25th May 2016
Two weeks ago, on 9 May, the People’s Daily devoted much of its front page and all of its second page to a 10,000-character interview with someone described only as an “authoritative person”. This interview included some strong statements which differed sharply from current policy:
- Debt is the “original sin” from which all others emanate, and excessive debt will lead to systemic financial crisis and negative growth
- Using loose monetary policy to stimulate the economy is a “fantasy” which should be abandoned
- China needs to de-leverage steadily
- Structural reform is necessary, especially of state owned enterprises (soes)
- Zombie companies must be allowed to fail
- The path of future gdp growth will not be v-shaped or u-shaped, but l-shaped, i.e. It will not rebound to past heights.
Why are we bothering to write about an anonymous interview? Although the People’s Daily is one of the most boring daily newspapers in the world, it is also one of the most influential. So, because it is the main publication of the Chinese Communist Party, what it writes represents official Party policy. In particular, the 3 million readers of the print version read it in order to find out what Party policy is going to be in future. Therefore an interview which takes up most of the paper’s first two pages is obviously important.
The attribution of content to an “authoritative person” is a way for the top leadership to signal forthcoming policy changes in advance so as to give dutiful Chinese bureaucrats time to align their views with the new Party line. The device was invented by Chairman Mao and the current leadership has used it twice in the last twelve months.
For those Party members who were a bit slow on the uptake, the 10 May edition of the People’s Daily included a previously unpublished 20,000-character speech which President Xi had made to key officials in January. Not surprisingly, the 10 May speech canvassed much the same themes as the 9 May interview, for example:
- The need for structural reform, especially of SOEs
- The low quality of Chinese growth, due to the shortage of innovation
- The need to make innovation the pivot of development
- China lacks adequate legal, financial and risk control resources to support Chinese companies in competing globally
- The failure of some Chinese industries to respond to changing consumer demand, e.g. in milk powder, toilet covers and electric rice cookers
- The fact that stimulating domestic demand would not solve problems such as over-capacity
- The vital importance of protecting the environment.
Hence it is clear that the content of the interview and the speech has major implications for Chinese economic policy. The most striking change was the warning about the dangers of debt: to date there has been very little official comment on China’s rapidly rising debt, which Bloomberg estimates has reached 247% of GDP.
It is also clear that the inefficient private companies and SOEs will be targeted for reform. The target audience for the speech was provincial officials. In the past their success was measured in terms of the level of GDP growth that they achieved. This approach has led to over-capacity in many industries, but provincial officials were unwilling to shut down uneconomic companies for fear that this would reduce GDP growth and tax in their region as well as increasing unemployment. The past focus on GDP has also led to widespread pollution of water, air, soil and food, which local officials had no incentive to prevent. Thus the speech was designed to tell the audience to shut down zombie companies and focus on serving the people by reducing pollution and encouraging innovation.
We believe that investors should treat the interview and the speech as positive signs because they indicate that the top leadership is taking the debt question seriously and will do something about it. To date, the relentless rise and rise of China’s debt since 2008 has looked like a train crash in slow motion – the engine just keeps coming down the track. The People’s Daily may have just told us that someone is about to put on the brakes.