2018 China Outlook: Xi's New "Paradigm and Architecture" for Modernizing China - Evan S. Medeiros, Ph.D. Practice Head and Managing Director, Asia
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2018 China Outlook:
Xi’s New “Paradigm and Architecture” for
Modernizing China
Evan S. Medeiros, Ph.D.
Practice Head and
Managing Director, Asia
May 2018
Agenda • Political Outlook • Economic Outlook • Global Outlook 2
Political Outlook
Xi Jinping’s coronation in two political events
19th Party Congress (November 2017)
• Xi promoted at least 15 allies into Standing Committee (7) and Politburo (18).
• Xi appointed allies to the key provincial posts –dominating center and periphery
• Beijing, Shanghai, Chongqing, Guangdong, Zhejiang etc.
• Defense technocrats rising as provincial governors
• Xi’s uses theoretical innovations as a boost to his authority
• “Xi Jinping Thought” inserted into Party Constitution
• Redefined “basic contradiction”: rising expectations as the core challenge
National People’s Congress (March 2018)
• Elimination of presidential and vice presidential term limits
Xi will rule for at least 10 more years (2027), possibly 15 (2032)
• Institutional restructuring focused on efficiency, party control
• Government restructuring remove redundancies
• New commission over “central leading groups” formalizes CCP above government
• Provincial governments get more administrative control, economic autonomy
Confidential & Proprietary © 2018 Eurasia Group | 4
Xi empowers the Chinese Community Party (CCP)
Xi in perpetuity?
Xi’s Agenda
• “Xi thought” and “Belt and Road” enshrined in Party constitution
• End of term limits on presidency sign that Xi is politically dominant enough to
stay for a third term, or more
Political Economic
• Short term: Xi will have the time and space to drive forward his agenda
Tightened Innovation
• Medium term: increased risk of policy failure, sole ownership of mistakes party control
Environmental
The Party has been gaining influence – all over Institutionalize Protection
anti-corruption
• State Council sidelined
Financial
• Enhanced role of Party committees and Party secretaries in business Extend China’s de-risking
hard and soft
Xi’s motivations for political changes power Urbanization
• Xi believes China’s rise can only be secured through strong leadership that unifies Territorial Reducing
all levers of national power – lesson of USSR collapse excess
disputes/
• The Party provides the political apparatus to break through corruption, policy Taiwan capacity
discipline and manage internal dissent
Confidential & Proprietary © 2018 Eurasia Group | 5
Anti-corruption drive becomes institutionalized
During Xi’s first term, focus was on cleanup
• Political weapon used to clean up patron-client
networks
• Focused on removing “tigers” within SOE sector
Xi’s second term will focus on changing
culture
• Beijing launches State Supervision Commission
(SSC)
At national, provincial, and local levels
Xi will use SSC to pursue top policy goals
SSC works with CCDI
• Committees will discipline/inspect Party members and
non-Party members “exercising public power” • Environment, supply-side reform; paralyzed decision making unlikely
as SSC can pursue cadres for laziness
• SSC will go after “bribe givers” and “bribe takers” –
increasing risk for foreign firms • Removing political opponents will become a secondary objective
• Source: CGTN Confidential & Proprietary © 2018 Eurasia Group | 6
Xi’s “three battles” for 2018
Dealing with pollution
• Even as cities begin to reduce persistent air pollution,
deepening water and soil pollution threaten China’s
farmlands, undermining basic food security.
Poverty alleviation
• Despite soaring growth rates, tens of millions of Chinese
citizens remain impoverished. Continued viability of the CCP
depends on improving their quality of life.
Financial de-risking
• All of China’s goals depend on economic stability, which
depends on regulators’ ability to deal with unregulated
financial products that threaten the entire system.
• Source: China Daily, SCMP
Confidential & Proprietary © 2018 Eurasia Group | 7
Economic Outlook
Financial de-risking receives top billing
Putting a halt to excess credit Financial deleveraging in focus
175%
• In December 2017, Xi identified combatting financial risks as key
challenge for 2018.
150%
• In 2017, strong nominal economic growth and commodity price
inflation, all worked to halt the growth in credit-to-GDP ratios. 125%
• Regulators cracking down on opaque financial products in asset
management and insurance; 100%
CBIRC will have greater oversight into this area.
75%
• The People’s Bank of China reported in May 2018 that overall debt-to-
3Q 2007
3Q 2010
3Q 2013
3Q 2016
2Q 2008
2Q 2014
2Q 2017
2Q 2011
1Q 2009
1Q 2012
1Q 2015
1Q 2006
4Q 2009
4Q 2012
4Q 2015
4Q 2006
GDP ratios grew only 2.7 percentage points in 2017, a stark slowdown.
• Xi’s new red lines against risks: Anbang’s receivership is both a take-
Credit to non-financial corporations (% of GDP)
down and a bail out.
A new financial regulatory architecture – and powerful trio
• Xi’s chief economic adviser, Liu He, has taken over coordination of regulation in the financial sector as vice premier and head of
the Financial Stability and Development Commission (FSDC).
• The FSDC will coordinate between insurance, banking, and securities regulation, as well as managing overall regulatory efforts
with macroprudential and monetary policy in tandem with the People’s Bank of China.
• Guo Shuqing the key driver of financial sector policy as party secretary of PBOC and head of CBIRC; Yi Gang in charge of
monetary policy as PBOC governor
Source: Bank for International Settlements, Eurasia Group Confidential & Proprietary © 2018 Eurasia Group | 9
Genuine focus on quality growth
From “high-speed” to “high-quality”
• Lower headline growth rate target: “around 6.5%”.
2018 first quarter GDP was comfortably above, at 6.8%.
• NPC report not focused on exceeding growth targets; new metric for
economic performance: unemployment rate.
• Local officials are increasingly judged on their ability to hit environmental
or innovation-related targets, rather than overall growth numbers.
• A slowdown in credit has been accompanied by selective support of key
sectors: new energy vehicles, artificial intelligence, and biotech.
Source: Xinhua
Ensuring that benefits reach the people
• To date, development favored urban and commercial interests; financial repression directed credit to economic development.
• Rising standards of living have increased expectations, and tens of millions of rural residents still live in poverty.
• Xi has doubled down on the Party’s commitment to increase incomes and quality of life even as overall growth rates may slow.
Confidential & Proprietary © 2018 Eurasia Group | 10Xi advances “Party capitalism”
Redefining the relationship between Party and market
• Enhancing the role of Party committees in corporate sector, particularly
SOEs
• CCP “leading small groups” as key loci of policy formulation, now
formalized as commissions.
• State council and ministries relegated to implementors
• Modest economic liberalization within framework of oversight and control
Using SOEs for policy implementation
• Forcing SOEs to adhere to Beijing’s strategic objectives, both economic
(upgrading technology) and political (Belt and Road Initiative)
• Key SOEs will continue to consolidate, as Xi pursues national champions
Source: Jon Berkeley, The Economist
with the scale to project China’s influence globally
Remaking the state
• To restructure the relationship between Party and the market, Xi is remaking the state.
• He is in the process of merging government ministries and regulatory bodies to reduce overlap of responsibilities. Target date for
completion is end of 2018 for central ministries and early 2019 for local offices.
• The process will be overseen by Xi’s chief economic adviser Liu He.
Confidential & Proprietary © 2018 Eurasia Group | 11China’s Global Role
China’s new international posture: rule shaper/creator
In his second term, Xi will pursue a more
activist role in Asia and the rest of the world
• New era is end of “hide and bide”: 15% increase in 2018
foreign affairs budget
• Transition from rule-maker to rule-shaper
• Developing a diverse toolkit: BRI, AIIB, 16+1, etc.
• Promote China as the “new option/alternative”
• Position China as paragon of open markets and
globalization
Xi is putting in place a number of policymakers who will execute this new approach
• Wang Qishan as VP; Yang Jiechi in the Politburo; Wang Yi as State Councilor
• New Office of International Development Cooperation announced at NPC
• But centralization of decision making on foreign policy will constrain effectiveness of global strategy
Military approach is evolving
• Intention to build “world-class” military forces: aircraft carriers, submarines, 5th generation planes – military bases
• Investment in ports and expanding regional footprint: Sri Lanka, Pakistan, Greece
Source: Pew Research Center Confidential & Proprietary © 2018 Eurasia Group | 13US-China tensions intensifying; volatility growing
Cyclical features Structural features
• Trump’s narrow US-China agenda • Maturity, density, expanding ties
• Trumps sees China as a “strategic competitor” • Broader competition: economic, security, technology etc.
• Trump’s personal affinity for Xi • Changing domestic politics on both sides
• Weak US-China communication channels • Strategic mistrust
• US uncertainty in Asia creates opportunities for China • Resilience amid Instability
US-China a mix of cooperation and competition Key 2018 events to watch
• Economic relations no longer the “ballast and propeller” Trump’s trade actions: 301, ZTE
• Trade, Taiwan, and North Korea are the hotspot issues –
more security competition Cross-strait developments
• Xi understands US-China friction; pushing boundaries
US-China coordination on North Korea
• Technology competition a new area of tension
• Rising US concerns about Chinese influence in media, China’s maritime behavior: SCS
education etc – an ideological competition?
Confidential & Proprietary © 2018 Eurasia Group | 14Outlook for Section 301 Dispute: tech in the crosshairs
Basecase: one round of tariffs then path towards settlement (55%)
• Each side needs to show resolve
• But fears of escalation will motivate leaders to seek deal
Alternative case 1: further escalation (30%)
• Risks rise as national security issues come to the fore
Alternative case 2: quick settlement (15%)
Least likely scenario given political costs to each side by backing down
But: “new normal” will have higher baseline of tension
• The pitched battle between economic nationalists and globalists will continue
• Battle will shift towards investment restrictions and other non-tariff barriers,
with tech in the cross-hairs
• “Investment reciprocity regime”
• Reforms to CFIUS process
Confidential & Proprietary © 2018 Eurasia Group | 15Taiwan moves from sleeper to headline risk
US ramps up engagement Chinese punishment grows
• Passage of Taiwan Travel Act will open door for higher level • China is using a mix of economic, diplomatic, and security
diplomatic visits actions to punish Taiwan
• Bolton and Schriver will push for more engagement; • Too early to tell if there has been a shift in red line on
potential new arms package reunification; but some believe Xi has staked credibility on
• Actions may complicate resolution of trade issues reunion trajectory
Taiwan stuck in the middle
• Tsai will continue to deny 1992 consensus, but will not rock
the boat with steps toward independence
• Administration will welcome growing US interest, but
worries are growing over being used as a bargaining chip
• Will struggle to diversify away from China economically,
feel the pain of lost diplomatic allies
Confidential & Proprietary © 2018 Eurasia Group | 16Brasília London New York San Francisco São Paulo Singapore Tokyo Washington DC
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