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China’s make-or-break economic transition

For the leader of one of the world's biggest economies, keeping it strong and thriving is laden with obstacles. Diana Choyleva, Chief Economist at Enodo Economics, provides her insights in how the Chinese policymakers are keeping their economy afloat in a time of many challenges and what we should expect in the near future.

Put yourself in Xi Jinping’s shoes. You need to rebalance China’s economy from investment towards consumption while arresting a structural slowdown that could ultimately threaten your grip on power. Very tough.

At the same time, you must wean the economy off its addiction to borrowing, which has propped up growth since the Great Financial Crisis but has saddled China with an alarming burden of debt. A tough job has just got tougher.

And then you somehow have to placate an irate, unpredictable US president who is threatening to ratchet up punitive tariffs and to bar China from making the hi-tech investments it needs to make a success of the flagship Made in China 2025 industrial modernisation programme. Mission impossible?

As general-secretary of the Communist Party, head of the military and state president, Xi has accumulated vast personal power. Erudite essays by academics critical of a return to Mao-style strongman rule and rumoured grumbling by elder statesmen will not throw Xi off course.

But the economy could.

China has overcome numerous crises in recent years that would have defeated lesser policymakers - an insolvent banking system; massive excess capacity in heavy industry; unsustainably high net exports and rates of investment; runaway local government borrowing; and, in 2015, large-scale capital flight triggered by a stock market crash and a bungled mini-devaluation of the yuan.

What’s different this time is the sheer number of economic problems pressing in simultaneously. So how are policymakers managing?

Encouragingly, Beijing has not fallen back – so far – on its bad habit of throwing money at the economy whenever growth slows. Yes, spending on infrastructure is speeding up, but the thrust of fiscal policy, wisely, has been to ease the tax burden and increase incentives. Likewise, monetary policy has been relaxed, but mainly to reduce the risk of a destabilising cash crunch resulting from China’s financial de-risking drive. Importantly, the authorities have kept the property sector on a tight leash.

China can also take credit for a gradual rise in the consumption share in GDP thanks to a sustained rise in wages, a burgeoning online sector and an energetic campaign to develop the rural economy. The accompanying rise in goods imports along with a boom in overseas tourism and education has turned a current account surplus of 10% of GDP a decade ago into a deficit in the first half of 2018. The economy is gradually rebalancing.

Coinciding with the deterioration in the current account and the start of the trade war with the US, China has overseen a significant, controlled depreciation of the renminbi without triggering an exodus of capital. Exporters will cheer, but President Trump is already complaining and threatening to respond with yet more punitive tariffs.

The trade war is just one front in a broader geopolitical contest between the US and China, between the incumbent power and the challenger, that will play out in coming years. The unknowable repercussions of the confrontation, from investment curbs to military muscle-flexing, constitute one of the biggest risks to the Chinese economy.

The other, more immediate threat is that the authorities will push de-risking and deleveraging too hard, causing financial distress and undermining the confidence of households and businesses alike.

No doubt Xi is acutely aware of the fine line he is treading. The Communist Party’s legitimacy rests on an unspoken bargain with the people: give us total power and we will give you growth and jobs in return. For the past 40 years, the party has kept its side of the deal. It would be brave to bet against it continuing to do so.

Equally, however, the external environment for China is darker than it has been in decades at a time when Beijing needs fair weather to tackle a daunting array of challenges. The next 18 months will be critical.

Hear more from Diana at Asia's leading private equity and venture capital conference in Hong Kong this September >>

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