Emerging Market Equities: The dragon awakes
Joseph Mariathasan examines China’s Third Plenum, which some are hailing as a watershed towards a market-led economy
The Third Plenary Session of the 18th Central Committee of the Chinese Communist Party in November 2013 may prove to be a watershed. But its significance does not lie in poring over the details to forecast consequences for particular sectors.
“There is nothing remarkable in the substance, all of which has been around for years,” says Peter Batey, chairman of Vermilion Partners. “The question is will the party and government be able to drive it through against the vested interests of the state-owned enterprises, powerful ministries and the ‘great families of the aristocracy of 1949’.”
As Arthur Kroeber of Asia watchers GK Research explains in his post-Plenum analysis, most of China’s economic woes – wasteful investment spending, industrial excess capacity, local government debt – are not technical market issues but problems of governance. In particular, they are problems of local governance: localities are given the incentive to chase investment and GDP growth, not to optimise the delivery of public services; and their fiscal systems prevent them from pursuing a social-service agenda.
The real significance of the Third Plenum may therefore be the decision to create a central leading team for comprehensively deepening reform, because the critical thing is not generating faster GDP growth or a particular growth number, but rather what UBS economist Tao Wang and his colleagues describe in another post-Plenum analysis as “more sustainable and efficient growth, lower tail risk of a hard landing and meltdown in the medium to long term, and the improvement of household welfare and corporate performance at the micro level”.
The full public release of proceedings did contain a detailed blueprint for major initiatives and reforms with a decisive shift to using market mechanisms to allocate resources.
“Much of the official commentary surrounding the policy has made it clear that the goal is to reduce the ability of government at all levels to manipulate either the prices or the allocation of key resources,” explains Kroeber.
But as Batey points out, the wording in some of the published 2013 communiques also resembles that of the 2003 communiques, produced after the Third Plenum of the 17th Central Committee. “Alas little progress was made in implementation, probably because the old guard frustrated the ambitions of Hu Jintao and Wen Jiabao to further and deepen reform,” he warns. “This has left many China watchers like me with a sense of ‘10 wasted years’.”
What is different about the Third Plenum is the fact that a new leading group headed by the party secretary, Xi Jinping himself, will pave the way for reforms, and local government will then be given the task of implementing them, explains Danny Yee, CEO of Aktis Capital.
“Xi Jinping needs to build allegiance centrally but give time for people to clean up their acts,” he says. “We will see the first real change in 2015 while he will spend 2014 consolidating power.”
What this will lead to, argues Yee, is the growth of secondary cities, particular in the heartland of western China; more growth for small and medium-sized enterprises for job creation in these urban centres and greater consumption of goods and services. The move towards financial market liberalisation will encourage the proliferation of free-trade zones in China and non-bank finance will be favoured over the banks with greater foreign and private-sector investment encouraged in the financial markets.
“The market will be promoted to a decisive role and decentralisation is key since what matters is how regulations are implemented,” Yee says. “Beijing is less sensitive to local requirements, but if local authorities are given the ability to raise local revenues and implement decisions, a dialogue can be developed with Beijing to achieve better results.”
Economic reform cannot be separated from political changes and its scope potentially embraces social, government, military and political reform, explains Batey. The driving factor for this is that Xi Jinping’s primary objective is to preserve the Party’s leading role.
“He does not want to be China’s Gorbachev,” Batey observes. “Nor does he want to be Zhao Ziyang or Hu Yaobang, party general secretaries who lost the confidence of the party, and were removed from office.”
“Improvements need to be made to reduce the enormous gap between the rich and the poor in China, and raise the quality of life for everyone.”
To retain power the party needs to do three things: curb corruption, ensure that economic growth is sustainable so that there is money to spend to deal with problems, and spread that money more widely to ease social tensions.
Yee concurs: “Improvements need to be made to reduce the enormous gap between the rich and the poor in China, and raise the quality of life for everyone.” He explains there are concrete steps to ensure this does happen, including rises in the minimum wage of 15% per year, driving many businesses relying on cheap labour out of China; opening up protected industries to the private sector; and creating subsidies to allow people to move to cities through having access to cheap housing as well as gaining employment in SMEs.
Ultimately, to maintain China’s growth, Xi Jinping needs to deal with the monopolies, duopolies and cartels that have been slowly strangling growth. “In short, Xi Jinping needs to be China’s Theodore Roosevelt and to ‘bust the trusts’,” as Batey puts it, adding that the problem for Xi Jinping is the enormous economic and political power of the SOEs that are the monopolists. “Many of their heads are members of the ruling Central Committee and many of them are also members of the old political families which constitute the ‘aristocracy of 1949’ that rules China. That this situation has arisen is because of the decision to reverse Deng Xiaoping’s ban on princelings in the Central Committee – which included his own sons.”
It is for this reason that the new enforcement mechanism for the reforms is critical. “Let’s see whether it’s up to the mark,” says Batey. “I hope so for China’s sake – and I am broadly optimistic.”
Joseph Mariathasan is a partner of Pangaea Finance Partners, which focuses on the non-bank financial markets in China working with a number of local partners including Aktis Capital