China Looks to Tame an Economic Slowdown

China enters 2015 amid a deepening economic slowdown. Steady declines in home prices, home sales and real estate-related investment, combined with the impact of still-weak external demand and rising input costs for Chinese exports, all but ensure that China's economic growth in 2015 will fall to its lowest level since 1990. Stable growth in services industries, buttressed by rising household consumption, will mitigate some of the negative social and political effects of slowing industrial activity. However, these components of China's economy are not yet strong enough to offset the inexorable winding down of China's decadeslong export and investment boom. The core questions for China in 2015 do not concern whether or for how long the country's economic slowdown will continue — declining growth will remain the norm this year. Rather, the questions are how this slowdown will play out socially and economically across China's many diverse regions and whether the country's political and administrative structures canevolve to meet its rapidly changing needs.

Slowing economic growth in 2015 will bring to the forefront deep-set regional economic imbalances — not simply between the coast and the interior, but between different parts within coastal and inland China. Some provinces will feel the pain of declining housing and infrastructure construction disproportionately. Northern China's traditional coal, steel and heavy industrial hubs like Hebei, Shanxi, Inner Mongolia and Heilongjiang, where reliance on the health of nationwide real estate markets is highest, will be hardest hit. Naturally, these provinces will be the locus for local government and corporate debt concerns in 2015. As average home prices fall further, the likelihood of localized debt, economic and employment crises in these regions rises substantially.

At the same time, China's internal regional economic and financial fragmentation will limit these economic crises to a few provinces, providing a subtle but powerful buffer against nationwide financial contagion. This is the same fragmentation that Beijing seeks to overcome in the long run. Thus, even as the resource- and heavy industry-based northern Chinese economies grind to a halt this year, the country's more prosperous and heavily urbanized coastal and Yangtze River regions will see more stable growth bolstered by stronger services industries, more robust internal consumption bases and rising investment into higher value-added manufacturing.

The Chinese government will not seek to reverse the country's economic slowdown this year. Instead, it will rely on a combination of tools to ensure that the slowdown remains measured. First and foremost, it will use centrally allocated infrastructure investment, direct capital injections and targeted relaxation of local government housingand spending controls to support strategically significant industries and regions or to soften the impact of crises in others. Additionally, it will act as needed to ensure that the core state-owned banks and their provincial branches have ample liquidity to metabolize rising non-performing loan ratios and maintain a steady flow of credit to favored businesses. Beyond these measures, however, the Chinese government will let the country's economic slowdown do what central authorities have long struggled, and failed, to accomplish: push forward industrial consolidation, weed out unprofitable and wasteful investment, and curb endemic housing and basic materials oversupply. Ultimately, this process could pave the way for a more competitive and productive Chinese economy. However, during 2015, China will feel much of the pain and few of the benefits of industrial consolidation, all while maintaining just enough support to the economy to prevent that pain from becoming critical.

Beijing will take advantage of the housing and construction slowdown to implement a number of long-awaited economic and social reforms in 2015. First, it will expand fiscal reform measures, such as a municipal bond pilot program and value-based resource taxes, in an effort to reduce local government reliance on land sales for revenue, thus removing a key structural driver of China's post-1990s housing and infrastructure boom. In conjunction with fiscal reforms, the expansion of property taxes to more regions and the creation of a national property registration system, both set to take effect in the first half of the year, will undermine real estate speculation and help bring prices further in line with real average income levels, especially in the small- and medium-sized cities Beijing has targeted for future urbanization. China also will establish a national deposit insurance program, widely seen as a key step toward building a more mature and open financial system. Moreover, Beijing will adjust its household registration, or hukou, system to better manage shifting labor flows as some parts of the economy slow faster than others. Finally, the year will bring tangible progress on efforts to make the state-owned sector more internally competitive and to open key emerging industries — notably, shale gas exploration — to greater private and foreign participation.

Implementing these and other reforms will not be easy. The central government's powerful security and Internet censorship apparatuses will keep visible signs of outright opposition to a minimum. Yet at the local level and within state-owned enterprises and ministries, resistance to measures that threaten employment, social stability and vested interests will run high. The deepening economic slowdown and rising urgency of reform will fuel continued efforts by Chinese President Xi Jinping and his closest allies to consolidate their influence over Communist Party, government and military apparatuses and to bolster the central leadership's public image. In 2015, as in the past two years, the anti-corruption campaign will be the central vehicle for doing both. As before, anti-corruption drives in 2015 will target a combination of high-level officials across the military and strategic industries and regions as well as local-level officials and middle-level functionaries, with perhaps a growing emphasis on combating local corruption through policies like the national property registry. In line with this, 2015 will likely bring several waves of large-scale arrests and demotions, along with rising capital flight as officials accused of corruption seek to move assets overseas.

China's Maneuvers in its Periphery

Economic, social and political stress at home will not halt China's push to expand its diplomatic and security presence in the countries with which it shares land borders. China also will work to expand its overland transport, trade and energy connections with its land neighbors. In particular, Beijing will focus in 2015 on bolstering security and investment ties with Central Asian countries and Afghanistan and Pakistan as it seeks to stifle unrest in Xinjiang and curb its rising dependence on overseas trade in energy, resources and goods. Likewise, Beijing will continue cementing infrastructural ties to mainland Southeast Asia, with a focus on expanding rail and road transport between southwest China, the Greater Mekong Subregion and Myanmar. Last but not least, China's leading energy firms will deepen cooperation with their Russian counterparts in 2015 as Beijing looks to diversify its energy supply routes and hedge against Japanese-Russian energy cooperation.

This year will not be quiet by any means in the East and South China seas, especially with several Chinese construction projects on islets and atolls in island chains such as the Spratleys scheduled for completion. Likewise, as Stratfor has noted before, the steady proliferation of naval and commercial maritime vessels in both seas raises the likelihood of accidental collisions or confrontations. However, Beijing will also work to mitigate strong reactions from its maritime neighbors. Although China is seen as an assertive, and by some accounts aggressive, power in the South China Sea, it also carefully weighs its actions to avoid the strongest countermeasures. Beijing will make its maritime security elements — essentially its coast guard — more active than its navy in order to force China's neighbors to focus their procurement dollars on coast guard rather than naval vessels. It also will continue to hold out a potential code of conduct to the Association of Southeast Asian Nations as a way to keep the group divided and reticent of stronger military ties with outside partners, as they see some opportunity to constrain Chinese actions without being caught between Beijing and Washington and Tokyo.

Japan's Abe Focuses on Revival

National snap elections in December 2014 gave Japanese Prime Minister Shinzo Abe and his hopes of precipitating a Japanese economic, diplomatic and military revival a second wind. In 2015, Abe will try to use his strong parliamentary position to push through the politically sensitive structural economic and social reforms necessary to transform the temporary gains of monetary easing and fiscal stimulus — the first two "arrows" of his economic strategy, known colloquially as Abenomics — into sustainable, long-term economic growth.

At the top of Abe's agenda this year will be reforms to the worker dispatch law to make it easier for businesses to hire and fire employees, and measures to increase immigration and expand female workforce participation. Efforts to open domestic agriculture markets to foreign competition will help pave the way for Japan's accession to the Trans-Pacific Partnership in 2015. At the same time, Abe will continue pushing Japanese conglomerates to raise wages, offsetting the costs to businesses by further cutting corporate tax rates. In 2015, these measures will compound continued monetary expansion and steady fiscal stimulus to stem the tide of recession from 2014. However, unless and until structural reforms are firmly in place — and have the desired effect of raising worker productivity and substantially expanding the workforce — any gains likely will be temporary, especially as prolonged low oil prices dampen the effects of the Bank of Japan's monetary stimulus efforts.

Abe's economic maneuvers will meet with stiff resistance from powerful industrial lobbies and ministries, including the Ministry of Finance and elements within the Bank of Japan concerned about the mounting costs of servicing Japan's staggering sovereign debt and covering other social expenditures. During 2015, resistance within and beyond the government is not likely to reverse Abenomics, but will constrain any future move by the prime minister to expand bond purchases and fiscal stimulus.

Economics is only one component of Abe's national revival strategy. Equally important are military normalization and diplomatic engagement, especially in Southeast Asia. In 2015, Abe will make as much, if not more, lasting headway on these fronts as on the economy, with Japanese investment and trade ties with ASEAN set to grow and with Abe set to push harder for a formal revision of Article 9 of the Japanese Constitution, which would allow the country to have a regular military instead of just self-defense forces. However, in 2015 these matters will take a backseat to the debate over Abenomics.

In the area of foreign policy, some progress could occur in Japan's relations with Russia. Tokyo and Moscow are simultaneously facing constraints and compulsions that make it more vital than before to move beyond their lingering territorial disputes and enhance their energy and resource investments and trade, and both countries' leaders see a brief period where action can be taken to solidify a deal. Although far from guaranteed, a diplomatic agreement on the disposition of the Kuril Islands, which Japan calls the Northern Territories, is likely in the first half of the year, paving the way for both the formalized end to any lingering uncertainties from World War II and a shift in Japanese investments in the Russian Far East. Overall, Russia can be expected to be more active in Japan and China and both Koreas in 2015 and in expanding its economic relations in Southeast Asia, particularly Vietnam.

Southeast Asia's Economic Ambitions

This will be something of a watershed year for Southeast Asia. Plans to integrate the region into a single market for investment, trade and skilled labor by Dec. 31 — under the rubric of an Association of Southeast Asian Nations (ASEAN) "Economic Community" — will by no means be realized fully. Stratfor nonetheless expects significant discussion and concrete steps to be taken toward reducing the regulatory hurdles and bridging the political and economic divides that have long undermined ASEAN unity. As a result, Southeast Asia is likely to remain a favorite destination for overseas investment in 2015, especially from Northeast Asian investors like China, Japan and South Korea.

Regionwide integration and investment trends will be amplified — and in some cases constrained — by internal developments in individual ASEAN member states. Indonesia faces an ongoing struggle to recentralize political and regulatory powers and create a more stable and transparent environment for investors. Thailand is attempting to maintain unity and cohesion in the face of still-simmering regional divisions and a looming royal succession. In Myanmar, the government is making efforts to reach some form of accord with ethnic rebel groups before general elections late 2015. On all fronts, Stratfor expects progress to be halting and limited, constrained as each country's leaders are by other forces.

Latin America

Venezuela's Tumultuous Year Ahead

All the elements are in place to make 2015 a year of protests and difficult political decisions that will challenge the stability of the Venezuelan government. The downturn in global oil prices will strain Venezuela's public finances, which require oil prices to be much higher to satisfy the country's extensive social spending — a key element in guaranteeing voters' support for the government. Venezuela will struggle to fund imports at levels sufficient to meet public demand, and prices of food and goods will continue rising throughout the year. These shortages and inflation will lead to rising discontent among the Venezuelan public, which could spur another wave of protests. As the economic crisis mounts during the year, factions within the ruling United Socialist Party of Venezuela will have more incentive to undermine President Nicolas Maduro's rule. With rising discontent from potential voters and impending legislative elections in December, these factions could move to erode Maduro's power or even seek his resignation.

The stress on Venezuelan government finances will force Caracas to make crucial economic decisions. The government will try to obtain foreign currency wherever possible, but social spending cuts remain very likely. The degree of unrest on the streets will influence the scope of the government's cost-cutting plans. If widespread protests persist, Caracas will likely prioritize funding for domestic needs over debt payments to foreign bondholders or private firms. Venezuela's deepening economic recession likely will lead the government to continue reducing oil and refined product shipments to nations in the Petrocaribe energy alliance and to Cuba in an effort to maximize the country's foreign currency availability.

The Venezuelan government will also face a key political challenge in the December elections. The ruling United Socialist Party of Venezuela will go into these elections without a strong and charismatic leader at its helm and in a severely depressed economic environment. If the ruling party suffers an electoral setback, such as the loss of the legislature, rifts within the party will widen, and political rivals could begin efforts to challenge Maduro.

Driven by the potential threat posed by Cuba's re-engagement with the United States and the immediate threat from its ongoing domestic economic crisis, Venezuela will pursue a political rapprochement with the United States. Although Caracas will be looking for economic or political lifelines, Washington alone will not be able save the Maduro regime. The success of Venezuela's overtures to the United States will largely depend on Washington's desire to engage Venezuela.

Date: 2016-04-22; view: 605