|Louis Kuijs, Chief China Economist at RBS|
Rebalancing growthEarly signs suggest the government may be open to some reform. New Prime Minister Li Keqiang has commented on the need for change in this area on several occasions as part of a comprehensive rebalancing of growth patterns and to raise domestic consumption. Elsewhere, meaningful structural reform will be more complicated. Levelling the playing field between state-owned and private firms is a key challenge, yet past efforts have foundered on vested interests and a lack of political will. The government needs to significantly increase the dividend it charges state-owned enterprises and thus remove what is effectively a subsidy to their cost of capital. The extra revenue raised should go to the Ministry of Finance instead of being used for industrial policy. More is required. Barriers to entry in parts of the service sector should be swept away. The line between state and market needs to be properly defined so, for example, regulators and the companies they regulate are sufficiently separated to avoid corruption corruption and inefficient state intervention. Such politically-awkward reforms will require major commitment at the very top. Chinas system of collective decision-making, consensual leadership as well as vested interests has so far checked progress. Yet attempting to sustain Chinas still-impressive growth rate without tackling these fundamental issues will leave the country with unbalanced economic and social structures. The longer it takes to implement these reforms the harder they become.
Stop runaway lendingChinas challenge in the short-to-medium term must be to avoid a runaway expansion in lending and to put the property sector on a sound footing. The government has been keen to rein in house prices since housing sales began to revive in mid-2012. However, price pressures remain and greater urbanisation, rising incomes and the skewed incentives of local government coupled with a lack of property taxation mean prices are likely to increase further. Rising social housing construction and the governments recent call for greater enforcement of a 20 per cent capital gains tax on housing sales are welcome signs of a move towards addressing the fundamental problems on the housing market. Perhaps most importantly, China must quickly address an explosion in shadow banking. Non-bank financing is now expanding so rapidly that overall leverage is rising at an unsustainable pace. It is a particular concern given that the non-bank entities tend to lend more to higher-risk firms and local government platforms. Regulation and supervision of the shadow banking sector must be stepped up if China is to avoid financial instability down the road.
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