Beijing looks to tame an economic slowdown


CHINA has entered 2015 amid a deepening economic slowdown. Steady declines in home prices, home sales and real estate-related investment, combined with the impact of still-weak external demand and rising input costs for Chinese exports, all but ensure that China’s economic growth in 2015 will fall to its lowest level since 1990.

Stable growth in services industries, buttressed by rising household consumption, will mitigate some of the negative social and political effects of slowing industrial activity. However, these components of China’s economy are not yet strong enough to offset the inexorable winding down of China’s decades long export and investment boom.

The core questions for China in 2015 do not concern whether or for how long the country’s economic slowdown will continue — declining growth will remain the norm this year. Rather, the questions are how this slowdown will play out socially and economically across China’s many diverse regions and whether the country’s political and administrative structures can evolve to meet its rapidly changing needs.

Slowing economic growth in 2015 will bring to the forefront deep-set regional economic imbalances — not simply between the coast and the interior, but between different parts within coastal and inland China. Some provinces will feel the pain of declining housing and infrastructure construction disproportionately. Northern China’s traditional coal, steel and heavy industrial hubs like Hebei, Shanxi, Inner Mongolia and Heilongjiang, where reliance on the health of nationwide real estate markets is highest, will be hardest hit. Naturally, these provinces will be the locus for local government and corporate debt concerns in 2015. As average home prices fall further, the likelihood of localized debt, economic and employment crises in these regions rises substantially.

At the same time, China’s internal regional economic and financial fragmentation will limit these economic crises to a few provinces, providing a subtle but powerful buffer against nationwide financial contagion. This is the same fragmentation that Beijing seeks to overcome in the long run. Thus, even as the resource- and heavy industry-based northern Chinese economies grind to a halt this year, the country’s more prosperous and heavily urbanized coastal and Yangtze River regions will see more stable growth bolstered by stronger services industries, more robust internal consumption bases and rising investment into higher value-added manufacturing.

The Chinese government will not seek to reverse the country’s economic slowdown this year. Instead, it will rely on a combination of tools to ensure that the slowdown remains measured. First and foremost, it will use centrally allocated infrastructure investment, direct capital injections and targeted relaxation of local government housing and spending controls to support strategically significant industries and regions or to soften the impact of crises in others. Additionally, it will act as needed to ensure that the core state-owned banks and their provincial branches have ample liquidity to metabolize rising non-performing loan ratios and maintain a steady flow of credit to favored businesses. Beyond these measures, however, the Chinese government will let the country’s economic slowdown do what central authorities have long struggled, and failed, to accomplish: push forward industrial consolidation, weed out unprofitable and wasteful investment, and curb endemic housing and basic materials oversupply. Ultimately, this process could pave the way for a more competitive and productive Chinese economy. However, during 2015, China will feel much of the pain and few of the benefits of industrial consolidation, all while maintaining just enough support to the economy to prevent that pain from becoming critical.

Long-awaited reforms
Beijing will take advantage of the housing and construction slowdown to implement a number of long-awaited economic and social reforms in 2015. First, it will expand fiscal reform measures, such as a municipal bond pilot program and value-based resource taxes, in an effort to reduce local government reliance on land sales for revenue, thus removing a key structural driver of China’s post-1990s housing and infrastructure boom.

In conjunction with fiscal reforms, the expansion of property taxes to more regions and the creation of a national property registration system, both set to take effect in the first half of the year, will undermine real estate speculation and help bring prices further in line with real average income levels, especially in the small- and medium-sized cities Beijing has targeted for future urbanization.

China also will establish a national deposit insurance program, widely seen as a key step toward building a more mature and open financial system. Moreover, Beijing will adjust its household registration, or hukou, system to better manage shifting labor flows as some parts of the economy slow faster than others.

Finally, 2015 will bring tangible progress on efforts to make the state-owned sector more internally competitive and to open key emerging industries — notably, shale gas exploration — to greater private and foreign participation.

Implementing these and other reforms will not be easy. The central government’s powerful security and Internet censorship apparatuses will keep visible signs of outright opposition to a minimum. Yet at the local level and within state-owned enterprises and ministries, resistance to measures that threaten employment, social stability and vested interests will run high.

The deepening economic slowdown and rising urgency of reform will fuel continued efforts by Chinese President Xi Jinping and his closest allies to consolidate their influence over Communist Party, government and military apparatuses and to bolster the central leadership’s public image. In 2015, as in the past two years, the anti-corruption campaign will be the central vehicle for doing both.

As before, anti-corruption drives in 2015 will target a combination of high-level officials across the military and strategic industries and regions as well as local-level officials and middle-level functionaries, with perhaps a growing emphasis on combating local corruption through policies like the national property registry. In line with this, 2015 will likely bring several waves of large-scale arrests and demotions, along with rising capital flight as officials accused of corruption seek to move assets overseas.

China’s maneuvers in its periphery
Economic, social and political stress at home will not halt China’s push to expand its diplomatic and security presence in the countries with which it shares land borders. China also will work to expand its overland transport, trade and energy connections with its land neighbors.

In particular, Beijing will focus in 2015 on bolstering security and investment ties with Central Asian countries and Afghanistan and Pakistan as it seeks to stifle unrest in Xinjiang and curb its rising dependence on overseas trade in energy, resources and goods.

Likewise, Beijing will continue cementing infrastructural ties to mainland Southeast Asia, with a focus on expanding rail and road transport between southwest China, the Greater Mekong Subregion and Myanmar.

Last but not least, China’s leading energy firms will deepen cooperation with their Russian counterparts in 2015 as Beijing looks to diversify its energy supply routes and hedge against Japanese-Russian energy cooperation.

East and South China seas
This year will not be quiet by any means in the East and South China seas, especially with several Chinese construction projects on islets and atolls in island chains such as the Spratleys scheduled for completion.

Likewise, as Stratfor has noted before, the steady proliferation of naval and commercial maritime vessels in both seas raises the likelihood of accidental collisions or confrontations.

However, Beijing will also work to mitigate strong reactions from its maritime neighbors. Although China is seen as an assertive, and by some accounts aggressive, power in the South China Sea, it also carefully weighs its actions to avoid the strongest countermeasures.

Beijing will make its maritime security elements — essentially its coast guard — more active than its navy in order to force China’s neighbors to focus their procurement dollars on coast guard rather than naval vessels.

It also will continue to hold out a potential code of conduct to the Association of Southeast Asian Nations as a way to keep the group divided and reticent of stronger military ties with outside partners, as they see some opportunity to constrain Chinese actions without being caught between Beijing and Washington and Tokyo.


Publishing by The Manila Times of this forecast is with the express permission of STRATFOR.


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