Wednesday, 23 October 2013

The Third Plenum

After a year filled with headline grabbing events like the leadership transition, and the Bo Xilai trail, the event that has historically made the biggest news is still to come.

The Chinese Central Committee (CC) holds congress once every five years. Between these meetings they have plenary sessions (plenums). Historically, the third plenum has facilitated the unveiling of significant economic directives. Most famous was Deng Xiaoping's "seeking truth from facts" approach over the Huo Guofeng's "two whatevers" (referring to compete deference to the words and deeds of Mao). While this was a culmination of events, the political room created by Deng's acceptance of an approach not clearly defined in communist ideology set the ball in motion. The third plenum of the 12th CC saw Hu Yaobang bring some small scale reform (that moved away from collectivism) that had proved effective in rural areas to urban areas. And in 1993 the third plenum of the 14th CC approved Deng's "Socialist with Chinese Characteristics". These are the broad strokes that started and guided the Chinese down their current path.

What might this third plenum of the 18th CC bring?

The lists are long with many suggestions and imperatives. The mood seems to place a fair bit of urgency on these reforms with the expectations that the plenum will prove to be a bit of a let down. Some examples (here, here, here).

To my eye, things aren't as bad as many believe, and probably aren't as rosy as a few others believe (note: I'm certainly a China bull... but I don't see their ascension as inevitable,  a slowdown IS inevitable (due to size), and there will be many market corrections that will likely be claimed as a victory for the bears). Adjustments need to be made, just as they always have and I suspect they will be made.

Here are a few of the issues I'd like to see addressed at this plenum:

- Interest Rate Liberalization: The Chinese saver has long been repressed. The re-balancing towards a more consumption based economy would get a nice start by rectifying this imbalance.

- Increase Credit Availability/Competition: Giving autonomy to banks so they can lend at market rates to ANY business that justifies it, would act to legitimize competition to the big state owned banks without forcing the expansion of the shadow banking sector

These items go hand in hand and I think their impact would filter down through to address a number of other issues. Without savers subsidizing lenders, and without lenders being required to fund certain projects for certain companies due to their SOE status, the push for profitability will bring more equitable rates for China as a whole. I don't expect complete liberalization of either, but a move in that direction would be nice.

The level of debt held at all levels of government in the off the books shadow banking sector necessitate a better path forward. Having local governments compete for cash in a legitimate market will at the very least establish a certain measure of accountability.

I'm also a bit torn on a big Hukou reform (which is expected by many). All else equal this type of reform would absolutely be a must (allowing migrant workers to receive benefits and become permanent residents in the cities where they work). However, I think the need to develop the interior of the country and the huge capital outlays that have, and will go into this, require firms to move inland the ability to capitalize on the wage differentials that Hukou reform might hinder. Perhaps regional Hukou would be the first step. Or perhaps there remains an adequate quantity of excess rural labor to soak up. And how long would it take for the interior to build up enough spare capacity to facilitate the return of these migrants? Questions that I can't answer.

Ultimately, it's these long lists of problems needing to be addressed that make me optimistic about China growth potential. All that the Communist Party of China (CPoC) have done is gone about their business in lifting hundreds of millions out of poverty over the past couple of decades. I see these problems as opportunities, and based on this track record I would expect the CPoC to maintain their current trajectory.

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