The Party’s plan for the future is designed around a desire to preserve stability and maintain power
The China Dream of the most ambitious reformers in the Communist Party of China has hit the cold light of day. That is abundantly clear in this 13th Five-Year Plan (FYP) that seeks to march China into the future while digging in its heels to hold onto much of the past — in politics, policy and the shape of the economy. Three years ago when the Party issued the groundbreaking Third Plenum document, economic reformers and business people were almost giddy over the laundry list of game-changing reforms. The market was to take a “decisive role” in the economy, state-owned enterprise behemoths were to be disciplined and somewhat dethroned, the iron-grip of central government planners was to be relaxed as they morphed from all-powerful deciders to service-oriented regulators, and China was to become even more open to foreign business.
That was then. This is now.
Since those heady days of the Third Plenum pronouncements, Chinese President and Party Chairman Xi Jinping has emerged as a muscular leader who is employing tools of the Party’s past to advance his agenda of the “great revitalization of the Chinese nation.” His focus has centered on solidifying political control and social stability through an aggressive anti-corruption campaign and a wide-ranging clampdown on journalists, attorneys, academics and activists. At the same time, the leadership has been backtracking on its economic and financial reform plans while taking small steps forward along paths of least resistance.
With the 13th FYP, the Party under Chairman Xi is seeking to clean up a pile of distortions left over from three decades of growth-at-all-costs with a collection of compromises aimed at preserving stability-at-all-costs. That is not to say that the 13th FYP is mired in yesterday. There is a vision of a different future. The plan outlines a blueprint for a significantly upgraded and modernized manufacturing and technological base, a cleaned up environment and greener way of life, a more consumption-oriented economy with increased support and room for entrepreneurs, and improved healthcare and social security systems. The plan also outlines a tremendous amount of infrastructure spending for airports, sea ports, bullet trains, subways and expressways to tie the country together as regional municipalities are merged into megacity clusters of 100 million people or more.
The question is how smoothly and successfully the country can move forward while continuing to goose growth through government financing of state-owned enterprises (SOEs) and infrastructure. Premier Li Keqiang has promised to eliminate SOE “zombies” that live on state loans and lose money just to keep people employed. But instead of highlighting the Third Plenum initiative to reform central SOEs by treating them as investments instead of assets, the 13th FYP mostly puts forth past prescriptions. This is due to the Party’s focus on having strong political control of the economy and economic actors. Furthermore, it also reflects anxiety about social unrest if unprofitable industrials were to launch mass layoffs. When Zhu Rongji laid off some 50 million SOE workers between 1993 and 2003, workers did not have social media to organize themselves. What they did have was a booming economy to help absorb them and fewer expectations than today’s workers.
This is just one example of the tensions in China’s yesterday-tomorrow dilemma. Such pressure points abound in the 13th FYP. We take a closer look at a couple of these issues in the sections below. Winding down yesterday while winding up tomorrow is the challenge at the heart of China’s 13th FYP.
For foreign companies, a China with slowing but still world leading growth means the world’s second largest economy will remain a place that few companies can afford to not be seriously engaged. To tap into China’s tomorrow, foreign companies need to examine the government’s development targets and align with its plans. But they also need to remain focused on protecting their global business and core intellectual property as they do so. As China struggles to pull itself out of yesterday’s quagmire, companies should be prepared for this “New Normal” of policy inconsistencies and increasingly assertive demands as price of entry into the Chinese market.
The Chinese government has repeatedly acknowledged that in order to achieve more sustainable economic growth, it must significantly reduce overcapacity in SOE-dominated industries such as steel, aluminum, cement, chemicals, shipbuilding and heavy equipment. As the European Union Chamber of Commerce recently noted in a study, though demand and prices have plunged globally, Chinese steel production is now more than double the combined production of the U.S., Japan, India and Russia. In 2011 and 2012, China produced as much cement as the U.S. did during the entire 20th century.
Although the 13th FYP pays lip service to this problem by calling for “proactive, prudent resolution of excess capacity,” its moderate language pales in comparison to Li Keqiang’s statement at the end of NPC 2015, when he declared, “This is not nail clipping; this is wrist cutting. No matter how painful, we must bring down the knife.” Coming on the heels of a year fraught with stock market volatility and steep declines in exports, this linguistic retreat reflects official ambivalence over how to carry out difficult structural reforms while preserving social stability.
The 13th FYP is short on details concerning SOE reform and lacks a specific timeline for implementation. Nevertheless, prior to this year’s NPC, the Chinese government announced its intention to “transfer or replace” about 1.8 million workers in the steel and coal industries, as well as cut 100-150 million tons of steel capacity. While opening these industries to market competition and facilitating the exit of debt-ridden SOEs would be the most efficient way of making these cuts, Li Keqiang’s Government Work Report characterized bankruptcy as a last resort, instead favoring “mergers, mixed-ownership reforms, reorganizations and debt restructuring.” Given China’s track record, it is unlikely that these reforms will wean SOE executives from their tendency to prioritize old loyalties and short-term political gain over market fundamentals. As a result, the government will encounter considerable difficulty as it attempts to reduce excess capacity across traditional industries.
Even though Chinese officials have expressed disapproval of massive stimulus on many occasions, Premier Li’s report repeatedly signals that Beijing is determined to keep the economic growth rate above 6.5 percent in 2016. Financial reform is vital to achieving this goal. This year, China will focus on monetary and fiscal easing, moving to increase its M2 money supply and aggregate social financing to 13 percent (possibly creating RMB17.9 trillion in new finance); expand its fiscal deficit to RMB2.18 trillion; increase general payments by 12.2 percent (some of which usually subsidizes local enterprises); and make upward adjustments to debt ceilings for certain local governments.
Liquidity unleashed from monetary and fiscal easing is expected to boost China’s recently sluggish real economy, which has troubled local governments and enterprises alike. Regardless, the key to rebalancing the Chinese economy lies in incentivizing local governments and businesses to grow sustainably. Currently, local governments – and SOEs in particular – are more than happy to embrace monetary easing without considering whether they are actually “drinking poison to quench thirst.” For example, local governments are now issuing bonds to replace old debts, while enterprises, including those in bloated sectors, are receiving an influx of loans from more diversified channels, including commercial banks, the margin trading market, peer-to-peer (P2P) and private lending.
However, uncertainties prevail: the danger of capital bubbles persists, and overcapacity has been exacerbated by a steady stream of capital input. Furthermore, recent government actions to address financial volatility have provided fresh cause for concern. In early January this year, domestic bank lending volume hit a historic high, which quickly caused overheating in the real estate market. More worryingly, most of these loans were believed to have gone towards rolling over old, unsustainable debts.
The 13th FYP focuses on reforms to ensure efficient budget expenditure, a healthy financial system and strong supervision over market players. Even so, the extent to which these reform measures will become reality remains unclear; in fact, most measures in this year’s plan have been proposed before. For example, reform of registration-based stock issuance was brought up in 2014 in order to relieve debt and increase direct financing for enterprises. Although the 13th FYP still prioritizes this as a top reform over the next five years, Premier Li omitted registration-based reform from his Government Work Report this year, possibly to avoid further destabilizing China’s volatile financial market.
James McGregor is the Greater China Chairman of APCO Worldwide and the author of two highly regarded books: No Ancient Wisdom, No Followers: The Challenges of Chinese Authoritarian Capitalism, published in October 2012, and One Billion Customers: Lessons from the Front Lines of Doing Business in China, published in 2005.
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