Xi's challenge to keep China growing

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China’s incoming leadership must to do more to fix deep-seated structural problems hurting the economy. If they don’t face up to the challenge, the country’s future growth and social cohesion is at risk, says Louis Kuijs, Chief China Economist at RBS.

Louis Kuijs, Chief China Economist at RBS
Early signs suggest President Xi Jinping and China’s other new leaders, who officially assumed power at the National People’s Congress (NPC) in March, are open to reform. New leaders have already criticised official corruption and lavish spending within the Communist Party to assuage public anger. China watchers are now studying what is said at the NPC for signs of change in economic policy, or a new emphasis on tackling deep-rooted problems within Asia’s biggest economy. The first such challenge is migration. Every year an estimated 13 million rural Chinese move to the city. More than half its 1.3 billion citizens are now urban dwellers.A more managed approach to migration has helped China avoid the shanty towns that blight big urban centres in parts of Latin America, Asia and Africa. But its approach to urbanisation needs to change. By restricting newly-arrived migrants’ access to public services and affordable housing the government is constraining the economic potential of millions of would-be consumers and service-sector workers. That hurts China’s broader aim of rebalancing the economy towards more consumption and services and away from a reliance on investment and industry. A major advance here would be a change in China’s controversial residency system – the hukou – to give newcomers better access to health, education, social security and affordable housing. At the same time, the government should overhaul the fiscal system 2013to give local administrations the means, and incentives, to fund public services and affordable housing for migrants. At the other end of the migratory trail, rural land reform is needed to consolidate land holdings and improve agricultural mechanisation to raise rural residents’ incomes.

Rebalancing growth

Early 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. China’s system of collective decision-making, consensual leadership – as well as vested interests – has so far checked progress. Yet attempting to sustain China’s 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 lending

China’s 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 government’s 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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