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Where is China headed?

Executive Summary

  • Amid a number of home-grown crises, the Chinese Communist Party (CCP) faces uncertainties about its future course, with more clarity on both personnel and program expected from the party congress in mid-October.

  • Under enormous pressure to maintain prosperity, the CCP has increased political interference in the economy, effectively regarding domestic institutions and companies as useful instruments to maintain its power.

  • China increasingly relies on “leverage countries” to assert its interests, using dependent states to counter the West’s global dominance and increasing presence in the Indo-Pacific.

Implications for

International Businesses

  • Continued stringent and sometimes arbitrary lockdown measures constitute an ongoing risk, especially for the manufacturing industries.

  • Increased policy intervention is likely in areas like joint ventures, as highly indebted regional governments seek to implement their policies as prescribed by the central government.

  • Planned financial reforms in China that restrict foreign firms’ access to Chinese capital could require higher cash flows from foreign firms operating in China.

State of Play Beijing is struggling to address

home-grown crises

With the 20th Party Congress of the CCP scheduled for October 16 rapidly approaching, controversies are mounting over the party’s – and, thus, the country’s – future course. For one, there is dissent over personnel issues, mainly whether President Xi Jinping should serve an unprecedented third term as party leader. For another, some observers wonder aloud whether a return to the reform agenda of the 1980s and an opening-up of politics is imminent. That is because current decision-making processes are hampered by a deepening economic crisis and the still-rampant Covid-19 pandemic. The CCP has de facto abandoned the economic growth target for 2022 and not set new targets for 2023, which is a first for a party that wants to maintain confidence in its economic leadership. The economy is experiencing a steady decline and risks further inflationary dynamics. Public debt continues to rise and now extends across all provinces, making policymakers less and less able to intervene financially.

For companies operating in China or with close ties to the country, this results in growing uncertainty about the political environment. For business operations, arbitrariness in dealing with lockdown measures is increasing, which means risks for the manufacturing sector in particular. A likely increase in the hostility of Chinese foreign policy towards the West may pose structural hurdles for European companies, in particular to secure a permanent foothold in China. Moreover, geopolitical tensions regarding Taiwan as well as China’s arms buildup vis-à-vis Japan, South Korea and other East and Southeast Asian countries increase long-term risks. Especially manufacturing and R&D activities that can be linked to supply chains in dual-use areas are becoming sensitive, both for Beijing and for Western governments. Tighter restrictions of a political nature will be the result on both sides.

Key Issues Competing camps to determine China’s course at party congress

The current Chinese system is moving under enormous economic pressure toward a state capitalist system with increased political interference. For the past forty years, economic performance has been the main source of the CCP’s legitimacy. The party now faces the difficulty of redressing the imbalances caused by China’s growth model while continuing to grow fast enough to maintain political stability. In light of this, Xi Jinping has tried to turn as many stakeholders as possible into servants of overriding party interests. While competing groups exist within the party, none dares to question the overall raison d’état – the sustained leadership of the country by the party. As various corporate crackdowns over the past years have shown, the CCP is willing take any risks to achieve its goal of retaining power.

The political instability is compounded by the government’s dilemma to maintain a vibrant economy while keeping pandemical spread under control. In fact, the urgency to manage multiple crises has only increased: from handling various bank crises while simultaneously saving giant real estate firms from bankruptcy; to dealing with mass unemployment reaching new highs and the potential for social unrests; to preventing foreign investors from fleeing China while weighting the competitive threat these companies pose to withering Chinese firms.

This trend of hastened decision-making, often in seemingly opposite directions, will likely continue at least till the Party Congress next month. Whether it will also go beyond it, mainly depends on whether there will be radical political changes of the likes of introducing major reforms, and on possible personnel shifts. In particular, the new composition of the Politburo and its Standing Committee will be relevant. Opposition to Xi is growing as the economy is slowing; however, no one has clearly emerged as the spearhead of this opposition. This makes the current political situation highly risky, especially for government officials and party leaders, as they fear being removed if they choose the wrong side.

A nationalist approach to maintain power creates global tensions

Driven by internal crises, the CCP has for many years pursued a nationalist foreign policy to maintain the legitimacy of its claim to power. Against this backdrop, the Taiwan issue may be the most persuasive leverage to demonstrate the party’s determination to serve a nation yearning for historical redemption. Moreover, the portrayal of China as a rising great power is increasingly becoming a sacred principle that must be upheld, though without causing an open conflict that China could ill afford at present. This approach was on display in Beijing’s carefully calibrated acquiescence of Russia’s attack on Ukraine and even more so in its – bombastic, but also largely symbolic – response to the visit of Nancy Pelosi, Speaker of the US House of Representatives, to Taipei in August.

Guided by such nationalist doctrine, Chinese foreign policy will most likely continue to pursue to some degree a demonstrative confrontation against a “new” West that is once again broadly united behind the United States. As countries like France and Germany show a growing readiness and determination to join the Indo-Pacific Strategy of the US, Japan, Australia, and India (“the Quad”), Beijing is shoring up support from its partners. However, it does not view states like North Korea or Pakistan as allies in a classical sense, but rather as “leverage countries” that it can use to better position itself. China, as it happens, does not have a single reliable ally, and instead aims to strategically exploits its relations with such countries to assert its interests vis-à-vis the West.

Even under a new CCP leadership, a fundamental confrontation with China remains in the cards, and every stakeholder, including companies, will have to choose a side. The exchange of sanctions against major Western companies like Nike, Adidas, H&M, and the increasing coercion against Western high-tech companies to hand over their source code to the Chinese authorities already point in this direction. This will intensify, especially for German companies, if Berlin, as the Ministry of Defense announced, will increase its military presence in the Indo-Pacific to counter China’s expansion.

The recent meeting of the Shanghai Cooperation Organisation, which Beijing informally leads, was also instructive: In Xi's first foreign visit since the onset of the pandemic, he provided moral support to his Russian counterpart, coupled with mild criticism over the Russian army's rapid retreats in Eastern Ukraine. Moreover, Iran – another supporter of a "multipolar", i.e. non-US-dominated world – was formally admitted to the club. While primarily being a tool for China to manage security in its neighborhood and advance its economic interests in Central Asia, the organization is also a convenient tool for China to strengthen an anti-Western alliance


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