China certainly knows how to make an impact. The communiqué it released on November 12, at the end of its Third Plenum, was widely held to be disappointing. There was certainly no euphoria evident in the markets. The same vague language as usual, said many observers; an encouraging direction, said the more optimistic.
That all changed last Friday. The release of a longer, more detailed document transcended even the most positive expectations in terms of refashioning the financial markets and the state-owned enterprise sector. Most noticeable was the strong language around allowing markets to play a juedingxing (decisive) role. Party secretary Xi Jinping even said the market had proved itself to be the best allocator of resources.
Among the capital market highlights of the 20 page blueprint are permitting privately owned banks, increasing corporate access to bond and equity markets, accelerating the convertibility of the yuan and liberalising interest rates, including the introduction of a market-driven treasury bond yield curve.
The SOE reforms include allowing more private participation, increasing the level of dividends companies pay to the state and reducing the SOE control on areas such as real estate and steel.
But the document’s 60 points cover everything from adjusting the one-child policy to enhancing social mobility for its citizens in rural areas. China’s leaders want nothing less than to remodel the country from top to bottom.
All mouth, no trousers?
China bears — and there are a lot of them — are already playing down the paper as large in ambition but likely to be lacking in action. Their concerns are well-founded. China’s five year plans from 2006 and 2011 outlined strategies to deal with China’s unbalanced economy and have largely failed to have any meaningful impact. And with the state playing such a large part in the economy, vested interests often mean that reforms come up against huge resistance. Until now, there has been a lack of political will to push them through.
But the latest announcement goes far beyond what has been seen before. The rejection of a Marxist approach to capital markets is a reversal of the dogma that has been in place since the Communist party came to power in 1949. To commit this to paper suggests that the government of president Xi is serious about reform. And while this reform will not happen overnight, it will have a huge impact on Asia’s capital markets.
Opening up China’s industrial and financial markets to more competition should drive longer term economic expansion. In the meantime, though, it will hurt GDP growth. Interest rate liberalisation is likely to lead to higher funding costs across the board, which could constrain consumption and investment. And when China suffers, so does the rest of Asia, as investors have a habit of turning bearish on the whole region if the country’s prospects look less rosy.
As state institutions lose their monopolies and have to pay more money to the government, their margins will come under pressure. Those investors who this year bought $31.7bn of SOE bonds in G3 currencies may have to adjust their credit expectations as the private sector becomes more involved.
It’s been a long time coming butFriday’s announcement finally moved China’s transformation to a fully globalised economy away from pure rhetoric and more towards reality. Even the sceptics need to sit up and take note.