Commentary | 11 March 2018

Xi Jinping must defuse China's debt bomb

Originally published in Australian Financial Review.

Originally published in Australian Financial Review.

In the fortnight since Xi Jinping cleared the way to stay leader for life in China, the professionals paid to interpret the country for the world have expended most of their energy on analysing the implications for Chinese politics.

The more salient question, however, might be different, focusing instead on what the move means for the Chinese economy.

Xi's cementing of power and his sidelining of all enemies, real and imagined, doesn't provide an instant guide to the issues possessing capitals in the US, Europe and the region over China's economic rise.

For the moment, Xi's absolute ascension is unlikely to be pivotal in the Trump administration's trade policy; nor will it alone crystallise thinking in Berlin about whether Germany should reassess Chinese purchases of shares in its industrial crown jewels.

Likewise, closer to home, any decision China might take to make Australia pay a price for what it regards as the Turnbull government's hostile rhetoric over foreign interference won't be down to one man's whim.

The real battle to watch in the wake of Xi's anointment is over economic policymaking inside China, where large numbers of the technocratic elite who guided the Chinese miracle will quietly recoil at the sight of a single leader amassing so much power.

The communist party stands, and potentially falls, on its ability to improve the lives of its citizens. Since 1979, they have by and large done spectacularly well. At a moment when China is trying to remake its economic model, that job will fall to Xi alone.

Naturally, the idea that Xi himself can effectively pull the reins of a complex, globally integrated economy has its sceptics. At The Australian Financial Review Business Summit in Sydney this week, Kenneth Rogoff, a former IMF chief economist, said if a leader's opinion was needed for every mayor or company to make a decision, "you are not going to have a very dynamic economy."

Jonathan Woetzel, of McKinsey Global Institute, who has more than three decades on the ground in China, countered during the summit that such views misunderstood Chinese policymaking. Far from dictating to localities, Beijing sets them goals and then largely leaves it to them, within certain strictures, to find ways to reach them.

Woetzel is right that the Chinese economic miracle has been as much a ground-up as a top-down phenomenon.

The Communist Party likes to say it has lifted 700 million people out of poverty in China since 1979. Equally, however, you could argue that 700 million Chinese lifted themselves out of poverty, once the state got out of the way.

Both formulations on their own are tendentious, with the truth, as ever, somewhere in the middle. Chinese leaders have empowered their people, and both parties reaped the benefits.

Xi is lucky in one respect. To a greater extent than any of his predecessors, he presides over an economy in which output and jobs are driven overwhelmingly by the domestic private sector rather than relying on lumbering state behemoths.

The CCP can't hire and fire the executives of private companies as it can with the state enterprises. But it can lock them up, as it has with several entrepreneurs lately, or clip their wings, as it has with others.

But on China's perennial dilemma – of the centre versus localities – there is little doubt where Xi's instincts lie. If nothing else, Xi believes to his core that a strong centre is indispensable for the party, and China's, survival.

Dovetailing with that is the biggest problem his government needs to address, reining and cleaning up local debt, incurred by city governments and the like largely since the financial crisis a decade ago.

It is no longer China's big state banks owned by the central government that are wobbly with bad debts. In the last 10 years, smaller local institutions have gone on a lending spree, often using money funded by the shadow banking system rather than deposits.

The central government, in other words, may need to play a greater role than ever in past years to stave off a financial crisis and keep the banking system, or a multitude of small banks, solvent.

That, in turn, raises the issue of whether Rogoff might be right after all. A stronger centre means less room for dynamism outside Beijing, because the system can no longer afford it.

The margin for error in Xi's China is narrowing, and local officials know it.