As China's economy teeters under COVID-19 and housing market in meltdown, President Xi Jinping looks set to become permanent ruler

Talk about timing. By this time next week, China's President Xi Jinping will be well on the way to securing a stunning personal victory.

After a decade of leading the world's second-largest economy, lifting China's global influence and positioning the country as a military superpower, Xi next week will cement his own destiny by securing a historic third term as general secretary of the Communist Party and head of the military.

For all intents and purposes, he will become China's permanent ruler.

It has been a close call. The deft political footwork required to jettison a four-decade rule that limited power to two terms has been steadily unravelling. The country's economy is teetering under funding shortfalls and mounting debts, a shambolic response to COVID-19 and a residential property sector threatening to implode.

When it comes to our future, and that of our region, nothing matters more than China.

Once the economic miracle whose growth helped propel Australia through the Global Financial Crisis, China now is facing serious economic problems.

Just as Japan entered a decades-long stagnation in the 1990s, China's growth, fuelled by huge government spending, is stalling as it enters what is known as the "Middle Income Trap".

That would be concern enough, given it is our biggest trading partner by a country mile. But add in Xi's determination to install himself as supreme ruler, and his strategy of shoring up domestic support with an aggressive military stance abroad and the situation becomes extremely worrisome.

Turning back the clock 

In 1982, Deng Xiaoping imposed the two-term rule in a bid to forever avoid a repeat of the social and economic disaster presided over by Mao Zedong.

It was a policy that paved the way for China's industrialisation, growing sophistication and its ascension into the economic superpower club after decades of famine and oppression under a brutal dictatorship.

If Xi's rule is so far notable for anything, it is for his focus on his own position rather than on rectifying the myriad of deep-seated macroeconomic problems threatening to undermine the country's future.

Cementing his own power base, regardless of the cost, has become a hallmark of his leadership. From political rivals who were quickly dispensed with early on under corruption crackdowns, Xi in more recent times has turned his attention to the country's homegrown billionaires.

Jack Ma, the founder of Alibaba, may have been the highest-profile victim of the purge. But it extended to the hierarchy behind many of China's most successful tech companies including Tencent and Didi. Before long, authorities had trained their sights on education companies, to the dismay of western investors.

Not long afterwards, at least 73 firms announced they would contribute to Xi's "common prosperity fund", a term that harks back to the days of Mao.

What is wrong with China's economy? 

Where to start?

In the short term, Xi's insistence on eliminating COVID-19 has been a disaster. Huge parts of the country's manufacturing base and its distribution networks have been shut for extended periods at enormous cost, making China the only country to continue stringent lockdowns.

There is a reason for that. Its vaccine rollout, particularly for the elderly, was haphazard and slow. In addition, its homegrown vaccines have been next to useless against more recent COVID variants and its hospital system is inadequate.

That's taken a toll with growth slowing, potentially slipping into reverse, which will weigh on a global economy foundering under the weight of interest-rate hikes.

But there are more fundamental problems with China's economic structure.

The first is that household income is painfully low and savings are way too high. That means household spending – the engine for most developed economies – just doesn't cut it. To compensate, economic growth has been driven by Beijing spending huge amounts of borrowed money on investment.

True, the country has incredible infrastructure with high-speed rail, massive highways and modern cities. But maintaining that momentum involves pouring ever more cash into ever more marginal projects that don't deliver quite as much. Eventually, you end up with roads and bridges to nowhere and cities with no residents. And a mountain of debt.

Longer term, China has an even more serious demographic problem.

Its working-age population peaked in 2014 and, depending on which study you read, its population will start shrinking as early as next year. According to the Centre of Strategic and International Studies, that will knock between 2 and 3 per cent from its growth rate by 2030.

Property market in meltdown 

The rest of the world may be in a frenzy of interest-rate hikes. Not China.

For the past few months, the Peoples Bank of China has been cutting interest rates in a bid to spur on growth. It cut rates twice in August and there is talk more are in the offing.

That has sent the currency, the yuan, into freefall in recent months, prompting a scramble by the Peoples Bank of China to support it.

Despite the lower interest rates, home prices keep heading south. They've fallen every month for the past year with sales down around 20 per cent, a situation now threatening to create a revenue problem for the government.

Chinese property developers, meanwhile, are in a world of pain. Once among the world's most highly valued real estate enterprises, they now rank globally for all the wrong reasons. A series of high-profile debt defaults, led by China Evergrande, has seen investors flee the sector.

Given property development has been a major source of growth for China's economy, a slowdown will have major ramifications for Australia, and our economy.

That's got our policymakers in a lather. A fortnight ago, the Reserve Bank of Australia published a report on the outlook for Chinese developers. It didn't paint a pretty picture.

The graph above, which excludes the beleaguered China Evergrande, highlights the contagion that has swept through privately owned property developers during the past two years as investors have fled indebted operations that can't muster government support.

Troubles on the home front

The crisis initially was sparked by a policy shift in Beijing that attempted to rein in debt within the sector with what was known as the "Three Red Lines" policy. It backfired spectacularly as "these regulations made the financial position of the riskiest developers even more precarious in the short term as they attempted to quickly deleverage".

The problems rapidly spread. Unable to obtain finance, property developers were forced to stop building or to scale back operations, which only exacerbated the problems.

"Consequently, the vast majority of major listed property developers and more than half of all listed developers, have now either already defaulted or been under severe financial stress," the RBA report notes.

Alarmingly, it adds that local councils, which depended upon revenue from land sales to developers, are now trying to replace the lost revenue by selling instead to state owned finance vehicles, a kind of round robin deal to mask the problem.

Meanwhile, angry home owners who had paid for apartments where construction has stalled, have refused to continue mortgage repayments, threatening to destabilise the banking system.

Despite these troubles, Xi has continued his hard line on developers having declared years ago that housing was for shelter not speculation.

His sentiment may be correct. Ultimately, however, as western governments learned during the Global Financial Crisis, taking the moral high road (letting Lehman Brothers collapse) can lead to chaos.

In China's case, it is likely to lead to a state bail-out and a winding back of the great flirtation with capitalism.

Xi's reign could look more like Mao's.