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China’s leadership transition doesn’t look good if you’re a foreign business

China’s 18th party congress began today. The country’s new leaders, whose identities will be formally revealed on or around November 15, look likely to be a fairly conservative group when it comes to economic and political reform. That shouldn’t harm China’s giant import and export markets, but it augurs badly for foreign companies, particularly in the banking and media sectors, who are hoping to get rich selling services to China’s  close to 1.4 billion consumers.

“The new leadership are closely allied with China’s state owned enterprises and will want to protect these companies, including the state-owned banks, from competition,” says Dr. John Lee, an associate professor at the University of Sydney who studies the various factions within the Communist Party. “China’s current generation of leaders have also left a mess behind, socially and economically,” he adds. “The new leaders’ instinct will be to kick into survival mode economically. And to clamp down on social controls.”

Here is what Dr. Lee’s insights probably mean for foreign businesses trying to work in China.

Western financial institutions, after battling for fair treatment in China for a decade, are now fighting even more of a losing game. China’s likely new premier Xi Jinping, Dr. Li explains, is a so-called “princeling”. This is a group from established Communist Party families who are loyal to former Chinese leader Jiang Zemin and who basically support China’s status quo. Part of that status quo is China’s state owned enterprises (SOEs) including the nation’s biggest banks.

The princelings’ relatives often have key jobs (paywall) in SOEs, including the banks, and derive great wealth from them. If China’s economic slowdown continues, fortifying SOEs will be a priority for a new princeling-dominated leadership.

The new leaders will do all they can to protect China’s broken banks. The banks were used to finance China’s massive economic stimulus in 2009-2010, including many questionable projects, and they remain an important source of funding because China lacks a well-developed bond market. That leaves them looking vulnerable because of a likely pile-up of bad loans. They also sold sub-prime loan derivatives, much like those that set off the US housing and financial crisis, to retail investors, and will likely have to repay them if the Ponzi-like vehicles implode.

What this protection could amount to is that foreign banks interested in taking stakes in Chinese banks may face trouble. Canada’s Scotiabank announced a deal to buy a 20% stake in Bank of Guangzhou 14 months ago and to increase its existing holding in Bank of Xi’an, and is still waiting for regulatory approval. Foreign banks in China wanting to open new branches will likely find it slow going too. It would make them more competitive with Chinese banks, whose depositors generally end up with negative interest rates after inflation.

And foreign banks’ share of the Chinese market is already tiny. Back in 2001, one of the promises China made upon acceding to the WTO was to open up its banking sector to external competition. This has not really happened. Institutions such as HSBC and Citigroup regularly play up the importance of China to their businesses. In fact, foreign banks’ market share in China is just 2%, the smallest of any major emerging market.

Meanwhile, China could become more inward-looking and less likely to lift media repression. There are two media hardliners among the likely leadership line-up. One is Zhang Dejiang, who replaced the disgraced Bo Xilai as party secretary of Chongqing and who has earned the nickname “the iron fisted enforcer”. Zhang clamped down on reporting of the outbreak of the deadly SARS virus in southern China’s Guangdong province when he was party secretary there. (According to the Brookings Institute, Zhang also studied economics in North Korea and is the son of a former major general of the People’s Liberation Army and a “protege of Jiang Zemin”). The other is Liu Yunshan, whose current job title is “director of the Communist party propaganda department”.  Liu has been accused of blocking the liberal faction of the Communist Party’s calls for political change from Chinese media. Dai Qing, a friend of detained Chinese Nobel laureate Liu Xiaobo, reportedly said of Liu Yunshan that “if it is he who will oversee ideology, there will no longer be any hope.”

If the reports about a hardline leadership prove accurate,  foreign media outlets’ access to China will probably weaken further. Google has left China. Bloomberg has been occasionally blocked and the New York Times’s Chinese-language site, launched this summer, seems vulnerable after the paper’s investigation into the wealth of outgoing premier Wen Jiabao’s relatives.

Western social-media companies have little chance of breaking into the Chinese market now. The conservative faction of the Communist Party wants less social media, not more. Weibo, a Chinese version of Twitter that has around 300 million users and functions as a giant, virtual forum in a nation where speaking in public remains a big risk, is already a headache for party hardliners. (Progressive elements of the party favor influencing the conversation on social media instead of repressing it.) Facebook’s Mark Zuckerberg has read the tea leaves and shelved any ambitions he may have harbored to crack China.

An economic reformer who is adored by Western financiers will get a post, but not necessarily an influential one. The New York Times reported that Wang Qishan, a man who “advocates for far-reaching economic policy changes in China have long pinned their hopes on,” will likely make the final leadership line-up. But he will “be relegated to a Communist Party position that will carry limited influence over economic policy.” The Financial Times believes Wang, who it describes as “a straight talker with a good feel for media, a strong grasp of finance”, will make the top team though it is a “big unknown” whether his powers “will be deployed in the economic arena.”  The US administration will have its fingers crossed for Wang. Former US Treasury Secretary Hank Paulson once wrote an entire article for Time magazine about how much he likes the Chinese reformer.

And a liberal popular with China’s urban intelligentsia seems to have been shunted out. Wang Yang, who currently leads the freewheeling and economically advanced southern Chinese province of Guangdong, was recently viewed as likely to make China’s new leadership. According to the SCMP, he is out. Wang has made loud calls for the Communist Party to reform itself. Following rioting in a small village in his province named Wukan, Wang allowed the villagers to hold democratic elections. The Financial Times proclaimed  (paywall) that Wukan offered a “democratic model for China.” In fact, incidents like those in Wukan are what princelings fear the most, as they threaten to upset the status quo.

But retailers, car makers and fast food chains should continue to do well. “Western retailers are OK,” says Dr. Lee. “The party doesn’t believe branded goods and consumer choice make people agitate for more personal freedoms. Retail is really not a sensitive sector.” So companies such as Yum Brands and BMW, who have thrived in China, will probably carry on expanding unless their ambitions are curtailed by the country’s economic slowdown.

Meanwhile, here is an excellent explainer from CNN on the secretive process the Communist Party is going through to choose the next leaders, and why this is such a politically sensitive time for the nation and its authoritarian rulers.

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