The potential for a US-China olive branch moment will tantalize global markets over the next 10 days.
The setting is San Francisco where, first, US Treasury Secretary Janet Yellen will meet with Chinese Vice Premier He Lifeng. That rarified exchange today and tomorrow sets the stage for Xi Jinping’s arrival in the city for the November 14-17 Asia Pacific Economic Cooperation (APEC) summit.
There, the hope is that Xi and US President Joe Biden meet on November 15 to re-establish president-to-president level discussions. To be sure, no one expects big breakthroughs. That’s why Beijing and Washington are looking “to intentionally keep that bar low,” says economist Jude Blanchette at the Center for Strategic and International Studies think tank in Washington.
Yet the meeting itself would be a tonic for Asian economies caught in the middle as the two superpowers parry and thrust on a range of touchy issues. In fact, Xi’s scheduled dinner meeting with American corporate chieftains could prove to be more pivotal for bilateral relations.
The dinner meeting will be a rare opportunity for the Chinese Communist Party leader to reassure top US CEOs that Asia’s biggest economy is still open for business and that actions his lieutenants are taking now will morph economic headwinds into tailwinds in short order.
The speed with which capital has been fleeing China suggests that Xi’s efforts to communicate that Beijing is in control of its myriad challenges are not getting through. In recent months, Xi and Premier Li Qiang have rolled out a variety of policies to stabilize a cratering property market and weak demand.
Global investors, though, aren’t getting that memo as new threats emerge atop of old. In September, investment capital outflows from China saw their biggest net decline in nearly eight years; outflows hit nearly US$12 billion in the third quarter.
This is the first time on record that foreign investment into China went negative, according to the State Administration of Foreign Exchange. That speaks to the sharp deterioration in China’s perceived economic prospects and a continued collapse in confidence in its state-led model under Xi’s leadership.
There’s confusion in international circles, too, about Xi’s commitment to giving the private sector and market forces “decisive” roles in Beijing’s decision-making. That 2012 pledge was first called into question in 2015 when Xi’s government intervened aggressively to stabilize Shanghai stocks.
Questions only increased after Xi began cracking down hard on mainland tech platforms in late 2020, starting with Jack Ma’s Alibaba Group. The inquisition rapidly widened to Baidu, Didi Global, JD.com, Tencent and other top internet companies. The clampdown had some Wall Street banks debating whether China might be “uninvestable.”
In the months since Li took charge of reforms in March, the government has repeatedly promised to treat private sector companies on par with state-owned enterprises and increase outreach efforts with tech firm founders.
Yet a perceived lack of follow-through is drawing complaints about “promise fatigue,” including from the head of the European Union Chamber of Commerce in China.
As President Jens Eskelund told Bloomberg: the chamber has “not yet seen signs of willingness to implement structural reforms needed to address the fundamental challenges facing China and allow foreign and private companies to deliver on their potential for supporting the Chinese economy.”
The ongoing decoupling, de-risking and de-globalization trends pitting Xi’s Beijing against Biden’s Washington hardly help at a moment when US bond yields are at 17-year highs.
“Capital outflow pressures may persist in light of the unfavorable interest rate differentials,” notes economist Maggie Wei at Goldman Sachs Group Inc.
Morgan Stanley strategist Laura Wang adds that foreign outflows from China’s A-share market is in “an unprecedented stage.” Between August 7 to October 19 alone, cumulative outflows topped $22 billion. That is the largest in the history of Stock Connect, which links mainland and Hong Kong bourses.
All this raises the stakes for Xi’s dinner with top CEOs. It’s an ideal opportunity to reboot Beijing’s faltering effort to win back the foreign investment crowd. And to slow the exodus of companies diversifying supply chains away from China to reduce risks.
Goal one is allaying concerns that China’s economy is heading into a dismal 2024. Many investors worry the International Monetary Fund is looking through rose-colored glasses when it projects China will grow 4.6% in 2023 amid property sector weakness and subdued external demand for Chinese exports.
China, for example, slipped back into deflation in October. The consumer price index fell 0.2% year on year after a flat reading in September.
What’s more, “there are signs that activity has started to slow entering the fourth quarter,” says economist Carlos Casanova at Union Bancaire Privée. “That means that policymakers need to remain on high alert and continue to support the economic recovery.”
To date, he added, the People’s Bank of China “has been reluctant to deploy stimulus measures in 2023, against the backdrop of higher US rates and a strong dollar. However, we believe that another 10 basis-point rate cut and an additional 25 basis-point reserve requirement ratio cut will be necessary in December.”
Even more important, Xi must convince executives that big supply-side disruption is coming. Bold steps to repair the property sector, increase productivity, level playing fields for entrepreneurs, recalibrate growth engines from investment to domestic demand and create bigger social safety nets are needed to head off growing “Japanification” comparisons.
Beijing is quick to dismiss talk of a Japan-like funk. “China’s current situation is vastly different from what Japan used to be in,” says Liu Shijin, a member of the PBOC’s monetary policy committee. Claims that China is falling into a “balance-sheet recession” like Japan in the 1990s are off-base, Liu claims.
China, Liu argues, still has policy scope to pivot to an innovation and consumption-led growth model that enables the government to gain control of its debt trajectory.
Trouble is, the external sector might be less hospitable to Xi’s hopes to recalibrate growth engines — reducing the rapid economic growth rates needed to win party-wide support to push through sweeping and disruptive reforms.
As the IMF notes in its latest assessment: “Over the medium term, growth is projected to gradually decline to about 3.5% by 2028 amid headwinds from weak productivity and population aging.” The IMF’s economists also warn that financial stability risks are elevated and increasing “as financial institutions have lower capital buffers and growing asset quality risks.”
Geopolitical tensions loom large, too. A September survey by the American Chamber of Commerce in Shanghai cited Sino-US hostility as a major reason why foreign companies are looking for exit ramps from China to other Asian economies. In its own survey, UBS Group cited India, Japan and Vietnam as “top destinations” that are “gaining more attention.”
The good news is that Xi’s inner circle seems to be turning away from the “wolf warrior” antics of recent years.
Recent sit-downs, and those to come, “have sent out positive signals and raised the expectations of the international community on the improvement of China-US relations,” Vice President Han Zheng told Bloomberg.
“A stable and sound China-US relationship is the common expectation of all sectors in our two countries and the international community as a whole. We’re ready to strengthen communication and dialogue with the US at all levels,” Han said.
Team Biden, too, seems keen to lower the bilateral temperature. Of course, the White House’s actions must speak louder than words. Generally, those actions tend to be focused on Chinese containment.
Last month, Biden’s trade representatives again narrowed the types of semiconductors that US companies can sell to China. In doing so, it closed loopholes in existing policies with particular emphasis on limiting China’s ability to compete in supercomputing and artificial intelligence.
“The upshot is that China’s ability to reach the technological frontier in the development of large-scale AI models will be hampered by US export controls,” says Julian Evans-Pritchard, head of China economics at Capital Economics. This could have even bigger implications, he adds, since “we think AI has the potential to be a game-changer for productivity growth over the next couple decades.”
But the more important signal Xi must send to CEOs in San Francisco is that his team is getting under the Chinese economy’s hood. One law of economic gravity that Xi’s team has tried to beat these last 10 years is the idea that a developing nation must build credible and trusted markets before trillions of dollars of outside capital arrive.
In China’s case, this means increasing transparency, making local government officials more accountable, prodding companies to raise their governance games, crafting reliable surveillance mechanisms like credit rating companies and strengthening the financial architecture before the world shows up.
Too often, Xiconomics has China trying to flip the script, believing it can build a world-class financial system after waves of foreign capital arrive. And the Xi era’s efforts to communicate that a financial Big Bang is afoot continue to get lost in translation in boardrooms from New York to London to Tokyo.
The sense that Xi’s China tends to over-promise and under-deliver financial upgrade-wise was first seen in the summer of 2015, back when Shanghai shares plunged by one-third in three weeks. Beijing’s response was to treat the symptoms of the market rout, not the underlying causes.
Since then, Xi stepped up the pace of winning Chinese stocks places in top global indices, from MSCI for stocks to FTSE-Russell for bonds. Yet increases in access to yuan-denominated assets has often outpaced the reforms needed to prepare China Inc for global prime time.
Whether China can win back investors’ trust is an open question. As Chinese stocks are reminding us – as well as a yuan down 5.6% this year – there are certain laws of gravity that still apply to economies transitioning from state-driven and export-led growth to economies centered more on services, innovation and domestic consumption.
In San Francisco next week, Xi has an ideal opportunity to convince top Western decision-makers that they can indeed believe the hype about China’s prospects for 2023 and beyond. Investors of all stripes love to hear a great growth opportunity story. China has one, but Xi needs to prove he’s genuine about the narrative.
William Pesek is on X, formerly Twitter, at @WilliamPesek