CHINA’s current economic situation is fragile. Reports by various media sources paint a gloomy picture. Household spending is reportedly less than expected. Commercial borrowing and investments have dropped. Unemployment in the youth sector has spiked to the point that Beijing decided to stop releasing the data. A major slowdown in China raises a lot of questions for the global economy as well as tough consequences for everyone who benefits from Chinese consumer and manufacturing demand.

A growth shock would surely affect regional trade, financial flows and FDIs. Economies with direct trade exposure to Chinese demand for a range of goods may bear the brunt of a sustained slowdown in China. Slower economic growth would translate, for example, into diminished demand for iron ore, copper, aluminum and other base metals. China is one of the country’s top three trading partners. Sixty-eight percent of China’s nickel ore imports are from the Philippines. China is arguably the Philippines’ biggest source of imports. It’s also the country’s third biggest export destination.

Beijing is in a tough spot. On the one hand, it could have the perfect policy response for the problems that ail China’s economy and stabilize growth at a relatively robust pace. On the other hand, it could bet on risky decisions that may worsen matters. These have implications on the geopolitical front. An economy that grows more slowly also reduces revenue collections, which means that the Communist Party of China-People’s Liberation Army (CPC-PLA) may have some tough choices in subsidizing technological development, spreading largesse to the developing world, or defense spending that shifts the balance of power in the Pacific.

The biggest drag on China’s economy right now is its depressed debt-fueled real estate market. It’s having another meltdown. Home prices are falling, developers are defaulting, and people are angry. Financial markets have been hoping that Xi Jinping will institute tough measures to combat the slowdown. Instead, a steady stream of incremental measures is being taken, reflecting a faulty belief that the country’s economy is strong enough to weather the storm. Will it work or fail?

When China opened the stimulus floodgates during the global financial crisis of 2008 to keep its economy afloat, it worked. China made it through virtually unscathed and became the main engine for global growth. But it came at a cost: local governments borrowed some $9 trillion off-balance-sheet debt to build infrastructure. Huaan Securities Co. reports that more vehicles are missing payments on short-term debt; a number of local government financing vehicles (LGFV) are overdue on commercial paper; investors are slashing LGFV bond tenors. And there’s another debt risk warning: China’s $400 billion pension!

The outlook darkens as fresh data flash warning signs. Economists are trimming their forecasts; deflation and a balance sheet recession are worrisome. The reluctance on stimulus reflects its fragile financial condition that will cap growth this year. Clearly, the sentiment on China’s economy has grown increasingly negative, with public discourse variously emphasizing “structural” issues such as debt, demographics and China’s deteriorating relations with the West. There’s a massive crisis of confidence among private businesses and consumers that points to several factors:

First, there was the mishandling of the Covid-19 pandemic. Lockdowns and the sudden abandonment of “zero Covid” were highly disruptive and stressful.

Second, the withering attack on the private sector, particularly internet-based companies, and pronouncements on “common prosperity,” leading businessmen to fear short-lived success.

Third, the growing tensions with the US and other advanced economies that raise the possibility of war; rising doubts about future access to technology, markets and capital; and curtailed engagement with the West.

China’s VUCA (volatile, unstable, complex, ambiguous) situation is translating to a broad loss of confidence that the country’s headed in the right direction. While the CPC needs to tackle debt and demography issues, the real challenges are to: a) re-instill

a sense of a common positive purpose about China that the public will accept; b) reduce tensions with the West; and c) demonstrate basic competence in governance.

The trouble is that policy support for the economy has been piecemeal, reactive and limited in scope.

Centralized governance has positioned Xi Jinping alone to deliver confidence-building messages and no one else. He will surely rise or fall in his solo performance. Since 2012, Beijing has been re-centralizing power and controlling behavior through anti-corruption and ideological campaigns. It’s unclear whether those achieved political goals. What’s clear is that it weakened innovation and sapped entrepreneurial energy, and also blinded leaders to the core problem of state-sponsored incentive systems to which insiders say it is parasitically attached.

What that means is that without fundamental reforms, China’s economic difficulties won’t make things much easier for its trading partners. No one should assume that China’s current worries will make it any more inclined to make concessions. In fact, it may be less ready. China doesn’t negotiate outcomes that are against its core and self-interest. That includes both the impact of substantive policy and the critical dimension of “face” — how the outcome fits China’s sense of importance and image. From a “face” perspective, China will resist any economic outcome that helps perceived adversaries.

That brings us to the question of whether Xi may make the wrong decision to go to war, as other leaders in other places and eras have done, to save his skin and face before the people and the world. John Stoessinger suggests that a leader’s personality is of critical importance and that the most important single precipitating factor in the outbreak of war is misperception. Such distortion may manifest itself in four different ways: in a leader’s image of himself, in a leader’s view of his adversary’s character, in a leader’s view of his adversary’s intentions toward himself, and finally, in a leader’s view of his adversary’s capabilities and power.