite economic policies is called Common Prosperity. It's been defined in the past as reining in private capital and narrowing China's huge disparities in wealth. We've seen this happening for years. Think of Chinese tech giants Alibaba and Tencent have been subject to crackdowns and massive tax bills from regulators.

Audio Clip: [00:08:53] We need fears that Beijing may roll out more restrictions for private enterprise, said Chinese tech shares. So their worst two day drop since July.

Darcy: [00:09:00] So the way we should think about Chinese economic policy. The past 40 years have been growth, growth, growth, and it has seen 800 million people lifted out of poverty. But the next stage and Xi's common prosperity stage is about correcting the wealth inequality and the excesses of the growth stage. So this is going to continue. But what we might say is President Xi in his speech, extend the definition of common prosperity to include other things. We might see him introduce more social spending programmes, deregulation of smaller businesses, or a renewed tax system to more evenly distribute wealth within China.

Sascha: [00:09:36] Okay, so that's the domestic policy. What's happening inside China? What about trade with the rest of the world?

Darcy: [00:09:44] Xi's policy for trade has been what he calls dual circulation, and that concept involves relying primarily on domestic demand and innovation to propel the Chinese economy while still maintaining relationships with foreign markets and investors as a back up for Chinese growth. And this is essentially China transitioning from a manufacturing driven export economy to a consumption driven economy. It's China transitioning from an emerging economy to a developed one. But that policy has changed in recent years, and only partly by design. China's imports have stagnated this year, while its exports have soared, and it's produced the biggest trade surplus the world has ever seen. Those surpluses, not domestic demand, have held up China's economic growth this year. Without China's exports, they'd be really struggling to have any positive GDP growth. So it'll be interesting to see if she mentions that phrase dual circulation in his speech. If he doesn't, it could be a sign that he's reconsidering this policy.

Sascha: [00:10:43] So, Darcy, are we expecting any relaxation of the ongoing COVID era policy? I know we've done an episode on that before, and it's certainly been a topic of conversation.

Darcy: [00:10:53] I'm going to say no for this one. China still has relatively low rates of vaccination, especially for citizens over 80 years old. And very few people in China have developed resistance to the virus through exposure. You know, if there's any COVID cases, that means a lockdown. So almost no one expects to announce during the speech a rapid retreat from the Zero-Covid policy. But he may hint at a gradual loosening.

Sascha: [00:11:17] And what about the situation with Taiwan? Do you think Xi will make any comments on that?

Audio Clip: [00:11:24] China says it will fight to the very end to prevent Taiwan from being declared independent.

Darcy: [00:11:28] This is probably the biggest uncertainty about China for international businesses, and that's whether China will pursue some kind of military action in the coming years against Taiwan. Joe Biden said recently If China tries to bring Taiwan under the mainland's control, the US would help them resist. So it's on a knife edge, this situation. Even a vague mention bhajji in his speech of a timeline for bringing Taiwan under control, it could really damage financial confidence in both Taiwan and the mainland.

Sascha: [00:11:58] And what do we know about the new Chinese leaders that will be confirmed? This is, after all, one of the main functions of this upcoming Congress.

Darcy: [00:12:07] That's right. Particularly important to business is who is going to become the new Chinese premier. The premier leads the cabinet, but not the military. Xie himself runs the military. The Premier looks after the Finance Ministry, the Commerce Ministry and other government agencies. So China's Constitution bars Li Keqiang, the premier, for the past decade, from serving a third term in office. But the possible successors include Wang Yang, who's the leader of the Communist Party's top advisory board, and Hu Chunhua, one of four vice premiers of China.

Sascha: [00:12:38] Is there a favourite in this race at this current stage?

Darcy: [00:12:41] Yeah. Experts think Xi is more likely to choose Wang. Or another darkhorse candidate who doesn't pose any political threat to Xi who won't challenge him for power. There are worries that Li Keqiang may challenge in the future.

Sascha: [00:12:54] Darcy, lots of fascinating insights, setting the context for the Communist Party Congress coming up this Sunday. But let's leave it there for today. We'll be hearing plenty more about Xi after all, and his attempt to win a third five year term in the coming days. Whether he remains leader or whether we see a new president, we've got some big economic challenges ahead. And this is a big way because it's us as well as the rest of the world who will be watching. All right, Darcy, let's leave it there. If you enjoyed this episode, then please tell a friend about it. We're really proud of the show we put together, and we'd love more years to get it. So the best thing to do is take a picture, take a screenshot, send the link to a friend. Tell them how much you're enjoying the episode. It would really help us find new listeners. If you've just joined us for the first time, then welcome. Go back and check out our back catalogue, lots of episodes and business stories to explore and we've launched something new as well. Alongside this episode, there's going to be a short headline companion. It just takes you around the globe and gives you short, sharp business news stories to get you up to speed with what's going on in the world. You can find that right there in your podcast feed. Remember, you can follow us on Instagram. We're at the Dive Dot Business News. You can contact us by email, the diver Equity Mates dot com and you can subscribe wherever you're listening right now. See, you never miss an episode. Thanks so much for joining me today, Darcy.

Darcy: [00:14:15] Thanks, Sascha.

Sascha: [00:14:15] Until next time.