China’s bold reform plan won’t halt growth slide

Reform of state-owned enterprises may boost productivity but politicised decisions will continue

Euphoria over the reform agenda released by China’s Communist Party on Friday helped push global shares to a six-year high yesterday. Chinese stocks listed offshore rose by 6 per cent, their best trading day in two years, while domestic shares increased by 2.9 per cent. Analysts at HSBC hailed the package, which includes plans to take on vested interests in the powerful state-owned enterprises (SOEs), to loosen the one child policy and increase the role of markets in the setting of prices and interest rates, as “the boldest package of policies seen in decades,” inviting comparisons with Deng Xiaoping’s landmark reforms of the 1970s and 1980s.

But uncertainty remains as to exactly how and when the policies will kick in. “What we’ve heard from China is still largely aspirational, and where there have been more solid commitments (such as the easing of the one-child policy), the calculated impact is actually quite small,” says Simon Smith of FxPro.

MORE MARKETS
The central emphasis of the reform plan is to upgrade the role of markets in allocating resources – from their historically “basic” role to a “decisive” one. And according to Wei Yao of Societe Generale, the policy document is “encouragingly specific” in this regard. Leaders have pledged to make the prices of water, oil, natural gas, electricity, transport and telecommunications far more market-determined, while also opening up more of the economy to private and foreign firms.

An analysis by Goldman Sachs estimated that reforms to the hukou household registration system could reduce migrant workers’ precautionary saving motive, boosting household consumption by 2 to 3 percentage points over the next decade. And effective SOE reforms, reversing the productivity underperformance of the industrial sector, could reduce inefficient investment by up to 1.5 percentage points of GDP each year. The package as a whole, Goldman Sachs says, will support above-consensus growth in the medium term.

CHALLENGES REMAIN
But there are issues that have not been tackled. SOEs still dominate plenty of key sectors (see chart), and the government does not seem to plan on breaking any of them up or allowing them to fail – two key areas where Capital Economics has said reform is needed. And the $1.6 trillion (£1 trillion) of local government debt across China could mean slow progress on liberalising the setting of interest rates.

According to Goldman Sachs, “another uncertainty is how reforms towards decentralisation and a market-oriented system will be carried out in a centralised policy and political environment, and how the risks during the process of liberalisation will be monitored and managed.”

Jessica Hinds of Capital Economics said yesterday that, even a fully-implemented reform package may not prevent growth from slowing to as much as 6.5 per cent in 2015 (compared to Goldman Sachs’s forecast of 7.8 per cent), and that the dominance of SOEs in China’s stock markets means that reforms could actually dent earnings.

For Ishaq Siddiqi of ETX Capital, this means investors wishing to trade a bullish sentiment toward China should focus on strong international companies with a footprint there. Mining stocks like Rio Tinto, and luxury brands including Burberry may benefit from improved domestic demand, he says. But where traders may once have used the Aussie dollar to express a view on China, Chris Weston of IG also recommends either a direct play on the yuan against the dollar, or the FTSE China A50 index.