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China's Reform Agenda Cheers Wealth Managers

Tom Burroughes

20 November 2013

Wealth managers who had been initially disappointed last week at the cautious tone they saw in China’s reform plans of its state-directed economy have become more upbeat after the full scale of plans were revealed at the weekend.

At the Third Plenary Session of the 18th Central Committee of the Communist Party of China, it issued a report that goes further in first thought in calling for reform of state-owned enterprises, financial deregulation, greater recognition of property rights, a relaxation of the “one-child” policy and other measures.

Chinese equity market indices have rallied in the aftermath of the Chinese announcements, reports have noted, due to the heightened optimism associated with the reform proposals. China Life Insurance Co, the country’s biggest insurer, and seen along with financials as a beneficiary, rallied as much as 4.8 per cent at one state late yesterday (source: Bloomberg). The MSCI China Index has chalked up total returns of almost 6 per cent this year so far. However, the MSCI World Index of developed countries’ equities has fared better, with total returns (capital growth and reinvested dividends) of 23.6 per cent.

“We expect the said in a note. (The last comment reflects on how it expects birth rates to change.)

After a period of decelerating growth - prompting concerns that the Asian giant might falter, triggering problems such as a property market crash – Chinese policymakers in the country have wrestled with the issue of how to reform in a more supposedly capitalist direction without surrendering the decades-old control of the Communist Party. There have been fears of mal-investments, such as “bridges to no-where”, empty cities and excessive spending on prestige projects.

At , the UK-headquartered private bank said of the plans that “economic liberty is set to improve dramatically” and, while stopping short of the classical liberal model, it said the Chinese reforms acknowledged the truth that resource allocation is handled more effectively in a market economy than a centrally controlled one.

“While the state will still play a major role, market forces and private capital should become much more influential. Latent fears of insolvencies in the banking and local government sectors have been addressed by steps to increase accountability and liberalisation,” Coutts said.

Long-term

UBS said it expects the reforms to have a positive impact in the long term on the Chinese economy.

“We are encouraged to see the report de-emphasise GDP growth as a performance measurement criterion for local governments, and put weight on other areas that will improve the quality of growth, such as environmental impact, reduction of industry overcapacity, and debt levels,” UBS said. “We view this as a critical first step in reining in the excessive investment activities of local governments and, thus, the rising debt level of the Chinese economy,” it said.

UBS said a consensus GDP forecast for China of 7.4 per cent growth next year is conservative; the Swiss firm’s is pencilling in a 7.8 per cent rise next year.

Among the specific measures is development of a mixed ownership structure to allow more private involvement in state-owned enterprises, or SOEs and shift a portion of SEO shares to social pension funds and use market-based employment terms and salary systems.

“This area is the major positive surprise given the wording of the communiqué and the market’s low expectations,” UBS said.

On fiscal and tax reform, the Chinese authorities intend to allow local governments to widen their financing channels, such as debt issuance for construction projects and have the central government take back some spending tasks in areas such as social security.

On the “one-child” policy, which has been in force since 1980 and is blamed for an imbalance between males and females in the population, UBS said the relaxation of this controversial policy was not a surprise. China’s total fertility rate has fallen over the past decades to around 1.5-1.6, under a replacement rate of 2.1.

Rural land reform, which seeks more channels for rural collectives to sell land for construction and give more robust protection for property rights, UBS said this change will drive urbanisation in the still-predominantly rural country.

New tolerance

“There is a new tolerance for imposing market forces on strategically important sectors and those where previous stimulus packages have resulted in over-capacity and excess debt,” Coutts said in its appraisal of the reforms.

“The document also sets out a blueprint that champions ‘good’ sectors that advance China’s aims of boosting productivity while reducing the environmental damage that often comes with rapid change in developing countries. Within the environmental protection and clean energy space, we believe that the preferred sub-sectors of solar, waste-to-energy and natural gas will be net beneficiaries,” it said.

“The imposition of market dynamics on sectors that have been beneficiaries of easy credit from state-owned banks implies substantial restructuring. The six industries where market forces will play a much more assertive role will include water, petroleum, natural gas, electricity, transportation and telecommunications,” Coutts continued.

“What we have here is a blueprint for a substantial overhaul of the relationship between the state and individuals. As was the case two weeks ago, it is naive to believe, as some quarters did, that the plenary session would and can deliver virtually instant results. That was never a prospect and that this was believed, mostly by commentators outside of Asia, shows how far we still have to go before investors in developed nations pay the appropriate attention to the history, embedded culture and on-going development in this part of the world,” Coutts said.

“The great Austrian economist Friedrich von Hayek clearly demonstrated in 1945 that markets are a superior means of allocating resources and pre-judging the potential profitability of investment propositions. That China is now coming to the same conclusion is a very positive sign indeed,” it added.