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Chinese Step Up Antigraft Drive Despite Impact on Consumption

With the arrest of Zhou, President Xi signals a renewed push against corruption that analysts say could bolster economy in long run.

The recent takedown of former Chinese security czar Zhou Yongkang is the country’s biggest political purge since former paramount leader Deng Xiaoping led a putsch against the so-called Gang of Four, who controlled the Chinese government at the end of the Cultural Revolution.

Zhou, 71, made his name as chairman of China National Petroleum Corp. before vaulting to the Politburo Standing Committee, where he was put in charge of security and police agencies more than a decade ago. Although he retired in late 2012, Zhou remained very powerful, as many top security officials owed him their allegiance. On July 29 the Communist Party announced he had been arrested and was officially under investigation “for grave violations of discipline,” party shorthand for corruption. The move against Zhou is the culmination of an anticorruption campaign launched by President Xi Jinping 18 months ago. A total of 182,000 Chinese officials have been caught in the dragnet, including 31 senior-level officials, among them Bo Xilai, a former member of the Politburo and ex–party chief of Chongqing.

Sources say many officials, afraid of being caught up in the campaign, are refusing to take gifts from political favor seekers or even go for drinks with businesspeople. “I used to know whom to bribe at each of the ministries to get things done,” says one Chinese executive in the oil and mining business, who asked not to be identified by name. “Now these people refuse to even go out with me for drinks or dinner, let alone take money from me. Things are just not the same anymore.”

“The campaign has achieved sweeping results,” says Shen Jianguang, Hong Kong–based chief Asia economist at Mizuho Securities Asia.

The anticorruption drive has been good for lifting the spirits of Chinese citizens who have long been angry at officialdom and its luxurious ways but bad news for Chinese high-end consumption. Retail sales rose 12.6 percent in July from a year earlier, up slightly from 12.4 percent in June but down from 13.2 percent a year earlier. The high-end retail sector has been hit hard, though.

Sales of luxury goods in China may have topped 116 billion yuan ($19 billion) in 2013, but growth was just a tepid 2 percent, down from 7 percent growth in 2012 and 30 percent in 2011, according to report by Bain & Co. A gifting culture, especially the purchase of expensive gifts for officials in exchange for political favors, made China a mecca for global luxury brands, but those firms are feeling the pinch from the anticorruption drive.

“The anticorruption campaign has achieved sweeping results in China’s economy,” says Shen. “However, along with the government’s frugality drive, these measures have ensnared government and business spending, especially on luxury consumption, liquor and restaurant sales.”

Growth in catering sales, for example, slowed to 8.7 percent year-over-year in March 2013, from 13.4 percent in January 2012; the growth rate has settled at about 10 percent subsequently, Shen says. Sales of tobacco and liquor, as luxury gifts, also eased significantly since 2013. Diageo, the British distiller that produces Johnnie Walker whisky and Smirnoff vodka, reported that its Chinese sales dropped 23 percent year-over-year in the second half of 2013, with sales of its distilled Chinese liquor, baijiu, plummeting 66 percent. The company said antiextravagance measures in China had “severely impacted” its business there.

Although Xi’s anticorruption campaign has hit consumption in the short term, the efforts could have benefits for China’s economy in the longer term, says Shen. China is no longer the low-cost production center of the world, a result of rising wage and land costs and the appreciation of the renminbi, he notes. The government needs to boost economic efficiency to sustain strong growth, and enhancing transparency is vital to improving efficiency, he adds. “Reducing corruption could bring significant marginal impact on China’s growth,” Shen contends. In 2013 China was ranked 80th out of 177 countries in Transparency International’s Corruption Perceptions Index.

As a case in point, Liu Zhijun, the ex-minister of Railways, was the first top-level official to be arrested for corruption, Shen notes. The ministry has since been dissolved, with duties divided between the Ministry of Transport, which oversees safety and regulation, and China Railway Corp., which oversees construction and management. “The investment in the railway sector has since restarted as an important driver for China’s economic growth in 2014,” Shen says.

The Fourth Plenum of China’s 18th National Congress will convene in October, and the focus will be on rule by law. This suggests that the current anticorruption campaign is different from the previous efforts in that President Xi will institutionalize the process. Shen argues that the anticorruption push will help Xi’s push for further economic reform, especially allowing the private sector to take stakes in state-owned enterprises and financial market liberalization.

Xi’s anticorruption campaign is a high-stakes bet that may not be easy to win, contends Jonathan Fenby, managing director of China research at London-based emerging-markets research and consulting firm Trusted Sources.

Less than a week after the authorities announced the investigation of Zhou, reports of tough anticorruption talk by Xi appeared to raise the stakes even higher. The president reportedly told the Politburo in a closed-door meeting in late June that his campaign had reached a stalemate because of resistance from an “army of corruption,” and added that the Communist Party’s “destiny” was at stake in the outcome. An account of the meeting surfaced in a small party newspaper in northeast China, the Changbaishan Daily.

“If there were any doubt about how seriously he takes the campaign, this latest turn of the screw shows the Chinese leader is ready to tie his future to its success,” Fenby says. “This significantly raises the temperature in China as Xi and the new leadership have made the drive the core element in implementing their economic reform agenda.”

Not everyone is as sanguine about Xi’s drive to root out corruption, though. “Xi is just driving a stake into the heart of his former rivals, and it is China’s consumption that is suffering,” says a government adviser who asked not to be identified by name. “Every time a new leader comes into office, he wants to rout the opposition. Only this time, Xi isn’t just routing the opposition; he is making everyone suffer, especially those who cater to the entire feeding chain that caters to Chinese officials and officialdom.”

Follow Allen Cheng on Twitter at @acheng87.

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