China in a hard pivot to more supply-side reforms

China in a hard pivot to more supply-side reforms

Ten years ago, when China’s leader first took power, Xi Jinping pledged to let market forces play a “decisive” role in economic policy and financial regulation. At the time, and since, foreign investors assumed that meant the government would set the private sector free.

Yet a decade on, Xi is now making an argument few saw coming: the key to making China more resilient and productive via bold supply-side reforms isn’t less Communist Party control – it’s more.

It’s not what international investors expected at this week’s National People’s Congress, but might it just work?

Michael Pettis, finance professor at Peking University, wonders if Xi’s pivot might be a gamble in which the end result of greater central control could justify the means.

“The major impediment to the medium- and long-term economic policy changes that China must implement is likely to be bitter political and elite resistance to the necessary structural and institutional reforms,” Perris says.

“In that case perhaps what China needs is not policymakers that can best understand and design the needed economic and financial reforms so much as policymakers that understand local politics and can force through these reforms in the face of stiff local opposition,” he adds.

Such views shed some light on why Xi’s inner circle thinks now is a wise time to create a mega regulator that bigfoots Beijing’s banking supervisor and certain functions of the People’s Bank of China.

The People’s Bank of China could lose some of its regulatory authority. Picture: AFP

As Pettis readily admits, “I realize that this is a fairly optimistic take on what most analysts otherwise see as a terrible development, but I think most analysts overestimate the complexity of China’s needed economic reforms and underestimate the sheer political difficulty of implementing them.”

What’s abundantly clear, though, is that the economic team led by Xi’s choice as next premier, Li Qiang, is gearing up for a structural supply-side reform regimen sure to recalibrate China’s main growth engines.

That includes policies that encourage households to consume more and increase Chinese self-reliance amid US efforts to halt the flow of advanced technology to Xi’s economy.

It’s not like Xi’s predecessor Hu Jintao, who led from 2003 to 2013, didn’t know what upgrades were needed to raise China’s economic game. But powerful fiefdoms within party circles that exert extreme power over regulatory bodies have vested interests in protecting the status quo in China’s $60 trillion financial system. Students of Japan wondering why change in Asia’s No 2 economy seems so impossible will understand the parallels.

Rather than tolerate further infighting between China’s financial and banking regulators, Xi is creating an enlarged national regulator to get big things done. The powerful China Banking and Insurance Regulatory Commission is going to disappear, while the China Securities Regulatory Commission will get increased clout as it’s put directly under the State Council.

Whether these changes succeed in, as Xi’s team puts it, “solving the long-standing conflicts and issues in the financial area” will remain an open question. Yet it seems that Xi is finally getting serious about putting market forces in the driver’s seat to increase competitiveness – not just pumping up gross domestic product (GDP) indiscriminately year after year.

As part of the structural shakeup, Xi is slashing by 5% the number of jobs across central government departments, possibly the biggest purge since 1998. That was the year then-premier Zhu Rongji launched the boldest reform drive since Deng Xiaoping’s day.

Not only did Zhu guide China’s way into the World Trade Organization, but he also streamlined the state sector. His powerful assault on state-owned enterprises led to the shuttering of 60,000 inefficient companies and the loss of more than 40 million jobs. Now Xi may be taking a page from that playbook.

In compliance with his “common prosperity” drive, Xi signaled that Beijing’s financial watchdogs may face big pay cuts. In some cases, the cuts could exceed 50% of current compensation.

The moves at the NPC “clearly illustrate that this government pays more attention to growth quality,” says economist Zhou Hao at Guotai Junan International.

Aerial picture of container cranes and containers at the Lianyungang Port Container Terminal in Lianyungang, Jiangsu province. Photo: AFP / Hector Retamal

Jefferies Financial Group analyst Edison Lee thinks it’s highly significant that Xi’s government “stressed growing the digital economy and achieving tech localization along with other major goals. SOE reform seems to have received a big focus, which likely explains the recent southbound-driven rally of telco-related stocks.”

Economist Vivek Dhar Commonwealth at Bank of Australia adds that “it looks likely that China’s infrastructure‑related commodity demand impulse may ease this year” and it’s less likely to use debt and other short-term stimulus to juice GDP.

Wang Huan, economist at Shanghai Zige Investment Management, notes that the “wording around real estate seems to suggest that the worst of the risks are behind us. The upgrade of industries and tech innovation should remain the priority in the years to come and see great policy determination to refrain from turning back to the old drivers of growth.”

Citigroup economist Griffin Chan adds that it’s notable that “property was not a focus in the 2023 work report while the overall tone was gentle and supportive. Given recognition of systematic risks for property and a focus on downside protection, expect credit-side supports to be enhanced and demand-side easing to continue to drive basic/upgrade housing purchases.”

Even so, economists generally agree that this year’s 5% GDP target is reasonable as China’s reopening from Covid-19 generates growth tailwinds. UBS economist Wang Tao predicts China will grow 5.4%, up from his earlier estimate of 4.9%.

That said, analysts at Moody’s Investors Service note that global headwinds from the US and other high-tech economies that shift their investments from China amid geopolitical tensions will complicate Xi’s year.

“Additional measures by Western countries to restrict investment flows to China, block access to technology, restrict market access for China’s firms, and promote diversification policies, could continue to weigh on foreign investors’ risk perception regarding doing business in China,” Moody’s says in a report. “These measures also have the potential to weaken China’s economic outlook.”

Xi is making similar consolidation plays in other sectors. The Ministry of Science and Technology is being restructured, while Xi is creating a new agency for data. The plan here, says Xinhua News Agency, is to “better allocate resources to overcome challenges in key and core technologies, and move faster toward greater self-reliance in science and technology.”

China is gunning for more tech self-reliance. Image: Twitter

China’s top health regulator, the National Health Commission, no longer has responsibility for strategizing over China’s aging population challenge. The Ministry of Civil Affairs will not oversee the development of elder-care issues.

The State Council will now also oversee the National Intellectual Property Administration. The same goes for the National Public Complaints and Proposals Administration in order to, as the government put it, “better protect people’s fundamental interests.”

Global investors may not have seen this big pivot in Xiconomics coming. But there’s little doubt that the supply-side shakeup markets wanted is afoot.

Follow William Pesek on Twitter at @WilliamPesek