The 18th Party Congress last week confirmed a new leadership, led by Xi Jinping and Li Keqiang. We believe the new leaders are fully aware of the urgency of reform, as evidenced by Xi's inaugural speech which made numerous references to “the people” but with no mention of the traditional ideologies, and which candidly highlighted key challenges, including official corruption. The fact that Xi is simultaneously taking over the Party Secretary position and the chairmanship of the Military Committee is also positive, as it will allow the new leaders to move more swiftly on the reforms. In addition to these encouraging signs, we believe the very high public expectation of reforms and the technical readiness of many reform measures mean that economic reforms in many areas can move faster than expected.
Most likely economic reforms
We believe the most likely economic reforms in the coming three years include resource pricing reform, interest rate liberalization, greater exchange rate flexibility and capital account liberalization, nationwide implementation of the VAT reform to more service sectors, a new resource and environment tax system, and an increase in social spending. On the other hand, we believe SOE reform and the introduction of a property tax will likely be slower than hoped.
Incremental political reforms are feasible
We believe that, while radical changes to the political system will be not be accepted by the new leaders, many incremental steps will likely be taken to reform the political system and governance of the administration. The specific reforms we think are possible and impactful in the coming few years include intra-party democracy, public disclosure of official wealth and income, megadepartment reform, and relaxation of controls on NGOs.
Macro impact of economic reforms
Our CGE model shows that the likely economic reforms will improve the economic structure. They should lift the consumption to GDP ratio by 1.3ppts in the coming three years compared with the baseline. These reforms should also reduce the investment to GDP ratio by 0.4ppts and reduce the net exports to GDP ratio by 0.9ppts. The reforms will also help reduce the long-term economic risks and thereby improve the sustainability of economic growth.
Eoin Treacy's view If China is to continue on its already impressive path to further development it will need to deliver on additional reforms. Until the last few years, its rapid industrialisation has focused on low end manufacturing and infrastructure development.
Many of those who would argue that China represents a bubble focus on overcapacity in steel production and excess property inventory. They have a point and much of China's efforts on the monetary front since 2009 have been aimed to curbing property market speculation. Additional efforts have been made to rationalise various industries.
Concurrently, large strides have been made in developing a consumer society, promoting the services sector and moving up the value chain in terms of manufacturing. Minimum wages, social security, medical care, water, sewage, environmental issues and civil rights have all attracted more attention during this evolution.
At least in part as a result of tightening measures the stock market has been an underperformer. Valuations have contracted to previously supportive levels but a catalyst is required to spur investor interest. Progress on additional reforms may be required to initiate more persistent bullish action.
This additional report on China, kindly forward by the same subscriber, might also be of interest.