Rx for China: Expect Fairly Comprehensive Moves Soon

On March 5, China’s government presented its work report for 2014 to the National People’s Congress, which is currently holding its annual meeting. In this article we discuss the overall messages, macroeconomic policy and targets and reforms for this year.
 
Our overall take-away is that the government plans to start implementing a fairly comprehensive set of reforms. However, the approach to changes in economic policy remains cautious and gradual:
 
  • Growth remains the key objective
  • The approach to rebalancing seems to have evolved
  • In terms of the political economy, the government plans a pragmatic approach on how quickly to move in different areas
 
Separate reports with more details on policy implementation were also prepared by the National Development and Reform Commission and the Ministry of Finance.
 
Overall messages
The government plans to start implementing a fairly comprehensive set of reforms this year. Following the messages of the communiqué released after the third plenum in November 2013, the government work report discusses plans to take reforms this year towards a larger role for markets and private enterprise and, in conjunction, a recalibration of the role of the government.
 
However, the approach to changes in economic policy remains cautious and gradual in several ways.
 
Growth remains the key objective. The work report stresses that “development [i.e. growth] remains the key to solving all our country’s problems” and that China “must keep economic development as the central task and maintain a proper economic growth rate” as that is good for market confidence and employment and promotes economic structural adjustment.
 
“Ultimately, stable growth will ensure that [people’s] incomes increase and people’s lives improve,” says the report. Accordingly, and as we expected, the GDP growth target remained unchanged at 7.5%.
 
What does this mean for the growth-policy outlook? In our fairly benign base scenario, with sufficient “organic growth,” the government succeeds in reining in the pace of the rise in the credit-to-GDP ratio while protecting its bottom line on growth.
 
In a less benign scenario, with less organic growth, we would expect the government to be less forceful on reining in credit growth. In that case, we would not expect to see systemic financial problems or instability any time soon. However, amid credit events and hiccups, the financial markets would continue to remain anxious and nervous about financial risks in China, thus keeping sentiment bearish.
 
The approach to rebalancing the pattern of growth seems to have evolved. Many outside observers and China’s own 12th Five Year Plan have called for a rebalancing of the pattern of growth away from investment and industry towards consumption and services.
 
As we emphasized before, nowadays the government puts it somewhat differently. It calls for increasing domestic demand and boosting consumption. But it also wants to “fully leverage . . . the key role of investment” and says it “will take investment as the key to maintaining stable economic growth.”
 
The government said it would aim for a 17.5% increase in fixed-asset investment, down from last year’s 18%, and would maintain a target of 14.5% growth for retail sales. In 2013, fixed-asset investment growth exceeded the target, while retail sales fell short of it.
 
Consistent with its supply-side perspective, the government also maintains an emphasis on upgrading the industrial structure and moving up the value chain.
 
In terms of the political economy, the government plans a pragmatic approach on how quickly to move in different areas of reform. Even though the government calls for “breaking vested interest[s],” the report also calls for a “focus on areas where the public call for reform is strongest” and on “links on which there is extensive public consensus.”
 
This is in line with our traditional view. Those reform areas that are likely to see significant progress are the ones where there is broad agreement and no strong vested-interest resistance.
 
Macroeconomic policy and targets
Several targets have been announced. In addition to the 7.5% GDP growth target, other goals include CPI inflation below 3.5%, M2 money supply growth of 13% and creation of 10 million new urban jobs – all unchanged from 2013.
 
The government also aims to start with the construction of 7 million government-subsidized housing units, and grow international trade (exports plus imports) at roughly 7.5% (down from 8% in 2013).
 
In the government’s terminology, fiscal policy will remain “proactive” and monetary policy “prudent” in 2014, although these labels do not say much about the actual stance, in our view.
 
The target for the official fiscal deficit remains unchanged at 2.1% of GDP. This amounts to RMB1.35 trillion – RMB950 billion of the central government and RMB 400 billion of provincial level government debt, borrowed by the Ministry of Finance on behalf of provincial governments. It is hard to say what the total fiscal deficit will be, including the borrowing by local governments from banks or the shadow banking system.  
 
The government notes its objective of further changing the structure of government expenditures towards more spending on “the basic public services system and people’s well-being,” while containing administrative and general government spending.
 
The 2014 budget suggests that central government spending on health, education and social security would rise by 15.1%, 9.1% and 9.8%, respectively. This is faster than overall central government spending growth of 8.6%, although central government spending on education and social security would fall as a share of GDP.
 
On the monetary policy front, the reports do not contain many specifics on the stance. The government’s work report stresses the need to “foster a stable monetary and financial environment” and “strengthen macro-prudential management to encourage an appropriate increase of monetary credit and nongovernmental financing.”
 
Plans for reform
Looking at the plans in various reform areas, there are relatively concrete plans in several areas where there is good agreement and/or no strong vested-interest resistance, which is broadly in line with our expectations.
 
This is especially the case for financial and monetary reform, where the language is quite concrete on the direction, although there are no indications on timing. According to the work report, the government:
 
  • will continue to liberalize interest rates
  • expand the renminbi’s floating range
  • move toward renminbi convertibility under the capital account
  • establish a deposit insurance system
  • introduce a resolution mechanism for bankruptcy of financial institutions
 
Also, the government plans further progress on administrative reform and delegation of power to lower levels of government, reducing red tape, and making the formation and operations of businesses easier.
 
On the other hand, the approach is more gradual and cautious approach in reform areas where the political economy is more difficult, such as in the case of fiscal reform, rural land reform, and SOE-related reforms.
 
In the fiscal area, the plans and intentions on changing the intergovernmental fiscal relations remain cautiously and gradual. The government says it will “work faster on ways to adjust the power and spending responsibilities between central and local governments; and progressively adjust distribution of revenue between them while keeping the current division of financial resources between them basically stable.” There will also be further budgetary reform, towards better accountability and transparency on fiscal matters.
 
Having said that, the report also has more concrete language than previous top level documents on the complicated area of improving the quality of urbanization and Hukou reform. The government has set itself three tasks involving 100 million people:
 
  • granting urban residency to around 100 million rural people who have moved to cities rebuilding rundown urban areas where around 100 million people live

 

  • guiding the urbanization of around 100 million rural residents of the central and western regions in cities there.
 
Also the government commits to:
 
  • “progressively grant urban residency to rural migrant workers and their families who are both willing and able to stay in cities and towns where they have had jobs or done businesses for a long time”
 
  • “steadily extend basic public services to fully cover the permanent population of cities and towns so that the rural people who live in them can contribute to the development of modern urban life and enjoy it together with the urban people.”
 
The government work report also envisages steps on reforms related to state-owned enterprises (SOEs). It calls for SOE dividends to be “turned over to public finance in the case of central government-owned enterprises.”
 
The government report suggests an evolution in the approach to innovation and R&D, with more emphasis on a leading role for businesses. The government will focus more on basic research.
 
About the Author
This article is excerpted from “Alert China: The Government’s Work Report: Aiming to Combine Reform With Growth”, a report by Royal Bank of Scotland and affiliated companies that was published on 5 March 2014. It has been re-edited for conciseness and clarity. ©Copyright 2014 The Royal Bank of Scotland plc and affiliated companies (RBS). All rights reserved.
 

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