China policy uncertainty
25 July 2017
The remainder of 2017 poses many questions for EM investors such as the pace of Fed tightening and whether it will occur amidst tightening from the other major central banks; or will global trade peter out as the effect of China’s stimulus wanes? Despite the many global issues facing EM over the remainder of this year, we are choosing to focus on the many uncertainties emanating from China over the next five months, namely the national party congress and the fraught US-China relationship. China’s importance to overall EM demand and sentiment means the outcome of this year’s party congress or a significant change in US-China relations has the ability to impact on EM more broadly.
What is the national party congress and what impact could it have? The party congress occurring this autumn is a once every five year event that not only selects the leadership for the next five years, but also sets the direction of policy. The outcome will signal what direction Xi intends to take on economic reforms and leadership succession; furthermore, it will indicate how much support there is for his agenda, and how his agenda might evolve in the coming years. One important indicator will be how many members are named to the Politburo Standing Committee (PBSC), the Party’s top body. A reduced size from its current seven members would further consolidate Xi’s power by giving him less peers and factions to contend with. However, it’s important not to over-interpret the final number, as the composition has changed many times over the Party’s history (see Chart 9). What are the main outstanding questions regarding this congress? While Xi’s first term focused on Party matters and foreign affairs there is an expectation that economic policy will be higher on the agenda in his second term -- will Xi signal a move away from the growth target? Will he signal the continuation of the current tightening over the financial sector? It’s impossible to know which direction policy will take, especially on structural reforms; Xi’s first term was a muddled mix of progressive policies and regressive government control which highlights that leadership itself is still unsure and the internal debate is still ongoing.
Our second question facing EM and China is how the US-China relationship will evolve over the rest of the year? Will China offer enough market access and capacity reduction concessions to satisfy Washington or will US policymakers ramp up protectionist policies to compel China to change? The US concerns are two pronged – North Korea and the bilateral trade deficit. The US wants China to allow more market access for US service exports and to do more to curb North Korea’s destabilising nuclear and ballistic missile programmes. By staking progress on these two items as a prerequisite for continued unfettered access to the US market, the relationship is on course for friction. Judging by the recent Comprehensive Economic Dialogue, China is reluctant to agree to firm targets. As a result, the US is set to put further pressure on Chinese investment (see Chart 10) and trade by broadening the CFIUS mandate and/or using Section 232 to apply trade restrictions on Chinese steel and aluminium. In addition, lack of progress on curbing North Korea’s ambitions makes Washington more likely to use secondary sanctions on Chinese companies. Internal leadership changes and external pressure could make for an eventful rest of 2017.