China: Growth, re­form or both?

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

Is China’s govern­ment more fo­cused on short-term growth or long-term re­form? Those hop­ing for a clear an­swer are get­ting dis­ap­pointed.

At the turn of the year, the an­swer seemed to be clearly re­form: lead­ers had pushed for­ward with a new agenda in Novem­ber and seemed un­afraid to dis­rupt lo­cal gov­ern­ments, state-owned en­ter­prises and even cur­rency mar­kets. Since then, the pen­du­lum has swung back to­ward sup­port­ing growth, as a hous­ing mar­ket cor­rec­tion meant the of­fi­cial 7.5% GDP growth tar­get for 2014 was in se­vere dan­ger of be­ing missed.

But just when it seemed that re­form­ers had given in and were ready to do what­ever it took to pump up growth, the wa­ters have been mud­died again. At a meet­ing of the rul­ing Polit­buro on Mon­day, the lead­er­ship ap­proved a plan for fis­cal and tax over­hauls to be com­pleted by 2016, as well as one on re­form­ing the house­hold-reg­is­tra­tion sys­tem to pro­mote ur­ban­i­sa­tion. This is sig­nif­i­cant be­cause fis­cal re­form and ur­ban­i­sa­tion have been two ar­eas where the sub­stance has not kept up with the rhetoric; more progress has been made to date in fi­nan­cial re­form and Xi Jin­ping is try­ing to rein­vig­o­rate progress in those lag­ging ar­eas. And to re­in­force the point that it is not just a mat­ter of busi­ness-asusual, the Polit­buro also an­nounced the most se­nior tar­get yet of the anti-cor­rup­tion cam­paign: re­tired Gen­eral Xu Cai­hou, him­self a for­mer Polit­buro mem­ber.

The mes­sage from these mixed sig­nals is that China will try to pur­sue growth and re­form si­mul­ta­ne­ously. Since Bei­jing continues to be­lieve, rightly or wrongly, that it can have its cake and eat it too, it doesn’t ac­cept that it has to choose one key pri­or­ity. Short-term stim­u­lus mea­sures will have lit­tle ef­fect on con­fi­dence with­out oth­ers that im­prove the pri­vate sec­tor’s longer-term prospects. Con­versely, a vir­tu­ous diet of struc­tural re­forms is likely to prove un­sat­is­fy­ing if growth plunges. So what we should re­ally ex­pect from Chi­nese pol­icy are mea­sures that do a bit for growth and also move for­ward re­form.

On Mon­day, bank­ing reg­u­la­tors an­nounced a tech­ni­cal change in how banks’ loan-to-de­posit ra­tios get cal­cu­lated, which will have the ef­fect of al­low­ing them to lend more be­fore they reach the cap on the ra­tio. This is clearly an­other move to sup­port credit growth. But the strict reg­u­la­tory cap on the loan-to-de­posit ra­tio is in fact one of the ma­jor im­ped­i­ments to lib­er­al­is­ing in­ter­est rates in China.

The reg­u­la­tion in­cen­tivises banks to hoover up de­posits at the end of ev­ery quar­ter (when the ra­tio is checked), a process that causes huge vo­latil­ity in in­ter­bank in­ter­est rates be­cause of the surge in de­mand. Such vo­latil­ity makes it im­pos­si­ble for short-term in­ter­bank rates to carry clear sig­nals of mon­e­tary pol­icy from the cen­tral bank, as they would have to in a lib­er­alised regime. So the mar­ginal re­lax­ation of the ra­tio is a wel­come sign that con­ser­va­tive bank­ing reg­u­la­tors have started to ac­cept the cen­tral bank’s ar­gu­ments for phas­ing it out.

In hous­ing pol­icy there is a agen­das. With hous­ing sales govern­ment has al­lowed cities sim­i­lar con­ver­gence of de­clin­ing, the cen­tral to start re­lax­ing cer­tain re­stric­tive poli­cies. Last week Ho­hhot, the provin­cial cap­i­tal of In­ner Mon­go­lia, said it would no longer pre­vent home pur­chases by house­holds which al­ready own a property or by non-res­i­dents of Ho­hhot. Clearly the in­ten­tion is to sup­port hous­ing sales. But it’s also the case that these re­stric­tions, in force in most ma­jor cities, are dis­tor­tionary and clearly un­sus­tain­able over the long run—not least be­cause they block pur­chases by new mi­grants, the main source of ur­ban pop­u­la­tion growth in China. Since the re­stric­tions have to be re­moved even­tu­ally, it might as well be done when the eco­nomic cy­cle can get the most ben­e­fit. Of such happy co­in­ci­dences is Chi­nese eco­nomic pol­icy made.

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