Great L forward

China’s president Xi Jinping is not a happy man. Not happy at all. Yesterday’s People’s Daily newspaper carried a thinly veiled rebuke of government economic policy by an ‘unidentified authority’ close to the president’s office. But it remains unclear whether this heralds a change in policy, or is intended only to shield the president from the next unpopular market crash.

GDP grew by 6.7pc in the first quarter. But ‘there has been no improvement in the contradictions inherent in China’s economy and some new problems have exceeded expectations,’ according to the People’s Daily’s senior authority. The commentary, believed to come from one of the members of Xi’s ‘leading small groups’ (LSGs), warns that China faces an L-shaped ‘recovery’. As there’s no upturn in an L, the message is that things will get worse before they get better.

Last year’s stock market collapse wiped billions of yuan off the value of middle class savers’ investments and, in August, the central bank sharply devalued the currency. Many pinned the blame for this chaos on Xi Jinping but, ultimately, it was Xiao Gang, chairman of the China Securities Regulatory Commission (CSRC) who got the sack. This year, Chinese markets again look frothy — and that is, evidently, causing consternation in Zhongnanghai, the communist party’s headquarters.

High debt levels are the ‘original sin’ besetting China’s economy, the mysterious pundit explains. The central bank cut state-owned banks’ reserve requirement ratios — the size of their reserves relative to loans — in February, despite a rise in bad loans. Banks have to keep lending cash to companies that would otherwise keel over, but much of their extra lending is diverted into more profitable areas.

‘Total social financing’ — a measure of the amount of money flowing into the economy — reached a record 3.42 trillion yuan ($526bn) in January. Since last year’s stock market crash, investors have been looking for alternative channels for this money. As a result, billions of yuan have flooded into the more-traded ferrous metals markets. Cash has also flowed into China’s construction sector, boosting demand for diesel and naphtha. Crude imports of 7.5mn b/d in January-April were 13pc above year-earlier levels.  High debt levels characterise the balance sheets of teakettle refiners as well as China’s ‘zombie’ steel mills and coal mining firms.

Regulators have moved to tamp down trade in iron ore and steel rebar futures, by raising trading fees. The unnamed official identifies a bubble in real estate markets, perhaps suggesting that measures to rein in property prices may be in the offing. If that happened, paring construction rates, demand for diesel for transport and naphtha for petrochemical products would suffer.

China’s cabinet, the State Council, administers laws passed by parliament which are, in turn, based on policies proposed by the communist party. In the past, policy reflected compromises agreed by different factions within the party. But now it is directed on a macro level by highly opaque LSGs assembled by the president himself. The People’s Daily answers to and is run by the party — effectively, Xi Jinping — unlike state-run news agency Xinhua, which reflects the administrative side of politics, represented by prime minister Li Keqiang. The People’s Daily interview appears to be a rebuke to China’s administrators by their political masters, possibly by the LSG for the Comprehensive Deepening of Reform headed by Liu He.

China’s economy will have to ‘step back in order to take two steps forward’, the unnamed official warns. Efforts to tackle weak demand and overcapacity in heavy industry mean the country faces fairly bleak short-term economic prospects.

If a clampdown on debt sounds ominous, it is worth bearing in mind that the Xi administration announced plans for major economic rebalancing and reform in 2012. But fundamental problems persist, as the mysterious pundit acknowledges. If LSG policies manage to steer China’s economy through these threatening shoals, it will be a credit to Xi Jinping’s powers of delegation. If not, well, Xiao Gang’s successor had better buff up his resume.

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