China rebalancing: winds of change

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The economy continues to defy the doom-mongers, but to nurture a sustainable and domestic-led growth model China’s new leadership must embark on painful, destabilizing and controversial reforms.

China’s mid-year economic wobble now seems a distant memory. Summer 2012 saw predictions of looming disaster: a dawdling export sector, sluggish retail consumption growth and a crash in fixed asset investment. Now, rebalancing is gathering pace.

Nevertheless, in recent years, many in the west predicted – not without a dash of schadenfreude – tough times ahead for the People’s Republic. In China’s provinces, there was a gleeful rubbing of hands. Regional governors sat around waiting for a panicky Beijing to pump trillions of dollars into local infrastructure projects via state banks. When nothing happened, some governors announced their own stimulus plans in an effort to force Beijing’s hand.

At the highest levels, it’s clear that China’s top mandarins finally recognise the glaring need to rebalance an economy skewed in favour of an export-oriented state sector – an economy where private firms scrabble around for cash while government-run banks channel low-interest loans to often poorly managed state-owned enterprises (SOEs); where a bloated state runs marketable goods and services, from banks and telecoms to power producers and insurers.

China’s leaders know too well that the country can no longer pursue economic growth, propelled by low-margin bulk exports earned by uncompetitive SOEs or by pump-priming the economy with trillions of stimulus dollars. That worked once before, but China, notes Jim Walker, founder and managing director of Hong Kong-based economic consultancy Asianomics, now “has no real choice but to cap the credit impulse”.

The $600 billion stimulus package of late 2009, he adds, unleashed “generalized inflation”, created overcapacity in steel and cement production, generated new local infrastructure boondoggles and concentrated activity “in unproductive areas of the economy”.

For some, China, under president Hu Jintao and premier Wen Jiabao, became a country content to rest on its laurels so long as the economy expanded by at least 8% a year, the minimum rate deemed necessary to create enough new jobs.

However, there are signs that this gung-ho economic strategy is changing. In countless speeches, policymakers say there is a consensus that the country must push ahead with much-needed economic reforms: diluting the throttling power of the state; boosting private investment and industry; liberalizing the financial sector; opening up the capital account; and transforming social security.

Some indeed believe that the first step in the reform agenda – creating an internally driven economy more reliant on domestic consumption – is successfully under way. Economic rebalancing is clearly “beginning to happen”, says Pieter Bottelier, a senior adjunct professor of China studies at Johns Hopkins’ School of Advanced International Studies in Washington, citing the advance of domestic consumption.

 
Xi Jinping, source: Reuters 
Wang Qinwei, a former monetary expert at the People’s Bank of China, now a China economist at London-based Capital Economics, says: “China is at the point now where reform has to happen. If it doesn’t rebalance the economy and tackle the rich-poor divide, the natural rate of economic [expansion] will slow and growth rates of 8% will be a distant memory.”

China’s incoming leaders – president-designate Xi Jinping and premier-designate Li Keqiang, the latter an economist by training and nature – know that the problem exists and that reform is necessary, even desirable. However, will they have the stomach for the fight?

We will likely only know once both are comfortably settled in office after March. However, if they are up for the challenge, expect to see a few minor but telling rule changes implemented as the year progresses, including income redistribution plans – favouring rural over urban workers – and a higher tax on state enterprises, allowing Beijing to divert more resources into social welfare and pension reform.

Other likely policies include a tax cut on private sector firms coinciding with a push to force state banks to channel lending in their direction. Such decisions would signal genuine intent to push ahead with reform, by creating the conditions necessary to allow private enterprise to compete on an equal-terms basis with the sluggardly state sector, complemented by further measures to globalize the renminbi.

Breaking the cycle

However, breaking the state’s stranglehold on, say, the power producers or the banks would dilute the power of ministers and regulators, and dilute the authority of everyone from provincial governors down to county-level officials. It would also lead to layoffs in the public sector, where workers, notes Wang, would have “the zeal and the impetus required to halt any reforms”.

Perhaps most importantly, reforms designed to diminish the power and reach of the state would likely force the economy to slow, before private sector-led efficiencies kick in further down the line. In that way, perverse though it might sound, the country could well do with a healthy short-term dose of lower growth.

Few expect China’s economy to expand by less than 8% in 2013, certainly in the first six months. However, if economic and financial reforms appear as the year progresses, accompanied by signs of a gently slowing economy, don’t expect Beijing to panic. For a new generation of leaders keen to stamp their identity on history and reform an economy grown stale, it might be all part of the plan.



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