China is going to grow 5.5% this year, even if it can’t. This is, in a nutshell, the signal Xi Jinping is sending to global investors.
Just about no one looking at global events seriously thinks Asia’s biggest economy can make this year’s gross domestic product target. But then, this is no normal year for Xi, who’s angling in the months ahead for a third term as leader.
This norm-breaking feat will be much easier for the Communist Party to accept if Xi’s “zero-Covid” scheme isn’t crippling its GDP. It is, of course. Xi’s massive lockdowns have some economists forecasting 2% growth, at best. For China, that effectively is a recession.
But if Xi does manage to pull off the impossible and engineer a GDP rebound, it’ll be better news for him than China’s 1.4 billion people. Getting closer to 5.5% might help Xi’s political goal in the short run. But it could exacerbate China’s debt troubles in dangerous ways.
On Wednesday, Xi pledged that “we will step up macroeconomic policy adjustment, and adopt more forceful measures to deliver the economic and social development goals for the whole year and minimize the impact of Covid-19.”
This, Beijing watchers agree, is unusually forceful language for a Chinese president. Yet, it avoids pledges to deemphasize giant lockdowns of the kind seen in Beijing, Guangzhou and Shanghai. Shutting down entire metropoles may have worked in 2022. In the more transmissible Omicron era, not so much.
This means that the coming stimulus shock and awe might have to be rather epic in size. It could include the People’s Bank of China adding waves of fresh stimulus. More likely, though, it will feature already highly indebted local governments ramping up borrowing to finance infrastructure no one needs.
Since before Xi’s day, back in the 2008-2009 era, Beijing relied on municipal leaders to order up huge public works projects: six-lane highways; monorails; international airports; stadiums; conference and shopping centers; city hall complexes; corporate campus districts; five-star hotels; massive museums.
There was a clear incentive structure. What quicker way for an ambitious local powerbroker to get Beijing’s attention than routinely turning in above-average GDP rates? And it’s an incentive system Xi had been pledging to alter.
Back in 2012, when he first took power, Xi promised to let market forces play a “decisive” role in Beijing decision making. And at times, he did just that. Over the last five years, for example, Beijing worked to reduce leverage in the financial system and curb risks among property developers.
Yet Xi’s real economic legacy is growing the size of the state sector. This dynamic has come at the expense of the private sector he is pledging to empower.
One of the bigger examples is Xi’s draconian crackdown on Alibaba Group founder Jack Ma and other tech billionaires. It’s erased nearly $2 trillion of market capitalization. It’s also undermining China’s most innovative industries with the greatest scope to disrupt the economy.
Now, top-down incentives are swinging back in the direction of government stimulus and away from deleveraging. This means China’s problems with excess credit and debt will get even worse. The same goes for the return of incentives for unproductive investments that put China on its current trajectory.
The problem is China’s extreme opacity, which in many ways grew worse in Xi’s watch. In September 2021, well before Xi’s “zero Covid” lockdowns, economists at Goldman Sachs Group estimated that hidden local government financing vehicles, or LGFVs, had increased to more than half the size of China’s $14.7 trillion economy. They put the number at about 53 trillion yuan (roughly $8 trillion) from 16 trillion yuan in 2013.
The important point is that the amount of LGFV debt is bigger than official outstanding government debt. And given the lag between when these local-government debts are taken on and reporting, it’s safe to assume the overall amount has swelled markedly since then. And may continue to grow going forward.
“In our view, infrastructure is the most important driver of Chinaʼs ambitious 5.5% GDP growth target this year, and local government special purpose bonds are a key funding source,” says analyst Zoey Zhou Qianyun at research company CreditSights.
Yet this $8 trillion dark side just means that once the Covid era ends, the debt troubles with which Beijing must contend will be bigger than ever. Xi may indeed get his wish for a third term. If his government isn’t careful, Xi may spend much of it paying the price for that success.