China not about to swerve away from reform path

By Shen Jianguang Source:Global Times Published: 2016-5-9 0:38:01

Illustration: Luo Xuan/GT

Recently, there has been conflicting and confusing information about the state of the Chinese economy and the financial market, along with heated debate about the country's policy direction.

China's economy performed quite well overall in the first quarter but growth in private investment almost halved compared to the same period in 2015. And bond defaults and cancellation of bond issuance have become more common amid a loosening of monetary policy. China has vowed to focus on five key tasks this year - tackling industrial overcapacity, reducing inventories, deleveraging, cutting costs and shoring up weak links in the economy - but whether the country will achieve the desired results remains to be seen. Debt-for-equity swaps have become a byword for deleveraging. There has been a tendency to keep firms open rather than allowing them to close down in order to maintain employment as the country tackles industrial overcapacity. Reducing inventories has also become problematic as home prices in first-tier and second-tier cities have shot up.

Given all these contradictions, concerns have been voiced as to whether the Chinese government has decided to abandon its plan to let the market play a bigger role in the economy and whether China might back off from its economic reform agenda. 

President Xi Jinping's recent visit to Xiaogang village in Anhui Province, the symbolic birthplace of China's reform policy first introduced in 1978, may help to clear up the misunderstandings about China's policy direction. Recognizing that reform has transformed China's economy, President Xi assured farmers during his inspection tour that the Party will stick firmly to the path of reform.

Now that the reform direction will not be reversed, how should we assess the above-mentioned contradictions facing the Chinese economy, as well as the problem of tackling overcapacity and deleveraging?

The five tasks that Chinese policymakers vowed to focus on this year are certainly encouraging reform plans. But there will inevitably be contradictions as we seek to implement these plans and find a balance between growth and restructuring. For instance, reducing overcapacity and deleveraging will drag on growth as downward pressure persists. Besides, the key to tackling overcapacity and deleveraging is advancing State-owned enterprise (SOE) reform. But the reform path remains unclear.

However, the message from the annual sessions of the national legislative and consultative bodies in March has signaled the government's attitude toward the way it steers the economy: That is, stabilizing growth and keeping employment stable remain top priorities.

While President Xi offered reassurance of his determination to stick to the reform path during his visit to Xiaogang village, he also stressed the need to ensure laid-off workers find new employment as soon as possible and the need to boost demand properly. That means stabilizing the economy is still a priority in the short term. Given that the reform direction will not change, why can't the reforms achieve more notable progress? I believe that one of the key reasons for this is that China is in a special political-business cycle - the 19th National Congress of the Communist Party of China (CPC) will convene next year. Since the 11th National Congress in 1977, China's business cycle has coincided closely with its political cycle. A year before and after the Party Congress, the economy normally performs better than in other years. It indicates that ahead of the change of party leadership, officials at all levels are more motivated to achieve better economic performance.

Domestic and overseas scholars have conducted a lot of research into the theory about the political-business cycle. For instance, Li Yinan, an economist at Stockholm University, suggested in 2012 that fixed-assets investment in China tends to rise one year before and after the Party Congress.

Ji Zhihong, an official with China's central bank, claimed in 2014 that the total volume of bank credit is related to the age of local officials and it peaks when local officials' average age is 54. Tan Zhibo, a researcher at Fudan University, found out in 2015 that credit and fixed-assets investment are closely related to the tenure of provincial Party secretaries and governors, with their relationship showing an inverted U-shaped curve.   

Based upon various theories and research findings, I tend to believe that the connection between China's political cycle and its business cycle makes sense. From this perspective, it can be understood that China is now striving to unswervingly push forward economic reforms. It is expected that ahead of the 19th National Congress of the Communist Party of China, the country will continue pro-growth policies in the short term aimed at stabilizing the economy and ensuring sufficient employment. Against the backdrop of still fragile economic growth this year, the country's monetary policy is likely to remain loose and expansionary fiscal policy will continue, which is in tune with robust growth expected to be seen in infrastructure investment. What's more, deeper reform efforts are expected after the 19th CPC National Congress.

The author is managing director and chief economist at Mizuho Securities Asia. The Chinese version of the article was first published by the Financial Times.

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