China is about to kick off its annual Central Economic Work Conference, where policymakers review the previous year’s efforts and set policy for the coming year. The exact date for the conference remains unknown, which is not uncommon given China’s lack of transparency, but policymakers and prominent think tanks have been hinting at potential agenda items for weeks. Just like last year, structural reforms, boosting domestic demand and maintaining economic growth will top the list for discussion. The theme of the conference will be a continuity of policy stimulus, which should come as no surprise given that the Politburo has said it will leave economic policy unchanged in 2010. Still, the recent focus on industrial overcapacities and the continued weakness of external demand will give impetus to these initiatives, perhaps even enough to see more such reforms than in 2009.
The Importance of the Economic Work Conference
The government has yet to announce the exact date of the conference, and even state media reports have been contradictory, but it is expected to convene within the next week or two. President Hu Jintao and Premier Wen Jiabao are expected to address the conference, but most of the negotiation will be between technocrats from China’s economic ministries behind closed doors. The policymakers will hammer out China’s economic policies for 2010 at the meeting, but numerical targets will wait for the State Council’s Government Work Report, which will be submitted to the National People’s Congress in March. This follows a familiar pattern in Chinese politics: Ministerial technocrats send their ideas up to the State Council, the government’s 50-member administrative body, which then seeks approval from the Politburo’s Standing Committee, composed of nine Communist Party leaders, who then send the policy back down with targets for the technocrats to achieve.
The conference will focus mostly on industrial and fiscal policies, leaving monetary and credit policies to the central bank and financial regulators. Although the 25-member Politburo recently pledged to maintain China’s fiscal and monetary policies, it also said it would “make policies more targeted and flexible, based on new situations and new circumstances.” This could give the technocrats maneuvering room to use fiscal policy to go after industrial overcapacities and cool the property bubble in 2010, but any changes to the overall composition of the fiscal stimulus will be marginal. Next year also marks the final year of the current Five-Year Plan, which aims to create a “harmonious society” through “scientific development.” Policymakers will be looking to lay the groundwork for the next cycle’s plan, the drafting of which probably already has started. (For RGE’s analysis of China’s monetary and credit policies in 2010, see “What is China’s Exit Strategy?”)
Few Fiscal Policy Changes Expected
The Politburo has announced that the fiscal stimulus will continue into 2010, and many consumer subsidies also will be extended. This indicates that China is likely to once again adopt a 3% budget deficit target. This has posed a challenge in 2009, especially at the local level, and RGE forecasts China will post a 3.5% deficit for the year. Policymakers still may hit their target in 2009 given that nearly the entire deficit will be booked in December, when government expenditures generally triple from their monthly average. In fact, through October, China was sitting on a RMB848 billion (US$124 billion) fiscal surplus, albeit 38% less than the government’s surplus at the same point last year. With local governments’ off-balance-sheet spending factored in, however, China’s fiscal position looks less solid.
The central government’s budget worries paled in comparison to those of local governments in 2009. Revenue-sharing problems with the central government and limited fundraising opportunities pushed local officials to rely more heavily on quasi-official municipal development and investment companies to cover their shortfalls for the fiscal stimulus. These companies take out loans from local banks or issue bonds to fund local government initiatives, often using their loans to the local government as collateral. This scheme has been one factor driving credit growth in 2009.
The central government is justifiably concerned about these arrangements, and the Chinese MoF has issued RMB200 billion (US$29.3 billion) in bonds on behalf of local governments, who are banned from issuing debt, lest they run up deficits, to cover some of the shortfall. Although the booming property market should boost local government revenues, similar bond issuances are likely in 2010. Such fundraising likely will fail to cover the shortfall in local revenues, though, and the deficit will probably be hidden in another shell game with municipal development companies, adding to the central government’s contingent liabilities. The Research Institute for Fiscal Science, a think tank within the MoF, estimated that off-budget local debts totaled RMB4 trillion (US$586 billion), or 14% of GDP, at the end of 2008. This figure surely rose in 2009, as quasi-municipal debt issued in H1 2009 accounted for 38% of total domestic debt, after comprising a 13% share in the same period last year, according to the National Development and Reform Commission (NDRC).
Because external demand is likely to remain weak, and some of this year’s subsidies will be continued, policymakers will find it difficult to meet their 3% deficit target again next year, though RGE does expect improvement in corporate tax revenues. This will encourage more government bond issuance, which rose 14% for the year through Q3 2009, according to the ADB, and will prompt regulators to continue efforts to increase the liquidity of China’s credit markets and expand the investor base.
Sluggish Industrial Reforms
Even before the financial crisis, China faced overcapacity problems in several sectors, but a drop in external demand and an increase in investment have exacerbated the problem this year. As in the past, steel, aluminum and cement have some of the most worrisome overcapacities, but new sectors like wind energy also look troubling. The European Chamber of Commerce in China recently estimated that the utilization rate for the steel sector will fall to 72% in 2009, while wind power could see its rate fall to 70%, and aluminum will operate at 67% of capacity. Policymakers will focus their energies on curbing further investments in these sectors through credit restrictions and stricter project approval requirements, but without addressing the conflicting interests of local officials, these efforts once again will have little impact. (For a more detailed look at China’s overcapacities, see “Chinese Monetary Policy: Little Effect on Overcapacities, and Risks of Blowing a Property Bubble.”)
This year saw a renewed national push against corruption, timed to coincide with the 60th anniversary of Communist China, and further efforts are likely to be discussed at the conference. He Guoqiang, China’s anti-corruption chief and a Politburo Standing Committee member, recently said that 198 officials had been punished in 88 cases related to the fiscal stimulus since November 2008. Look for further corruption probes to deal with this year’s credit surge.
The role of state-owned enterprises (SOEs) in China’s economy is also set to be discussed at the conference. The growing economic role of SOEs complicates effort to reduce overcapacities and boost domestic consumption. The fiscal stimulus and massive credit expansion in 2009 helped SOEs gain market share, increase their power base and even move into sectors like real estate that were p
reviously dominated by private actors. Local officials rely heavily on SOEs for revenues and have been reluctant to enforce reforms that would cut capacity or encourage mergers. SOEs also have contributed the bulk of the growth in China’s savings rate since 2003, as many emerged highly profitable from the previous reform era but had little incentive to pass these profits onto shareholders or the state.
Reforms were launched in 2007 that require SOEs to contribute up to 10% of their profits to the government, but these dividends do not go into the general budget. Instead, they funnel into a MoF fund controlled by the State-Owned Assets Supervision and Administration Commission (SASAC). Rather than being used to encourage domestic demand through transfers to the household sector, the funds generally are channeled back to the SOEs. SASAC has been pushing for greater control over the funds ahead of the conference to meet consolidation goals, as well as control over SOE budgeting, but the MoF appears to be the stronger adversary. The MoF could gain approval for a greater portion of the dividend payments to be channeled into a separate account to expand China’s social safety net, though at least initially this would be a rather modest shift. Some domestic think tanks argue that dividend payments should be increased, considering they are still less than 1% of GDP, but any increase seems unlikely this year.
Consumption Support Measures to Be Extended
In recent weeks, the Ministry of Commerce has been talking up the importance of boosting retail sales in 2010 to encourage a shift toward domestic demand. Consumer incentives for household appliances are likely to be extended into 2010, as are the reduced taxes on passenger cars that were set to expire at the end of the year. The NDRC expressed concern earlier this year that without further stimulus measures in 2010, the auto sector could face serious overcapacity problems. Some have suggested that the tax incentives could be expanded to all passenger cars (currently they only apply to those with engines under 1.6 liters), which would help to boost the profit margins of domestic suppliers but could hamper China’s efforts to reduce its carbon intensity.
Policymakers will hash out ideas to support consumption at the conference, but little progress is expected. The stimulus package included an expansion of health insurance, the construction of hospitals in rural areas and measures to control pharmaceutical prices, efforts set to be continued into 2010. With local governments expected to pick up 60% of the costs, however, the availability of funding appears uncertain. Even if the funds are found, the reforms only call for a US$17-per-person subsidy for health insurance that would cover 90% of the population next year. As insurance typically covers less than half of out-of-pocket health expenses in China, these reforms will have only a limited impact on consumer spending in the near term.
One sector that may see significant changes in 2010 is real estate, which is coming under increased scrutiny from policymakers. Subsidies that are set to expire at the end of the year may be allowed to do so (for example, the shortened lock-up period required to avoid taxes on profits), and developers’ leverage ratio limits could be lowered. Policymakers are wary of a return to the austerity measures introduced in 2007 that contributed to a correction, but the national regulators will be more inclined to enforce existing rules. Here, too, policymakers will move slowly as the rebound in property prices is extremely important to local government finances, retail sales and consumer sentiment.
Growth Target Likely to Stay
When China announced its 8% growth target for 2009 after last year’s work conference, few thought this was achievable. Although an exact target will wait for the Standing Committee’s approval, 8% has been the goal for many years. RGE expects 8.4% growth for China in 2010, below most economists’ growth forecasts.
The conference is likely to see plenty of references to increasing the “quality” of China’s growth, implying less concern for the “quantity,” but few policy changes in this regard are expected. China posted 8.9% y/y growth in Q3, and Q4’s rate could be in the double digits. Yet Premier Wen and others are still concerned about the four “un’s” they see posing threats to growth: China’s economy still looks “unstable, unbalanced, uncoordinated and unsustainable” in many ways, and the fiscal stimulus only exacerbated these problems. Many of the support measures for exporters that were removed in 2007 to address these imbalances were reinstated in 2009, and investment increased its already excessively high portion of growth. The Ministry of Commerce will likely block any attempt to remove the tax rebates and other support measures from the export sector, which may further exacerbate trade tensions next year. The reliance on investment will be a topic of discussion, but finding policies to address the problem once again will prove difficult.
Overall, 2010’s economic policies are likely to look much like those of 2009. These policies propelled China back to growth this year, and, at least for H1 2010, the trend looks likely to continue. The stimulus first lifted heavy industries and then in Q2 2009 began filtering down to lighter industries, where most jobs are concentrated. Q3 saw the property sector start to take over, even as industrial overcapacities once again loomed on policymakers’ minds. Through H1 2010, this trend will continue, and services also may start contributing more to growth, but excessive reliance on the property sector looks unsustainable much past mid-year. Around this same time, the infrastructure investments initiated by the stimulus will begin to fade, and if RGE’s forecast of weak external demand proves accurate, China’s growth will likely slow. The fiscal and credit stimulus may have temporarily stabilized China’s economy, but next year policymakers will have to deal with its unbalanced, uncoordinated and unsustainable nature. This will prove the harder task.