The illusion that China’s economy is in good shape

The Chinese economy has started showing signs of losing steam, just as it is incumbent upon the top leadership in Beijing to maintain a positive economic picture as it prepares for next month’s National Congress of the Communist Party. An official explanation goes that adjustments are being made to eliminate bubbles in the real estate sector and to reduce corporate debt. However, the real causes can be traced to reduced domestic investments and increasing transfer of capital offshore by both state-run and private-sector big companies, as well as to a decline in spending by the government.

The situation threatens to derail the intent of President Xi Jinping’s regime to keep the economy afloat through infrastructure spending by the government and capital investment by the corporate sector, thereby ensuring his bid to gain absolute power at the party convention. The risk of China’s economy plummeting toward the end of the year should not be discounted.

The way Xi’s leadership has managed the economy may be likened to a car-driving technique known as “heel-and-toe shifting,” which involves operating the throttle and brake pedals simultaneously with the right foot while facilitating normal activation of the clutch with the left foot.

Xi and his men have stepped on the brake pedal in their attempt to reduce excess production capacity as part of supply-side reform, but when the economy threatens to slow down sharply, they hit the accelerator by boosting infrastructure building and real estate investments.

Beijing has coined the phrase “new normal” to propagate the arrival of an age of medium growth of the Chinese economy. Since around spring, however, some economists at a government-controlled think tank have come up with another idiom — “new cycle” — to insist that the nation’s economy has entered another period of rapid growth. This may suggest that the Chinese government, while repeating heel-and-toe techniques in its economic management, has lost sight of the actual situation and the growth potential of the economy.

Large-scale development projects are underway at the Iskandar economic zone in the Malaysian state of Johor across the strait from Singapore. Most eye-catching among them is construction of the Forest City project undertaken by Country Garden Group, a leading Chinese property developer. It plans to invest about ¥10 trillion in this project, including ¥4 trillion already spent in its first phase. So far, 3,000 condominium units averaging ¥50 million each have been sold, while major Chinese corporations like Huawei Technologies Co. have moved into its office buildings to establish their Southeast Asian regional headquarters.

Two years ago, such moves would have been lauded by the Xi administration as symbolic of China’s economic strength. Today, however, Country Garden Group Chairman Yang Guoqiang is said to have been blacklisted by the Chinese government, which labeled the Forest City project as a typical example of capital outflow from China and is reportedly urging both Chinese individuals and businesses not to buy property there. This is a clear indication of Xi’s absolute mandate that money must be invested within China.

In late June, at the Annual Meeting of the New Champions held in Dalian, China, by the World Economic Forum, the moderator asked the top executives of 70 major Chinese firms in attendance, “How many of you have been investing in new projects in China?” Only two raised their hands. It is now common knowledge that no leading Chinese enterprises will make fresh investments at home. Even though China’s economy grew 6.9 percent in the first half of this year, surpassing the rate of growth for all of 2016 by 0.1 percentage point, top executives of those companies know those figures are an illusion created by Xi’s leadership. They cannot invest domestically at a time when demand is shrinking because they fear the investments will become bad assets.

Despite the Chinese government’s effective ban on investing in it, the Forest City project is progressing smoothly. Finished properties are selling fast and construction work is continuing uninterrupted. Well-informed Chinese are anxious to move their assets away from home. Their money is increasingly pouring into Southeast Asia, where ethnic Chinese have a firm grip on the economy, especially after countries like the United States, Canada and Australia are beginning to impose direct and indirect restrictions on real estate purchases and business takeovers by Chinese.

In late July, there was a surprise personnel shift within the “Big four” state-controlled commercial banks in China. Former Chairman Tian Guoli of the Bank of China became chairman of the China Construction Bank, replacing Wang Hongzhang, who stepped down. This move has been interpreted widely in financial circles as the Xi administration’s attempt to keep total control over the top echelon of the banking industry as well as over the flow of capital, to prevent capital transfers to other countries, and to get state-run commercial banks, which are increasingly afraid of offering new loans for fear of being stuck with more bad debts, to cooperate with the government’s macroeconomic policies by playing leading roles in the implementation of stimulus measures. Such an attempt by the government is also proof of an emerging situation where money is becoming hard to circulate in the economy unless banks are forced to move in that direction.

China was hit by something of a shock on Aug. 14, when three closely watched economic indexes were released for July: industrial output, fixed asset investments and retail sales. All three fell significantly short of market expectations. Especially worrisome was industrial production, which grew only 6.4 percent over a year earlier, or 1.2 percentage points lower than in the preceding month. The result defied expectations that the index would rise by more than 7 percent due to recovery of steel, cement and other materials output for infrastructure projects.

Capital investment by the private sector is weak, creating a gap that even aggressive spending on infrastructure projects cannot fill up. Real estate investment in July grew a mere 2.0 percent, far short of the 8.5 percent growth in the first half of this year. In anticipation of the slowdown in real estate investment, the Xi administration had launched a plan to build the Xiongan New Area, where economic functions now concentrated in Beijing would be moved. But despite the launch of the project with much fanfare, no concrete plans for construction of buildings and facilities have been publicly announced, and major state-owned corporations are said to be resisting the government’s call for relocating to the new area for fear of cost burdens and in the face of opposition from their employees.

The Communist Party convention is now set to be held in October — unlike earlier speculation that it might take place in November. There is speculation Xi decided to hold the convention sooner rather than later because his leadership was concerned that the economic downturn will become even more pronounced down the road. Xi’s government no longer seems to have decisive means for shoring up the economy, and his efforts to mobilize state-owned enterprises and commercial banks to stimulate the economy are facing resistance. China’s bloated government spending has become a source of international concern, and the International Monetary Fund warned in August that Chinese government and private-sector debts combined could reach 300 percent of the nation’s gross domestic product by 2022.

While Xi commands ever-strong political power, his government’s power to drive the economy is weakening. It should come as a surprise to nobody if the Chinese economy plummets further toward the end of the year after the party convention is over.

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