Letter # 52

We could be accused of indulging our vanity, but still we are going to say this: it gives us immense pleasure to announce this 52^nd weekly letter, marking the first anniversary of us publishing every Friday. It has been an enriching experience–a lot of learnings along the way and fruitful interactions with many of you post the publication (the brickbats and bouquets are appreciated in equal measure) make us look forward to the weekends. Onto this week then!

The last week saw a sharp contrast between established tech companies reporting record profits and new age tech businesses losing billions of dollars following the crackdown by China. But July 2021 also marked the 100^th year of the founding of the Communist Party of China (CPC) and a brief peek into their past might surprise a few–starting with the fact that it wasn’t the de-facto heir to modern China. Rising decibel level of China’s activity in the Taiwan strait amidst US navy leadership continued belief that China will take control of Taiwan soon, makes for interesting times. More on that in a bit, now a brief history of how the CPC got here.

Following the collapse of the Qing dynasty (1644 – 1912), it was chaos in China. By 1923, the Kuomintang (KMT) emerged as the principal party in China. Buoyed by Soviet Union’s support, KMT agreed to cooperate with the Chinese Communist Party (CCP) to form the First United Front. But, after the death of KMT’s founder in 1925, it split into left and right wings; the left wing aligned with the CCP. By 1927, CCP and KMT were in an all-out war, pretty much till 1949 (with a brief armistice during the second Sino-Japanese war, 1937-1945). The two Chinese parties fought the Japan war differently—while the KMT preferred conventional warfare, the CPC opted for guerrilla tactics.

The end of war saw CCP’s ambitions take wider wings. Based on the terms dictated by the US, Japan was asked to unconditionally surrender to KMT (and not to CCP). In the eyes of the US, KMT, and not CCP, was the heir apparent to modern China. Despite over USD4bn in post-war aid from the US, the war had left KMT significantly weaker. CCP’s membership, meanwhile, was rising dramatically – and it went for the kill. Mao Zedong proclaimed the founding of People Republic of China on 1^st October 1949. By then, the CCP had suffered 1.3mn combat casualties, but the same number for KMT was over 7.5mn! CCP systematically pushed out the KMT government from its capital in Nanjing to Guangzhou, then to Chengdu, and later across to the strait to Taiwan by December 1949.

Since then, the CPC has kept an iron grip on China. As Richard McGregor writes in his book, The Party: “the Party has made sure it keeps a lock-hold on the state; the three pillars of its survival strategy are–control of personnel, propaganda and the People’s Liberation Army.” The Party has a central committee (300 members), which reports into the politburo (about 25 members), which then reports into the sanctum sanctorum – the standing committee (5-11 members; currently 7). Since 1949, there have been five heads of the Party, Mao Zedong (1949 – 1976), Deng Xiaoping (1976 – 1990), Jiang Zemen (1990 – 2002), Hu Jintao (2002 -2012) and Xi Jinping (since 2013).

China adopted the Soviet model of Red Army, but under Deng, it judged that the arms race had brought down Communism in Moscow and that is how Hu’s confidant, Zheng Bijian, describes the ‘peaceful rise’ of China. Under the radar, until you gain the size. Operative word being: ‘UNTIL’.

Now that China has the size, it is time to let ambitions fly. Adm. Phil Davidson (US Indo-Pacific command, 2018-2021) ⁽¹⁾, and his successor Adm. John Aquilino (since March 2021) ⁽²⁾ have separately testified that “we have seen aggressive actions [by China] earlier than we had anticipated, whether be on Indian borders or in Hong Kong or against the Uyghurs.” Aquilino believes that China considers establishing full control over Taiwan as its ‘number one priority’.

Life appears to have come a full circle – Japan surrendered to the same KMT that is now relegated to being the opposition of a much smaller Taiwan–a country the US believes will be attacked by China within the next six years.

In the early 1980s, China had devised the ‘one country, two systems’ approach to regain control over Hong Kong and Macau; Taiwan unification was next in line. Geopolitical analyst Shrivan Neftchi in his Caspian Reports says, “Beijing has used economic isolation and political interference to coerce reunification.”  Eventually, China cut ties with Taiwan in 2016 after election of pro-independence forces and increased military activity in the Taiwan strait.

China, with USD250bn defence budget, significantly outspends Taiwan’s USD11bn, but given that Japan and US will back Taiwan in a war, the playing field is levelled. An all-out war, therefore, may not be the solution. What is possible, however, is that China begins a hybrid warfare – stop short of shooting and subdue the foe through fear and exhaustion, says Shrivan, which can be decisive if performed well. China’s Airforce breaches Taiwan airspace routinely. Last year, Taiwan had scrambled its air force nearly 3,000 times against China, costing it over USD900mn. And the tempo is rising. The number of Chinese vessels entering Taiwan controlled waters stood at 2 in 2017; by 2020, it had risen to nearly 4,000!

China can keep salami-slicing Taiwan and not go for an all-out war until it is desperate for approval back home. As Richard writes, “state sovereignty, territorial integrity and economic development are all priorities of the state, but all are subordinate to the need to keep the Party in power.” The crackdown on education sector is essentially China playing to the galleries (domestic middle class) by keeping education, healthcare and real estate costs down, while pandering to the communist agenda (serving middle class at the expense of billionaire founders and venture capitalists).

Geopolitically, India is not new to China’s tactics, and recent skirmishes at its borders suggest that India is up for the task. But financially, India might need to up its game if it intends to benefit from the massive business that ‘China plus one’ strategy brings.

PLI is a step in the right direction here, but the size of many Indian businesses is still a fraction of China and Indian corporates are wary of taking on more debt to fund growth. While extending a significant helping hand to corporates would help India seize the moment, the political pliability of it is questionable. Tactical deal-making with new partners (say for Indian textiles industry with Europe, for the GSP+ status) could help as well.

From the markets’ standpoint, it would be a stretch to believe that investors that lost money in the Chinese crackdown would automatically shift that exposure to India. India still does not have the size and an even stricter capital convertibility. The ‘Rupee risk’ investment will have to compete for that international investors’ pie and the best strategy to ensure that it comes to India is by strengthening the core (helping business grow, signing on more trade deals, bolstering the economy), rather than looking for quick fixes.

Notes:
(1) Davidson: China Could Try to Take Control of Taiwan In ‘Next Six Years’ – USNI News
(2) Chinese threat to Taiwan ‘closer to us than most think,’ top U.S. admiral says | CTV News
The story was originally published here: Historical Context To China’S Crackdown; Where Does India Fit? (cnbctv18.com)

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