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Transition management for China

European politicians like to meet with Jin Liqun, chairman of the board of supervisors of China Investment Corporation. As a man with more than $400bn (€309.2bn) in assets for investment outside China, they have been actively courting his fund’s capital.

But in Beijing in April, Jin zeroed in on China’s many economic challenges. As a former deputy finance minister of China, the chairman is particularly well placed to comment on the intersection between China’s economics and politics and to mediate this to an international audience. And as a former Asian Development Bank and World Bank executive, he also possesses a broad international outlook.

Ultimately, the political response to China’s challenges will have a profound effect on the economy, which will in turn affect the way Western institutional investors view the country as an investment destination.

GDP growth fell to 7.7% for the first quarter of 2013, raising fears once again that China will stall as an engine for global growth, with all the associated negative implications for indebted and sluggish Western economies.

Fitch’s April downgrade of the country’s local currency government debt rating, followed by a similar move from Moody’s, added to this gloom, with commentators also focusing on the large stock of local government debt and banks mired in loans to state-owned enterprises (SOEs).

Against this backdrop, it is notable that China’s once-in-a-decade leadership transition took place this year at a time when the country’s economic challenges are weighing on the minds of domestic and international commentators.

Speaking at Pioneer Investments’ 2013 Colloquia in Beijing, Jin emphasised that the problems are recognised and they have the full attention of the new leadership.  

Jin also highlighted the importance of structural economic changes designed, in part, to relieve China’s many domestic social challenges. They include the need to provide jobs and employment, to increase wages, particularly in rural areas, and to provide social infrastructure, such as hospitals and nursing homes for an ageing population.

“A host of social problems are waiting for a solution,” Jin elaborated. “Social welfare, income distribution, students encumbered by student loans taken out for them by their parents. In any country, social stability to a great extent depends on job creation and job opportunities for young people.”

The government particularly sees a need to improve the livelihoods of millions in rural areas who are particularly sensitive to price rises.

While the consumer price inflation rate is currently 2.39%, having peaked at 8.7% in
February 2008 and 6.5% in July 2011, the government is acutely aware that unpalatable rises in the cost of living could trigger social unrest.

Urbanisation is causing many villages to waste away effectively as orphanages, with an economy based on low agricultural efficiency, so social infrastructure is essential. Indeed, the urban population is said to be 70% if ‘de facto’ unregistered migrants from rural areas are counted and the population shift in favour of the cities continues.

Unchecked economic growth, particularly in the cities, is also leading to excessive pollution, and Beijing’s air quality plumbed new lows early this year.

Chinese people save a high level of their income, in part to compensate for a lack of a social safety net, particularly in rural areas.

The development of a social security framework, including workplace pensions, known
as enterprise annuities, would help boost consumer spending and move the economy away from its reliance on export-led manufacturing and infrastructure spending to create growth.

China’s economy has changed radically in the last 35 years but inefficiently managed SOEs still drain economic potential from the private sector through their privileged access to capital from provincial banks in a network of relations involving local politicians who, directly or indirectly, exercise ultimate control over the flow of capital, the way it is spent and how that spending benefits the wider economy.

None of these challenges are new. “What is new is the way these issues are about to be handled,” Jin predicted. “The leadership will make headway through changing the role of the government in the economy, [bringing ] a fresh style of government, reflecting the educational background and experience.”

So much for soothsaying. There are essentially two factions when it comes to economic step-change – the metropolitan reformers and the provincial power bases. Reformers, like Jin, wish to press ahead with a modernisation of the economy, but they are aware that this militates against the entrenched interests of the provincial and local political power bases with influence over SOEs.

“A consensus will emerge, with lengthy and heated debates. When a country is pushed towards a cliff, the government and people will not find it possible to continue with procrastination,” Jin continued.

He said there was effectively an “ultimatum to emerging markets with an export growth model without taking action”.

So for China’s leadership, this also means an awareness that reliance on infrastructure spending cannot continue. No doubt conscious of Japan’s ‘roads to nowhere’ infrastructure stimulus of the 1990s, Jin was keen to emphasise that China’s provincial projects are essentially good investments.

But there is an acute awareness of the need to overhaul the banking sector. To this end, Jin called on international banks to move away from their comfort zone in the coastal areas and to boost competition by lending inland.

China will not stop making and exporting goods, of course, but it will try to broaden its manufacturing base to focus on high-end, high-value products that are much less easy to substitute, whether in technology or even luxury goods.

Interviewed for UK television in the autumn of 2011, at the height of the euro crisis, Jin was rather disparaging about Europe’s problems. “The root cause of trouble is the overburdened welfare system, built up since the Second World War in Europe – the sloth-inducing, indolence-inducing labour laws,” he said.

To really reform the euro-zone, he said, there needs to be greater productivity in the labour force. “People need to work a bit harder, they need to work a bit longer, and they should be more innovative. We [the Chinese] work like crazy,” Jin added.

Jin’s words were, of course, intended to be provocative.

At the Pioneer Investments Colloquia, he referred to words from the WB Yeats poem Easter 1916: “A terrible beauty is born”, adding: “We have to understand to what extent China can contribute to the knowledge economy. China is on the cusp of a new round of reforms. If we do our job we will contribute to the rest of the world very positively.”

Investors will be looking carefully as China attempts to change its economic model. It is certain that its attempt to transition from a reliance on export-led manufacturing and heavy infrastructure spending, towards an economy with greater levels of domestic consumption and a necessarily lower savings rate, will be the key economic trend of our time.

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