November 10, 2016 12:00 pm JST

China's strongman has a weak point: the economy

Liaoning Province's once-thriving coal industry is now a shadow of its former self. (Photo by Daisuke Harashima)

BEIJING When it comes to political power struggles, Xi Jinping seems to have little trouble flexing his muscles, as the dramatic downfall of numerous foes attests. But the Chinese president is up against a tougher enemy now: a chronically ailing economy in need of painful structural reforms.

At first glance, the Chinese economy appears stable, especially compared with the tumultuous summer of 2015, when the country's devaluation of the yuan against the U.S. dollar and a sharp decline in Shanghai stocks sent shock waves through global markets.

But this seeming lull in the economic storm is only making it easier to put off addressing the persistent structural problems, including pervasive overcapacity and ballooning corporate debt.

XI'S DILEMMA Xi came to power as the Chinese Communist Party's general secretary at the party's last National Congress, held in the autumn of 2012. He assumed the post of Chinese president the following spring.

As China's top leader, Xi has faced the continuing dilemma of whether to aim for economic stability in the short term or push ahead with structural reforms needed to ensure a healthy economy in the long run.

More than anything, the Communist Party worries that a sharp economic downturn would trigger social unrest, potentially undermining its one-party rule. This has, unsurprisingly, resulted in increasing resistance to any potentially growth-crimping reforms.

Further deepening Xi's dilemma is the fact that since reaching its most recent peak in 2010, growth in the Chinese economy, now the world's second largest after the U.S., has been on a path of continuous slowdown.

Addressing a gathering of domestic and foreign businesspeople in Hangzhou, Zhejiang Province, in September, Xi acknowledged the slow pace of structural reforms and the concerns this has caused.

"Thirty-eight years of reform and opening up have unfolded rapidly," he said, referring to the policies introduced in 1978 by Deng Xiaoping, then the supreme Chinese leader. "Many people wonder ... whether China can continue its reform and opening up."

China's "zombie companies," loss-making operations that continue to survive on government support, have proliferated.

These zombies are at the heart of the overcapacity problem plaguing the Chinese economy, particularly in the steel and coal industries. One study found that half of China's listed steel companies are debt-ridden zombie companies.

HARD TO KILL In an interview published on the front page of the People's Daily, the mouthpiece of the Communist Party, in May, an anonymous "authoritative figure" stressed the need to take zombie companies off of life support.

That way, the figure said, companies that should go bankrupt finally will.

The article made a splash, as it was widely believed to have been written by people close to President Xi, including Liu He, Xi's top economic adviser. Liu currently serves as the director of the Office of the Central Leading Group on Financial and Economic Affairs, the Communist Party's top panel on economic affairs.

In China, even the national government plays second fiddle to the Communist Party, whose various central leading groups formulate basic policies. The State Council, China's cabinet, currently led by Premier Li Keqiang, implements specific measures in line with those policies.

The Central Leading Group on Financial and Economic Affairs is headed by Xi, with Li serving as its deputy head. Liu doubles as deputy head of the State Council's National Development and Reform Commission.

The People's Daily interview has been widely taken as a signal of Xi's determination to carry out reforms. Nevertheless, many local governments continue to throw a lifeline to companies teetering on the brink of bankruptcy.

At a press conference on Sept. 20, Zhang Anshun, the head of Shanxi Province's banking regulator, and other officials defended the local government after it urged banks to switch their short-term loans to the coal industry to medium-term ones to help cash-strapped companies. The officials claimed the local government was only giving guidance, not issuing an order, to the banks.

Excessive corporate debt is another potential source of financial turmoil, should too many loans go sour.

China adopted a stimulus package worth 4 trillion yuan ($591 billion at current exchange rates) in the wake of the 2008 global financial crisis. As part of that massive stimulus package, bank lending swelled. According to the Bank for International Settlements, China's corporate debt was equivalent to 169% of the country's gross domestic product at the end of March 2016, up sharply from 97% at the end of September 2008.

COZY RELATIONS The northeastern province of Liaoning has seen its economic growth slip into negative territory as its main industries, including coal and steel, remain in the doldrums.

Dongbei Special Steel Group, a major state-owned steelmaker in the province, went into bankruptcy on Oct. 10 after defaulting on its debts -- having missed as many as nine corporate bond payments.

That the company held on for so long shows how close the relationship between the local government and banks is, with the former wanting to protect jobs and the latter expecting unlimited bailouts.

On Oct. 10, the State Council, China's cabinet, released guidelines for debt-for-equity swaps, which will allow companies to reduce their interest payment burden by converting their debt to equity stakes.

The State Council's move comes despite a warning from the "authoritative figure" in the People's Daily interview against the liberal use of debt-for-equity swaps. Indeed, the swap scheme does nothing to solve the deep-rooted problem of economic inefficiency.

Ignoring market discipline to rampantly bail out zombie companies is a recipe for trouble, as Xi surely realizes. But the leader so adept at taking down his political enemies is finding the economy a much tougher foe to tame.

(Nikkei)

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