The past 18 months have presented investors with significant geopolitical risks. There has been a profound uptick in populism across Europe, the UK voted to exit the EU and in the largest economy in the world - the US - President Trump now sits in the Oval Office. While all of these outcomes should condition investors to be wary of political complacency in the West, in China a different kind of mystery cloaks the upcoming leadership transition.
Unlike in the West, where political institutions are generally well understood, but the electorate can be unpredictable, the mystery around China’s upcoming leadership change stems from a general lack of transparency of, and unfamiliarity with, the political system. While the process of leadership selection within the Communist Party of China generally lacks transparency, we can still construct meaningful insight ahead of the change.
In China, policy decision making is not just the responsibility of the President and Premier, but rather the seven members of the Politburo Standing Committee acting as a collegial, rather than an advisory, unit to the President or Premier. And while there is an established hierarchy within the Party’s Standing Committee, neither President Xi nor Premier Li can pursue their agendas without the support of at least some of the other members of the Standing Committee. This deconcentration of responsibility is further underpinned by the factional nature of the Communist Party. Former leaders and party heavyweights can maintain a degree of power by brokering factional loyalists into positions of power within the party. Due to the slow, but long running drift of China away from traditionalists and towards reformists, the influence - at least by number - of traditionalists is waning.
We believe that several nuances of the upcoming 19th Congress of the Communist Party of China make it possible to draw a degree of insight as to how the high level characteristics of the new Standing Committee might differ from the incumbent group of leaders. Firstly, we know almost for certain, that five of the current seven members will reach the Party’s informal retirement age of 67 and should step down. Wang Qishan (a senior leader of the Communist Party and public face of the anti-corruption campaign), who is arguably a reformist and spearheaded President Xi’s anti-corruption drive, might be an exception. President Xi and Premier Li are younger members of the committee. Importantly, we also know that apart from Wang Qishan the four departing members, despite their factional differences, are predominantly hard-line traditionalists.
Another key consideration is that the pool of potential Standing Committee members is relatively straight forward to define. Aside from the handpicked potential future presidents and prime ministers that are sometimes fast tracked from outside the Party into the Standing Committee, candidates are by and large selected from the current Politburo membership. At this transition, there are approximately (21) Politburo members who are under 67 years and therefore eligible for ascent to the Standing Committee. And while the group as a whole represents both princeling and populist factions, the overarching tendency of nearly all candidates during their path to power is a predisposition to pursue reform over traditional policy. This is interesting as it runs at odds with the overarching traditionalist nature of the five departing members, who have all favoured traditionalist policy throughout their careers, and who have probably acted as a headwind to Xi’s seeming objective of pursuing reform.
With these factors in mind, this upcoming 19th Congress could well mark a critical juncture in China’s political evolution where the pivot to genuine economic reform becomes cemented as the way forward for the world’s second largest economy, and one of the most influential.
If this scenario does indeed transpire, then what does this mean in terms of the outlook for policy? And how might the transition to a more reform-minded Standing Committee impact the economy?
Firstly, and perhaps most importantly, the transition is not likely to signal an imminent swing in policy toward reform acceleration. Rather the new leadership will most likely continue the gradual step-by-step shift towards further liberalisation within key segments of the domestic and external sectors of the economy, but with significantly lower risk of derailment of the reform process. This means that over time:
Growth will most likely tend to be slower but more balanced growth that is therefore higher quality and more sustainable. Nonetheless, in our opinion one of the most important consequences of impending change within the Standing Committee is not a profound acceleration of economic reforms. Rather, it is a lessening of the predisposition of policy to regress back to the old model of state sponsored growth by investment, should conditions turn adverse.
Under the current regime, diversion from the reform agenda is a constant risk, especially if economic conditions were to deteriorate. If either global growth slowed, or if attempts at reform were implemented too quickly, the incumbent regime might have acted hastily to stimulate the old economy. And while it is obviously far too early to call time on the possibility of another rapid investment stimulus, we believe that the new Congress will generally be more tolerant of slower growth than the incumbent Congress. If this is true, then all else being equal, China’s economic future after the leadership change support greater liberalisation, albeit at a moderate pace, but with a lower possibility of slippage toward conditions that could render a hard landing, and a less desirable scenario, more likely.
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