Muted policy response to slowdown due to more than Chinese leadership transition

The 18th Chinese Communist Party National Congress scheduled to start on November 8 will replace around two thirds of Chinas most senior political leaders. However, the associated transition is not thought likely to result in any radical changes in economic policy. Major reforms are expected to remain on hold well into 2013 while the new Politburo consolidates power. Future reforms will target slower but more balanced growth. It has been suggested that the current weak policy response to the growth slowdown mainly reflects problems connected with the ongoing leadership transition. However, we believe it is also due to authorities being less worried than expected by the slowdown due to resilient labour market conditions, and experience gained during the 2008-2009 stimulus programme.
MAJOR CHINESE LEADERSHIP TRANSITION. In Chinese politics, considerable power is centralised in the ninemember Politburo Standing Committee. The nine members of the Standing Committee which takes all important political decisions in China. Seven of its nine members are expected to be replaced this autumn at the 18th Chinese Communist Party National Congress, scheduled to start on November 8. In total, around two thirds of the countrys most senior political leaders will be replaced. This transition takes place against a background of increasing challenges for Chinese policy makers. Economic growth has slowed and tension with neighbouring South East Asian countries is mounting, while the US presidential election is creating increasing uncertainty regarding the countrys future relationship with China. XI AND LI TO TAKE THE MOST POWERFUL POLITICAL POSITIONS. Currently, we know little more now than in

THURSDAY NOVEMBER 1, 2012

the spring about who will eventually fill the political positions on offer. How leaders are chosen is known only to each other, though generally the selection of new leaders is guided by present incumbents. Still, it is now widely accepted that the two most important politicians involved are Xi Jinping and Li Keqiang, both already members of the Politburo Standing Committee. Xi is expected to replace Hu Jintao as General Secretary in autumn 2012 and President in March 2013. Li will replace Wen Jiabao as Premier. There are also rumours that the Standing Committee will be reduced from nine to seven seats to make it easier to reach a consensus. The leadership transition is not expected to result in any radical shifts in economic policy. Instead, Chinese policy changes tend to be consensus-based. Further, it would be difficult for a new leadership to depart from the existing five year plan. Future reforms are expected to target slower but more balanced growth driven less by investments and exports and more by consumer demand. Furthermore, the new Politburo is forecast to spend its first year in office consolidating power with major reforms left on hold until well into next year and possibly longer. (For further details concerning the leadership changeover and its effects on economic policy see our Economic Insight, Major Chinese leadership transition puts reforms on hold, March 16 and Emerging Markets Cross Assets, October2.)

Xi Jinping (left) and Li Keqiang

A TROUBLED LEADERSHIP TRANSITION So far, there have been several indications that the present changeover in leadership is not going particularly smoothly. The Bo Xilai scandal represents the biggest political crisis in China for two decades. Bo Xilai was a contender for a seat on the nine-member Politburo
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Economic Insights

Standing Committee but has been stripped of his official position and is awaiting trial, expected to be charged with corruption and abuse of power. The downfall of Bo has provided several insights into the political conflicts taking place within the party. Bo was associated with Chinas new left and led a political struggle in the party that ultimately backfired. Xis unexplained absence from public view for a week in September, without official explanation, prompted wild speculation. Moreover, the date set for the National Congress was also communicated unusually late, providing further indication that the handover is not proceeding as smoothly as many had hoped, a situation which may produce a few surprises at next weeks Congress. CANT EXPLAIN THE WEAK POLICY RESPONSE. Chinese GDP-growth has slowed for seven consecutive quarters and is currently at its weakest since the beginning of 2009. Despite the marked slowdown, the governments policy response has been muted; fiscal policy has centred on infrastructure investments, many of which were already planned, with the effects on growth spread over several years. Monetary policy has also proved hesitant. However, while some have suggested the leadership changeover is the main reason for the muted policy response, we believe it simply postpones reforms and does not by itself represent the only explanation. Firstly, the authorities have been less worried than expected about the economic slowdown, largely due to the resilient labour market. Chinese labour market statistics are patchy but show it has so far weathered the economic slowdown satisfactorily. Wages continue to increase quickly while plenty of anecdotal evidence exists showing the difficulties faced by manufacturers in attracting and retaining labour. The era when government was compelled to try to create double digit growth to provide jobs for a massive influx of young labourers is over. The proportion of working-age population to total population is expected to peak around 2015 and the labour market to tighten further. Therefore, a GDP growth rate around 7-8%, our growth forecast for the next five years or so, will not result in social unrest due to rising unemployment. Secondly, another reason for the muted policy response is the experience gained during the massive 20082009 stimulus programme. Worth around 7% of GDP, it led to imbalances and debt for local authorities, a situation they wish to avoid this time around. Reversing slower economic growth with heavy investments would also contradict the objectives of the present five year

plan to switch the current growth model from one based on investment and exports to another where domestic consumption becomes more important. Overall, we believe the reason for the lack of a stronger policy response to the slowdown reflects a combination of the leadership transition, the resilient labour market, and the countrys experience of its 20082009 stimulus package. Andreas Johnson SEB Economic Research + 46 73 523 77 25 andreas.johnson@seb.se