To reinvigorate the economy, China’s government will have to deliver on promises at key autumn meetings, writes Mark Godfrey.
After a summer of promises and pledges, China’s new government gets to deliver in November when Xi Jinping and his Communist Party of China (CPC) cadres meet in Beijing for a plenum that’s being billed as the most important in 20 years. China’s economy has been slowing faster than expected in the past three years and needs a new dose of reforms like those introduced by reformer-premier Zhu Rongji in the 90s. China’s economy has been running out of steam in the past three years as the old way of stoking growth – using lots of concrete and steel – is losing its effectiveness. Reforms are made all the more urgent by the fall in return on capital in China, from 18% in 2005 to 12% in 2013, suggesting the limits of China’s low-wage, investment heavy economic model has been reached. We’re now in the era of ‘Likonomics’, named for current premier, Li Keqiang, who promises no more artificial stimulus spending and lots of deleveraging and reform. The Li-Xi duo promise a switch to ‘consumption led’ growth but doing that will require painful but overdue change.
Economic reforms
The Communist Party has set November as the date for the third plenary session of the 18th CPC Central Committee. The naming of a date suggests that the Xi Jinping administration has reached a broad consensus on key economic reforms to be unveiled at the meeting. The biggest target of reform is the financial system. China’s next shot of growth will come from reform of the economy so that private capital is allowed a meaningful presence in sectors like energy and finance, where state giants have dominated. It’ll be surprising if the CPC doesn’t announce financial liberalisation – principally, a shift to free market interest rates and the easing of controls over inflows and outflows of capital as a final step to full convertibility of the Renminbi. Five state-owned banks account for 26% of China’s corporate profits while ‘the three oil cans’ as Sinopec and behemoths are known, contribute another 10%. The entire private sector, which contributes the bulk of China’s jobs, account for only 20% of corporate profits.
Political influence
The success of reform will depend on how deep the Xi government go on the state-owned sector, and in particular, the banks, criticised by former premier Wen Jiabao for holding back China’s economy by refraining from lending to the private sector. The banks were cushioned from foreign competition and have smothered private firms from getting into commercial lending. Risk and political influences have kept the big four lenders focused on the needs of fellow state-owned firms but more recently they’ve gone for high-return wealth management products which do little for the real economy here.
Faced with a liberalising of the interest rate system, China’s banks have to compete for deposits and allow depositors a realistic return. To date, China’s government set interest rates to guarantee profits for the banks through a healthy spread between deposit and lending rates. The spread has allowed a clean up of frequent bad loans messes at the expense of ordinary depositors whose interest return has hardly kept up with inflation.
Privatisation
In the longer-term privatisation of infrastructure – the source of so much local government debt in China – will also be required. Useful assets like railways and highways – built with local government debt – don’t generate cashflows. The solution here is to finally let private capital – and with it management expertise – flow into infrastructure development in China. Again, vested interests stand in the way, though the largest of these, the famously corrupt Railways ministry, was recently dismantled. It’s unclear how, or if, reforms will target China’s dysfunctional real estate market: the price to rent ratio in the industrial city of Tianjin is a lofty 30-1 and even higher at 60-1 in Hangzhou, way off international norms of 15-1. More alarming is the price to income ratio: 20 in Shenzhen, 13 in Beijing, compared to five in New York.
So what are the solutions? Giving a new income model to local government, who rely on speculative land sales for 70% of earnings, is one way to tackle the issues. Solution two would be to set and collect a property tax that makes hoarding empty property and land less profitable. More powers must be devolved to allow local governments to collect taxes, thus reducing their reliance on land sales and borrowing. Local officials need the money, but many officials won’t want the openness required.
Much political jockeying on policy details lies on the road to November’s meeting. It’s not clear that Chinese policy makers have the nerve to carry reforms through. Predictably, Beijing is trying to promote growth, through piecemeal, region-specific subsidy support. This will allow the mandarins to announce change from a position of strength.
Some of the strengths of the Chinese economy give room to make reforms. Private debt remains low, personal savings high at 50% and public debt to GDP is comparatively low. But savings rates will fall as consumption rises. And the country’s plans for better social and healthcare protection have to be paid for. China over the past decade has made plenty of promises on restructuring the economy – who now remembers previous calls for ‘innovation-led growth’? Yes, that didn’t really work out. Does Xi have the mettle to deliver on the latest, urgent promises and pledges? We’ll know in November.
