The Chinese Communist party’s 19th Congress continues to shape the way we think about China, policymaking and the state of the country’s financial and capital markets.

An increasingly authoritarian China will try to make the economy and society work better, not become more liberal. It will try to engineer a harmless deleveraging, which is without precedent. Its large savings are likely to remain trapped, limiting the oft-cited internationalisation of the renminbi.

These issues matter, not least for investors because China’s $7tn equity market and its $10tn bond market are the world’s second-, and fourth-largest, respectively. Next year, Chinese A-shares will be included in the MSCI emerging markets benchmark.

Chinese bonds face bigger hurdles to inclusion in global benchmarks but some bonds are already part of lesser indices. Party cells in company management and high scores given to issuers by Chinese bond rating agencies are now on every investor’s “must find out” list.

The centralisation of power around Xi Jinping at the apex of a strengthened party — a substitute for the institutionalisation of rules, constraint and consensus — means there will be more dogma than debate in policymaking.

To oppose the president will be to oppose the party. Binary outcomes mean that, when something goes wrong, market risks will be higher and blame will lie firmly at Xi’s feet. Investors always worry about politics but concerns are greater in the absence of sound institutions.

Xi Jinping’s China will probably be the antithesis of reform and opening up. There is no sign that the government intends to address its deeply conflicted roles as owner, participant and regulator in the economy and finance. Investor interests will always be subordinate.

The recent announcement to lift the ceiling of foreign ownership of financial firms might be significant if it happened on a significant scale but the financial commanding heights will not be ceded to foreigners.

The most immediate issue, though, is financial policy. The government’s current financial crackdown and regulatory tightening is aimed at China’s debt, which is still expanding at about 14 per cent per annum and funded by increasingly short-term and volatile deposits. Financial conditions have been tightening with 10-year bond yields up by almost 2 percentage points over the past year to reach over 4 per cent, the highest for three years.

Markets expect the squeeze to continue, along with more bond defaults, and rising concerns about deteriorating debt service capacity and credit rollover risks. Zhou Xiaochuan, the outgoing head of the central bank, has warned of a “Minsky Moment” if leverage isn’t reduced.

Here is the rub, however. Slower credit expansion is leading to slower economic growth, as recent indicators confirm. Ostensibly, the party seems prepared for this as its focus shifts to inequality, social, rural development and industrial policy goals. Yet, if the government were willing to permit a proper and sustained deleveraging, it would have to accommodate much slower growth, higher unemployment, and degrees of financial and currency stress — none of which are yet present.

The central bank’s key policy rate has been raised but, at about 2.5 per cent, it is far from the 5-8 per cent seen in the tightening cycles in 2011 and 2013-14.

Monetary tightening has been modest, especially with producer price inflation running at about 7 per cent, and rising core consumer prices. All lenders and most borrowers, including the array of local government borrowing platforms, remain fully funded. The central bank continues to inject several hundred billion renminbi regularly to keep markets calm.

We need to pay attention to the December Economic Work Conference and the actions of the new Financial Stability and Development Committee. But past and current behaviour suggest that, faced with more growth volatility and downside risk, the government will again ease policy — so 2018 will be a crucial time to determine the guts of financial policy.

More generally, from behind a wall of controls on outward capital movements, China is showcasing to the world its state intervention and authoritarian model. From the other side, we can see strongly controlled capital markets, a currency against which foreigners can’t build major claims, and a limited appetite for voluntary deleveraging.

Xi Jinping’s China will have to resolve a fundamental contradiction between rising economic heft — and increasing political illiberalism — at a time of significant financial volatility.

Published Date:2017-11-20