China Reform Coming: What Investors Should Look For


Reform in China happens at an impressive glacial pace. The country has not advocated quick change in a long time, preferring to move step by step to where it wants to go. In recent years, this has allowed the country to remain stable in an unstable world. The Third Plenary Session (3PS) of the 18th Party Congress will take place soon. There are reforms that some investors are banking on.

A new report form Citigroup Inc (NYSE:C) takes the top ten reforms likely to come out of the meeting. China may relax its one child policy to two, deposit rate liberalization, household registration reform, service sector deregulation, securitization, fiscal reform, property tax, local government debt reform, land monetization, and the treatment of foreign and Chinese investors.

Change in China

Change in china is going to be slow. According to the Citi report, the coming reforms are unlikely to be groundbreaking, but they will be meaningful. There will be a “natural balance between what will be done and what can be done.” There are three major themes that are likely to be expressed in the coming reforms and through reforms in the coming decades.

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These themes are, according to the report, rising market power, continued opening-up and policy flexibility. For investors, some reforms will be more meaningful than others. The major things investors will be watching for are China’s ability to deal with the financial problems currently brewing in the country, including the property bubble seen in the above chart, and the country’s ability to modernize its markets and the structure of its industries.

Financial reforms to avoid collapse

Of the ten reforms that were pointed at by the Citigroup analysts, one of the most important is the reform of local government debt. Right now, local governments are not able to sell bonds, and they’ve been using a shadow banking system to raise funds. That is generally viewed as unsustainable, and something that the Chinese government needs to put an end to.

According to the Citi analysis, “De-leveraging is needed to avoid a financial crisis in the next few years. Global experiences suggest that rising leverage ratio often ends with a crisis and sharp economic adjustment.” This is aimed squarely at local government. De-leveraging will not be easy, and the report admits that it will be a painful process and necessitate bankruptcies in the coming years.

The local government problem is part of a series of fiscal reforms that the Chinese government needs to make, in the view of the analysts. There are four main parts to fiscal reform in their view: cutting taxes, introducing property tax, local government debt restructuring, and redistribution of revenue between local and central government.

At the end of the day, China needs to become a less centralized country in the coming years in order to boost demand and ensure growth continues at a high rate. The country’s export share is sitting at around 16 percent, and it may not be able to go much higher. That means demand will need to come from inside the country itself. That represents a big change in the way China functions.

Heading towards a new China

China’s political institutions are notoriously opaque. That means it’s almost impossible to guess what decision they will actually make at the next conference. The Citigroup Inc (NYSE:C) predictions are based on things the analysts think the country needs. They might be distasteful to the government, however.

In a centralized economy that is liberalizing, almost all reform means the loss of some of the power of the government. Whether or not China is interested in real reform won’t become clear until the results of the conference are released.

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