The Plenum: another leap of faith?
The Plenum underwhelmed in details, but probably deliberately so
We could almost hear the sound of discontent when the curtain of the Plenum was finally drawn. The communiqué from the Plenum contains little detail on reform, but compensates with its lofty ideals. It touches briefly on the market’s decisive role in the economy, recognises the balance between the state and private sectors, as well as the importance of the constitution and the rule of law.
Investors are disappointed, and rightly so, as their hopes have been fanned by the mysterious pre-release of the 383 document outlining the blueprints and the details of a reform. But instead of reading between the lines of the ambiguous statement to infer the eventual policies as pundits do, we refer to the prededence of the communiqué from the historic 1978 Plenum. Indeed, the 1978 Plenum communiqué was never meant to be precise.
On the ideology front, it re-emphasised Chairman Mao’s forgotten principle of “seeking truth from facts” to marshal all social groups for one single purpose, and embarked China on the course of “socialist modernisation”. Intentionally or not, it was quite fortunate that the communiqué did not prescribe any specific reform measures, with the exception of agriculture, as China’s idea about market economy then was nothing much more than “Britain plus the communist ruling”. And the nation thus was able to reform through piecemeal experiments and marginal revolution. The same may apply to the communiqué from this year’s Plenum – to assemble everyone under one goal (to build a strong socialist country), one party (the Chinese Communist Party) and one man (President Xi) with two newly-created government organisations. And more details on specific reform are likely to emerge in the coming weeks and months.
Reform or not, market will be challenging; continue de-risking
The idea that an earthshaking reform will save the ailing market has proven to be a fantasy. The fact is that any reform involves costs and trade-offs. More details are needed on three important balances within the economy: 1) central versus local governments; 2) state versus private sectors and 3) capital versus labour.
The first balance must be restored through a comprehensive tax reform, including property and VAT tax. Local governments’ tax collection should be commensurate with local development costs, instead of the central government guaranteeing the liabilities. The second is about improving the efficiency of state assets, probably through the introduction of competition. And we have already seen initial signs in the telecom and railway sectors. The third balance is about labor’s share of income in the overall GDP. The fact that labor’s income growth has fallen significantly behind economic development suggests that return to capital owners must have been disproportionally large. This gives rise to income disparity and social instability, but could be resolved through social welfare programmes, hukou and perhaps land reform.
Yet in the near term, forces such as monetary conditions and investor sentiment drive the market, not the reform. We note that liquidity in China has been tight, with bond yields and IRS prices soaring to historical highs. Meanwhile, Sotheby’s share price (NYSE:BID) appears to be triple-topping. This top auction house is a signpost of discretionary spending and economic cycles. Together with China’s IRS prices, its shares had heralded the important market tops in October 2007 and again in April 2011 (Focus Chart 1-2). This time, it is unlikely to be different, and investors should brace themselves for global sell-offs in the coming days.
The author is Managing Director, Research at Bank of Communications (Int'l). Follow him on Sina Weibo.