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China's new leaders' agenda: time for change
20 Nov 2012
Qu Hongbin, Co-head of Asian Economic Research
Economic reform was never far from centre stage as China's leadership baton was passed from one generation to the next. There is consensus in Beijing that the only way forward is to lift the quality and efficiency of growth by pushing ahead with an agenda of economic change.
The new leaders, headed by Xi Jinping, are well aware that the reform process helped unleash the rapid labour productivity growth that has been an important part of China's industrialisation, globalisation and urbanisation.
Their first task is to ensure the economy continues to recover. In the near term, they are likely to maintain the current easing policy – the last thing they want is a growth double-dip or a W-shaped recovery – but external headwinds remain strong and the local labour market is still under pressure.
The new leadership has been set ambitious targets. The Communist Party aims to double China's 2010 GDP and per capita income by 2020. It also faces growing pressure to tackle structural problems through reforms. For example:
- Some 53% of local government debt is set to mature by 2013, creating liquidity problems.
- China's GDP has more than quadrupled since 2000 but the wealth gap has widened too. So while sales of luxury brands are buoyant, 8% of urban dwellers live below the poverty line.
- Despite the private sector's key contribution to GDP and investment growth, Beijing's massive 4,000bn renminbi stimulus package to fight the financial crisis was largely funnelled towards state-owned enterprises. Deregulation would help private investment.
- China is among the world's most rapidly ageing countries: between now and 2030 the related spending will rise by 4.1% of GDP according to the IMF.
- China imports more than 55% of its crude oil, up from 25% in 2000, leaving it vulnerable to big oil shocks.
But conditions are favourable for pushing reforms. The growth slowdown has been reversed; a sound fiscal position will allow tax cuts and income distribution reforms; financial markets and the banking system are largely healthy. China's current account surplus has fallen to less than 3% of GDP from the peak of 10.6% in 2007 and its currency is coming closer to equilibrium after appreciating nearly 30% since the 2005 exchange rate reform. This paves the way for capital account liberalisation.
The new leaders are likely to push through reforms that will reshape China's economic and financial landscape. The key is striking the right balance between the role of government and the market.
Besides the financial reforms, fiscal reforms hold the key to making structural changes that can allow more balanced and consumption-driven growth.
The regime is ready to launch a swathe of co-ordinated reforms to revolutionise China's financial system over the next three to five years. For instance, now that all the major state banks have been restructured and are more commercially driven with the non-state sector taking nearly 60% of total investment, the time is ripe to liberalise interest rates. Also, the bond market should double in size by 2017 to finance urbanisation-driven infrastructure investment.
And the renminbi should become convertible by then: since 2009 the proportion of China's trade settled in renminbi has quadrupled to more than 11% and could reach 30% by 2014, making it one of the top three global trade settlement currencies.
Besides the financial reforms, fiscal reforms hold the key to making structural changes that can allow more balanced and consumption-driven growth. The new leaders are likely to focus on income distribution, industrial policy, environmental protection, and social-security provisions.
China's government has deep pockets. Fiscal revenue growth has surpassed GDP growth for 16 years – but that means government has received a large slice of the GDP cake at the expense of companies and households. We think this will change and expect a wide range of fiscal and taxation reforms, including Beijing giving local governments a bigger share of tax revenue and tax reductions, especially for small companies.
Government spending on social security, housing and education – which has a significant impact on people's livelihoods and consumption patterns – has risen from 14% of GDP in 2000 to 35% in 2011. China's personal income tax rates still range between 5% and 45%, but reducing rates for middle-income groups to develop a stronger middle class would help, as would allowing family-based deductions for children and elderly dependents. And apart from VAT reform to boost services sectors, the authorities could provide more tax incentives for innovation.
Reform doesn't come easy. It requires political wisdom and courage.
The Party Congress said it will encourage, support and guide the development of the non-state economy. Five ministries and regulators have already taken steps to boost private investment and reform state enterprises but private firms are likely to gain access soon to other sectors such as financial services, energy and telecommunication.
Reform doesn't come easy. It requires political wisdom and courage. But only reforms can sustain rapid productivity growth – the key driver of GDP growth. We expect the new leaders to speed up financial and fiscal reforms, revitalise the private sector and improve income distribution. The process has already started in areas such as financial market deregulation, interest rate liberalisation and renminbi internationalisation. This will create a chain reaction in the way capital is allocated, which in turn should boost efficiency and consumer demand. And the next big move is likely to be on the fiscal front.