China’s reform announcement

Timothy Flanagan, Associate Portfolio Manager | November 21, 2013

  • China has announced significant social and economic reforms.
  • We believe the vague wording and lack of timetables in the announcement should allow for balancing policy changes against short‐term growth prospects.
  • If fully implemented, the plans announced should move the country towards a long-term sustainable growth model. If rolled out gradually, the near‐term effects on growth should be minimal.

The biggest take‐away from China’s recent Third Plenum announcement: the leadership has some significant and well‐rounded reforms on the agenda (both social and economic) and that new leaders seem bold enough to take on a number of contentious issues. The actual economic impact in the near term and when these reforms take effect is less evident. We should view all of these reform announcements as a broad outline of policy direction that will be rolled‐out over a very long period, not as specific changes that will take place in the short term.

The time frame and implementation has been left vague for most of the policies. Our optimistic view is that the vague wording and lack of timetables should allow for balancing policy changes against short‐term growth prospects.

There were a number of reforms announced that will help with social stability (labor camp abolishment, reduction in death penalty offenses, better administration of public complaints and grievances, land right protections, law enforcement changes).

On the economic side, there is a push for more market and private participation, while reiterating the importance of state dominance. A number of areas were covered (easing of the hukou system*, more state-owned enterprise (SOE) profits handed back to the government, changes in ownership rules of SOEs, tax reform, pushing forward liberalization of interest rates and yuan convertibility, deposit insurance). Some of the plans announced are already in progress (interest rate liberalization and tax reform for example) and seem to simply reinforce the leadership’s position.

The Central Committee seems to have hit the major areas required to move the economy to a long‐term sustainable growth model: Financial system liberalization for more efficient resource allocation, eventually reducing financial repression to spur consumption growth, balancing the fiscal disparity between local governments and the central government, eventually floating the currency, more SOE privatization, and improving social safety nets (pensions, land rights, and hukou reform).

If fully implemented, the plans announced should move the country towards a long-term sustainable growth model. If rolled out gradually, the near‐term effects on growth should be minimal, as some of the more costly reforms have begun already and growth drivers are still positive. We think there is a high probability of full implementation given the resolve and the ability of the new leadership. We also think there is a high probability of a gradual roll out based on China’s history of reforms. These are bold policies, but they should not upset the applecart in the short term. We believe the biggest reform drags will be on investment while consumption will see the biggest gain.

*Easing of the “hukou” system: The country will relax overall control over farmers settling in towns and small cities, and relax restrictions on settling in medium-sized cities in an orderly manner. China should set reasonable requirements for rural residents to obtain hukou in large cities, and strictly control the size of population in megacities.

Timothy Flanagan

Associate Portfolio Manager
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