Cyclical China bears morph into structural bulls post-plenum
China’s once-in-a-generation economic reforms have largely pleased some notable bears, as new policies reflect Beijing’s recognition that a growth-at-all-costs investment-led model is bust, while capital-account opening could help navigate short-term credit challenges.
For others, the plenum euphoria is overshadowed by the growing threat of a credit crisis without urgent redress.
The weight of expectation for this year’s plenum was huge. The most radical, in December 1978, under the leadership of Deng Xiaoping, initiated the process of market reforms and the opening up of China that continues to this day.
Fifteen years later, Zhu Rongji used a third plenum to launch his “socialist market economy” and begin the unpopular but necessary dismantling of the massive, but hopelessly inefficient, state sector. In just three years, 97% of the country’s 10 million state-owned enterprises had disappeared.
Are the expectations for this year’s plenum realistic? Will the promised reforms kick-start the next stage of China’s economic development, propelling it beyond the export-led investment growth model that has transformed the economy into the world’s second largest, but is now faltering?
Their scope is bold: boost the role of the market to play a “decisive” role in the allocation of resources and allowing it to set prices, open up the state sector to competition, speed up liberalization of interest rates and yuan convertibility under the capital account, and permit private banks.
There is also reform of land-ownership laws and residency rules holding back the urbanization necessary for China’s transition to a services and consumption-led economy.
For some, placing so many sacred cows on the block demonstrates a clear political will and commitment to push through deep structural reforms that will have a dramatic impact on the economy over the medium-term – with ramifications for all the other reforms that depend on economic strength.
China has had targeted growth of 7.5% in recent years, but almost always exceeded this level – until now. However, the fact Beijing is expected to lower next year’s target to 7% when the Chinese parliament meets in March is one indication it might be prepared to accept slower growth as the price for a more sustainable economy.
Hong Kong-based economist Freya Beamish at Lombard Street Research – typically bearish on Sino imbalances – argues all the signs point to China’s leaders understanding they have to act before total debt reaches the point where it causes a financial blow up.
“During the course of this year, we’ve gradually become more and more positive that they’re actually going for this,” she says. “The severe nature of the financial disturbances the types of reforms that need to be made will entail means it’s almost a bit much for us to expect precise timings because it makes things a lot more difficult for them.
“Either they have disturbances across the entire financial sector now – inter-bank stress, problems in the bond markets – and serious liquidity issues which will uncover the solvency issues, or they have an actual financial blow up two or three years down the line.”
Beamish adds: “We have to give them the credit for that and say that they do know their economy and that the signs that we’ve seen so far indicate that they understand what’s going on, they’re grasping the nettle, and are going to go through with these difficult reforms.
“That’s not to say they’ll go from black to white overnight, but the indications have been that they are going to do it a lot more quickly than we would have expected when the new leadership took over.”
Beamish argues opening the capital account is key because it will see an outflow of savings and private capital that will weaken renminbi, which Beamish says is overvalued by 30%. That will help smooth the transition to consumption-led growth and make sure capital flows to where it’s most productive.
However, for others, fears about the Chinese economy have not been allayed by the reform package unveiled in a 20,000-word blueprint after the four-day meeting. There’s disappointment at the absence of any concrete timetable for implementation, save for a vague target of 2020, and the fact it fails to address a credit bubble of epic proportions or the resulting bad-debt problem.
“Those who are very worried about China will still have cause for concern,” says Andrew Milligan, head of global strategy at Standard Life Investments. “The economy has built up an awfully large amount of debt, which can be managed by a financial system controlled by the government, but could become much more of a problem as deregulation appears.
“Moves towards external and internal liberalization of the financial system – opening up the capital account – these actually make it more difficult for the authorities to control the flow of capital, and brings forward the day where a crisis might appear.”
He adds: “One of our worries is whether the party is actually willing to go down this path at a very rapid rate because vested interests will lose out. The main drivers of the past few years have been local government construction, export-orientated growth, infrastructure investment. These have been the dominant themes which have worked successfully in relation to jobs for the many and fortunes for a few.
“This is the ground where the hard battle may need to be fought by central government in the next couple of years. Is the economy actually able to rebalance in the face of opposition from the vested interests, the princelings, the local government officials, who are really quite happy with the way things are?”
Milligan also warns of implementation risk – modern China is not a highly centralized economy, despite its reputation, but effectively a federation of many different provinces, regions, cities, some of which are the size of a country in their own right.
This crimps the ability of the central committee to put the reforms into effect, Milligan concludes.