Xi Jinping has cemented his leadership for an unprecedented third 5-year term, making him the most powerful leader since Mao Zedong. A third term was made possible when under Xi’s watch parliament changed the constitutional limitations in 2018. He has purged all remaining moderate law makers from the 7-man Politburo Standing Committee, including China’s Premier Li Keqiang who has been replaced by Li Qiang. Li Qiang was responsible for overseeing punitive Covid lockdowns in Shanghai and like the other members of the committee is a staunch Xi loyalist. With all rivals forced out from the standing committee and the 24-member politburo that sits below it, Xi Jinping has effectively paved the way to rule for life. To emphasise his grip on power he arranged for his predecessor Hu Jintao to be unceremoniously ejected from the Congress meeting. The ruthless maneuvre appeared stage-managed to coincide with the announcement of the standing committee and the arrival of the press in the Great Hall of the People.

Xi Jinping’s growing power has alarmed world leaders. Despite the war in Ukraine the US National Security Strategy stated that, “The People’s Republic of China presents America’s most consequential geopolitical challenge.” Ken McCallum, Director General of Britain’s MI5 Security Service said in late 2020, while comparing Russia with China: “You might think in terms of the Russian intelligence services providing bursts of bad weather, while China is changing the climate.” Xi’s address at the Congress omitted the standard reference to “peace and development”, instead referring to “security” 26 times, creating a strong impression that national security has replaced economic development as the communist party’s main priority.

His most controversial economic policies include rigid Covid-zero measures, crackdowns on the private sector, in particular the technology industry, which is a major engine of growth, and forced deleveraging of the all-important property sector. The impact on the economy has been dramatic. Covid-zero has drained the ability and willingness of consumers and businesses to spend. Residential property accounts for 80% of household wealth so its demise will also affect consumer spending. Consumer confidence has dropped to its lowest level on record. The crackdown on internet, gaming, online education and private sector wealth forms part of Xi’s drive for greater state control at the expense of more dynamic entrepreneurialism.

His target is to double the size of the economy by 2035, requiring an annual growth rate of almost 5%. This seems unlikely given the decoupling from the West and growing state control, an unlikely backdrop for the productivity boosts required to compensate for China’s shrinking population. In the third quarter, GDP grew year-on-year by 3.9%. For the first 9 months of the year, GDP grew by 3.0% on the year, well below the official target of 5.5%. The IMF cut its forecasts earlier this month, to 3.2% in 2022 and 4.4% in 2023. In Q3, property investment was down 8%. Retail sales were only up 2.5% and the unemployment rate increased from 5.3% to 5.5%. In the first nine months of the year, property sales measured by floor area fell by 22% on the year and new construction starts fell 38%. Over the past decade, economists have predicted that China would overtake the US as the world’s largest economy by 2030 if not before, but this now seems extremely unlikely. Demographics, excessive debt, and autocracy indicate the economy will be lucky to achieve an average growth rate of 2-3% over the coming decade, which means it would be lucky to catch up the US by 2060.

While Xi was powerful before, he is even more powerful now. According to Mark Williams, chief Asia economist at Capital Economics, “the official line appears to be that China has a leadership that will be united and stable. I suspect it will prove rigid and inflexible.” The checks and balances from the past 40 years of reform will likely disappear. The backdrop does not appear appealing for investment prospects. In May, OAM sold Fidelity China Special Situations across its global portfolios, while maintaining a halved exposure to the share in Growth portfolios. In July, Templeton Emerging Markets was sold in its entirety across global portfolios, due to its large exposure to China’s equity markets. The selling decisions have been vindicated by recent signals of autocracy and state control.

Although it is hard to find, there may be a silver lining in Xi’s supremacy. China’s slowing growth trajectory and forced deleverage will be deflationary and therefore helpful to the West’s battle with rising inflation. It could also be argued that fixing China’s structural imbalances, notably its inflated property sector and excessive debt, will require powerful leadership and unshakeable conviction. China’s national debt has surged to 275% of GDP. Although sustainable as the bulk of the debt is held domestically, its excess will crimp long-term growth and needs to be addressed. China’s property market is valued at twice the US property market despite its GDP being less than 70% of the US. According to MacroStrategy Partnership, China’s tier one city property prices could fall by two thirds, and they would still be as overvalued as London’s property market is today.

The economic outlook has clouded, and some believe that under the current regime, China’s equity and bond markets should be avoided. However, as the second largest economy in the world, it is too big to ignore, and its economy will inevitably continue to generate growth, earnings and dividends. The CSI 300 is trading at increasingly attractive valuations that are a long way below their long-term averages. The 12-month forward price/earnings ratio is 10.1x compared with the long-term average of 13.6x and the price/book ratio is 1.5x also well below the long-term average of 2.7x. For long-term investors, with a 10-year investment horizon, current valuations should guarantee superior returns, especially if there is compelling evidence that China’s structural economic imbalances are being corrected.