China’s president, Xi Jinping, has made an anti-corruption drive a hallmark of his administration. We noted that trend to our readers from the beginning, believing that Xi’s family history suggested he would be serious in this endeavor (his father, a prominent figure in the revolution, was imprisoned several times under the regime of Mao Zedong because he was thought to be too progressive).
Xi’s speeches made us believe that he viewed corruption as a basic threat to the stability of the Chinese state and the continued rulership of the Chinese Communist Party. Reading between the lines, we saw that he understood popular resentment against corrupt officials to be a grave danger, and that this was the discontent that led to the disaster at Tiananmen Square.
We were encouraged to see the progress he made against corruption, leveraging popular media such as Sina Weibo (“China’s Twitter”) to take down local officials guilty of petty corruption. However, we noted that until there was a demonstrated willingness to tackle major political figures, we could not be sure that Xi would go the distance. Given the nature of internal power politics within the Communist Party, we viewed Xi’s steady consolidation of power as a likely prelude to anti-corruption efforts against high officials and not just local miscreants.
Triangulating on Zhou Yongkang
We reported last year that anti-corruption investigations seemed to be focusing on a cast of characters that had a notable characteristic in common: they were all associates of a powerful figure named Zhou Yongkang. Zhou is no small fry, and he has now been detained for a formal investigation. He was a senior Politburo member in the last administration — in other words, one of the nine most powerful men in China, and in charge of the state security apparatus. Previously, he held many high government posts, and was closely associated with China’s oil and gas sector, heading the China National Petroleum Corporation (CNPC) from 1996 to 1998. Mr Zhou and his family are accused of stealing enormous sums from the government — more than $14 billion at last count.
His detention marks the first time that a former member of the Politburo Standing Committee has ever been formally investigated, in the whole post-revolutionary history of China. Zhou is also the highest-ranking official ever to be charged with such violations. We believe that this is an extraordinarily significant development.
Xi’s Consolidation of Power
The fact that President Xi is willing to take this step speaks volumes about his confidence in his political position. His consolidation of power, including setting up new government organs that, for example, puthe state security apparatus under his direct control, has evidently reached the point where he feels comfortable going after “tigers,” the corrupt high-level officials.
We do not doubt that this will win him favor with the Chinese public, as well as strike fear in lower-level corrupt officials. Since corruption is so deep and so endemic in China, we have no illusions about rapid progress, but incremental though this progress is, it is significant.
Implications for China’s Economy
We believe that Xi’s administration has so far focused most strongly on his anti-corruption drive and on the structural and political consolidation of power that was necessary to make it effective.
The detention of Zhou Yongkang may be a message that Xi’s initial focus has succeeded and come to fruition. That means, in turn, that President Xi may be able to spend more of his effort and his political capital on social and economic reforms to help China in its epochal transformation from a heavy industry economy to a consumer economy.
Anti-Corruption Meets Deleveraging
We have commented often on the connection between corruption and the over-leveraging of China’s property and financial sectors. Speaking simply, much of that leverage has fled the country as the result of theft by officials high and low, and found its way into assets abroad. Fraudulent loans were made and fraudulent projects created, and the proceeds have left China for good. This leaves the Chinese government to gradually clean up the mess, and the expansion of Xi’s anti-corruption efforts bodes well for the government’s attempt to stem the tide.
Reforming Residency Laws
There may already be emerging evidence of the government’s new willingness to tackle difficult reform problems with greater resolve. Last week, the government finally announced plans to reform the “hukou” system which governs who can live where in China.
China’s massive economic expansion has been enabled by large-scale migration from the countryside to the city. But the migrants don’t have the same rights as city-dwellers since they don’t have formal permission to move. This group constituted a group of “second-class” citizens, that lacked access to the same health and education benefits as city-dwellers. That worked for awhile, producing low-wage labor, but now it is becoming a source of potential social unrest, as well as holding back the development of second- and third-tier cities and the continued formation of a Chinese middle class.
The government announced that it intends to facilitate the “orderly” reclassification of 100 million rural migrants into their cities by 2020. If Xi’s victory in the anti-corruption effort allows him to turn effectively to this kind of reform, the implications for the Chinese economy will be profound.
Interesting Events in the Banking Sector
As another example of potential reform, we noted last week that the China Development Bank (CDB), a state policy bank, received a one-trillion-Yuan lending facility from the People’s Bank of China (PBOC). The CDB also received regulatory approval for a new business unit, a Housing Finance Department. Observers have wondered whether this new unit will use the bank’s new lending facility to bail out China’s property sector, effectively deleveraging the property and financial sectors, and transferring that leverage to the central government.
We have mentioned in these letters before that this was a possibility — while also expressing our opinion many times over the past few years that fears of a Chinese banking and property implosion will not come to pass. To date we have been correct, and we do not expect a banking collapse in the near future.
In any event, we view current political developments, including the detention of Zhou Yongkang, as highly significant for China, and investors should be attentive to potential progress in this market that has been much unloved of late. There are no instant solutions to the problem of corruption in China, but there is incremental improvement that is worth noting.
Investment implications: Because of lack of transparency and unreliable accounting, we believe Chinese stocks remain a matter of trading them, not investing in them. However, investors should be attentive to high-level political developments which may incrementally improve the fundamental market climate in China. Chinese stocks are also better for trading than for investment because the government engages in periodic easing and tightening of the money supply, which strongly influences the performance of Chinese stocks.
