China reform checklist: How to tell that this time it's for real?

Reuters

By Tomasz Janowski

TOKYO, Nov 4 (Reuters) - The message from Beijing could notbe clearer: China needs to shift to a more balanced economy thatis socially and environmentally sustainable.

That was the conclusion of a key Communist Party meeting adecade ago, yet what followed was more of the same: rapidinvestment-led expansion, which turned China into the world'sno.2 economy, but left it laden with debt, environmental damageand excess capacity.

Fast forward to 2013 and China's new leadership is againpromising more harmonious development and the question is how totell whether, this time, it is for real.

One encouraging sign suggesting that President Xi Jinping,Premier Li Keqiang and their team mean business is their greatertolerance for slower economic growth while they carry outreforms. After three decades of double-digit rises in GDP eachyear, the leaders have pencilled in 7.5 percent for 2013 - theweakest pace since the late 1990s.

"Since the reforms of the late 1970s, leaders have alwayswithout exception said that the growth rate is the firstpriority," said Zhao Xijun, deputy head of the Finance andSecurities Institute at Renmin University in Beijing.

"The new leaders don't say they don't pay attention togrowth, but the new priority is the stability of growth ratherthan a high growth rate."

The new approach was evident earlier this year wheninvestors fretted the economy may be slowing down too much.Rather than adopting the sort of massive economic stimulus ofthe past, Beijing announced small-scale and targeted measures tosupport economic activity.

Chinese leaders have repeatedly said China needs to weanitself off a reliance on investment and exports, which in partsof the country have led to industrial overcapacity andpollution, and rely more on services and consumption, more akinto the developed economies of the West.

To do that means encouraging tens of millions of Chinese tomove to cities to live while creating a social safety net andlaws, particularly on land ownership, that will give them theconfidence to do so.

The ultimate test of the new team's appetite for reform willbe its actions, but the four-day third plenary session of theCommunist Party's leadership starting on Saturday will offersome early clues.

Such meetings have served in the past as launch pads formajor economic reforms like those unveiled in 1994 that pavedthe way for China's World Trade Organization membership, thoughsome, such as the one a decade ago, failed to deliver.

By nature, the pronouncements are broad and oftendeliberately cryptic, but China watchers believe the tone andlevel of detail can reveal where the policy focus will be.

"For example, the state owned enterprises' reform will betouched on, but it will probably be in very general language andsimilar to one used before," said Haibin Zhu, chief Chinaeconomist with JPMorgan in Hong Kong.

"But in some key areas, like fiscal or land reform they willbe using more detailed language."

In the end, what will matter more is what the authorities doin the next six to 12 months. General expectations are that thefollow-up will not be as dramatic as in 1994, but also that itwill not be a non-event like a decade ago.

The consensus view in Beijing is that the authorities arenot ready to take on state-owned giants that dominate sectorssuch as finance or energy or to let the struggling ones fail.

The focus therefore will be on the rest of the agenda:financial, fiscal, land and government administration reforms,pricing of resources, changes to social security and openingprotected sectors to private and foreign competition.

All are seen contributing in one form or another to China'spush towards more private investment, consumption, services andhigh-value manufacturing, so any progress there would be welcomeby investors and economists.

"Many of these things hang together and you can't really gothe full length on one without another, so any significant stepon any of these will be welcome," Markus Rodlauer, deputy headof the International Monetary Fund's Asia Pacific Division inWashington, told Reuters.

What few seem to be advocating is for Beijing to break withits gradual, cautious approach.

"In a way, a gradual move on all of those (reforms) is whatwill in the end deliver," Rodlauer, who heads the Fund's Chinamission, said. "China has been well served by its strategy ofgradual, careful reforms and does not need nor should it venturesuddenly to implement Big Bang reforms."

Of all reforms, a financial overhaul is considered lowhanging fruit. Markets and the currency are closely controlledand capital movements in and out of the country are restricted.

Driven by the central bank's governor, Zhou Xiaochuan, thegradual move towards market-driven interest and exchange ratesand capital flows liberalisation is already under way and thereis a clear roadmap.

In the least, investors expect to see a further broadeningof the yuan's trading band next year and the establishment of adeposit insurance scheme - a prelude to a gradual freeing up ofdeposit rates and full liberalisation of interest rates.

"If we don't see anything on financial reform in 2014, thatwill be a very big disappointment," said JPMorgan's Zhu.

On the fiscal front, economists and investors will look forsteps to share more evenly revenues and expenditure betweencentral and local governments and the expansion of the use ofvalue added tax in the services sector. Local governments nowget about half of tax and other revenues, but are responsiblefor more than 80 percent of public spending.

Economists and observers will also look for progress towardsa bilateral investment treaty with Washington and a similar pactwith the European Union as proof of Beijing's intention tofurther open up its economy.

Some also expect to see land and residence registrationreforms tested in some areas, translated into a nationwidepolicy that would support China's stated goal to boost its urbanpopulation.

By contrast, a proliferation of pilot schemes, such as theShanghai Free Trade Zone trumpeted as a laboratory for sweepingfinancial market reforms, could signal a lack of politicalconsensus to roll out the changes on a national scale.

Economists say some caution is understandable given many ofthe reforms mean handing over controls to market forces andcoming months will show how quickly the authorities want to go.

But given no one knows how much time China has before itsdebt pile up, industrial overcapacity, environmental degradationand social tensions prove hard to control, erring too much onthe safe side may be risky too.

"We don't know how much time Beijing has and we don't knowwhether the incremental approach they've used in the past isstill possible," says Gudrun Wacker, a China policy specialistat German Institute for International and Security Affairs, aBerlin-based think tank.

"I believe they will spend the next five years trying tomanage the problems and not do anything drastic, but it's likereading from tea leaves."

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