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All China Economic Review wants for Christmas

Reform wish list

Chinese President Xi Jinping doesn’t have a long white beard, nor does he drive a sleigh of reindeer. However, like the mythical Western gift-giver Santa Claus, China’s party boss does have a penchant for red, something he’s made apparent with many a homage this year to China’s communist party.

There are other parallels to Ol’ Saint Nick. Xi, who officially came to power last March, has been handing out promises to revamp China’s economy like a reformist Kris Kringle. A 60-point document issued at the close of the year’s most important political summit in November pointed to several thorough and overarching reforms to China’s financial and social systems, many of which could launch in the coming year.

The promises are vague, though. China Economic Review has drawn up a wish list asking for five economic and regulatory reforms to be carried out in the coming year, all of which are realistic and highly plausible, even likely. The new administration has kept political reform off of its to-do list and therefore it is explicitly not included here. Xi has made it clear that one-party rule is here to stay.

1. All we want is a date

Asking Chinese regulators for a real timeline on the liberalization of the yuan is like asking Santa Claus for a large pet at Christmas: It’s just not realistic. What’s more feasible in 2014 is a concrete plan for currency convertibility in Shanghai’s free trade zone. The central government, under the direction of Premier Li Keqiang, rolled out the zone with little hesitation. After an early July announcement, the zone officially launched within three months. Regulators including the China Securities Regulatory Commission (CSRC) and the People’s Bank of China (PBOC) responded with guidelines that gave a wealth of details on how the zone will function. Yet, they have held off on any firm guidance for renminbi convertibility inside the zone. The Shanghai government has said that the zone should be fully functional before the close of 2014. If so, the State Administration of Foreign Exchange (SAFE), an incredibly powerful party organ that hides behind the cloak of PBOC, should keep up with these developments and issue a date when the yuan will be convertible within the FTZ. That, in turn, will set the pace for capital account liberalization as a whole.

2. Spend Christmas in a prison cell next year

A prison sentence might not sound like much of a Christmas present but this is what China Economic Review is wishing for Chinese companies and underwriters that fib in IPO prospectuses in the coming year. Mainland exchanges will open once again to floatations in early January after a year and two months without a single IPO. China Securities Regulatory Commission (CSRC) closed the market to IPOs because of low liquidity in mainland exchanges but also because listing companies often lied about sales and revenues in order to boost valuations. The losers were retail investors and the reputation of mainland markets in general. It might seem counter-intuitive, but CSRC could also lower regulatory hurdles in 2014 for companies that want to list. Firms might need only to meet a certain set of requirements, not strenuous and ever-changing regulation, if they want to IPO. That’s an applaudable development that would make the mainland look more like markets in the developed world. But it must come hand-in-hand with severe criminal penalties for cheaters. CSRC and China’s judicial system has been unduly lenient to these lawbreakers, who often have deep government connections. Only strict punishment for these executives, and the underwriters who abet them, will clean up the market when it opens to IPOs and potentially lowers its regulatory standards. That would truly be a gift to investors.

3. The holidays are a time for bonding

China Economic Review doesn’t want bonds for Christmas. But reform to several areas of China’s bond market in 2014 would be pleasant – if not absolutely necessary. One important step regulators can take is expanding China’s municipal bond markets. Most provincial and city governments can’t borrow directly from banks so they establish shell companies to borrow for them. Those companies have amounted up to US$3.9 trillion dollars in debt, at least half of it accrued starting in 2010, to pay for projects such as roads that don’t bring in much revenue. This borrowing is intertwined tightly with China’s US$3.4 trillion shadow banking sector as well as the high-risk market for wealth management products worth up to US$1.2 trillion at the end of 2012. China has already all started bond pilots in some provinces and cities. This must be expanded in order to cut down on off-balance-sheet spending by local governments. Another bond surprise could come in the corporate sector. China hasn’t allowed a corporate default in more than 12 years, something that has put an implicit government guarantee on corporate bonds. Corporations must repay US$479 billion in interest and principle in 2014, a 20% increase off of last year. The People’s Bank of China should a few weak companies default on their bonds. The a move would help revalue the market for corporate debt and assess the risks therein.

4. Don’t forget to gift the little guys

China was kind to its favorite mobile operator, China Mobile, in 2013. The company, with more than 760 million customers, got all it could ask for including a 4G license to operate its TD-LTE network and a sweet partnership with the world’s most valuable technology company, Apple. But China Unicom and China Telecom, the country’s two smaller operators, will need some handouts too. One gift the Ministry of Industry and Internet Technology (MIIT) could give the two firms is “asymmetric fees” for cross-network phone calls. It sounds technical but it’s actually simple: Currently, when a China Unicom user calls outside of his or her network and into the China Mobile network, China Unicom must pay a fee to China Mobile. That fee is the same, or “symmetric,” when a China Mobile user calls into China Unicom or China Telecom networks. This scheme has always resulted in a net profit for China Mobile simply because of its massive subscriber base, the biggest in the world. More people will always dial into China Mobile then dial out. MIIT should lower the cross-network fee for China Unicom and China Telecom in 2014 (it’s rumored they will). It’s the least the regulator could do in a sector that’s showering gifts on China Mobile.

5. Give us less in 2014

That’s right. Unlike a greedy child, China Economic Review is asking for less instead of more. China’s top policymakers should shoot for 7% GDP growth in 2014 rather than the 7.5% that many analysts predict. The growth target was likely set at the Central Economic Work Conferenc
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held earlier this month, however the figure won’t be released until the National People’s Congress in March. Slowing growth to the lower number means that China will invest less money in infrastructure projects. The country will need trillions of dollars in infrastructure in the coming years to support an influx of people migrating from the countryside to the city. What China doesn’t need is unbridled spending on lavish government buildings and other projects that won’t generate revenue or serve much of a purpose. During the early days of reform, the government took in decent returns on these kinds of investments. But China’s incremental capital output ratio (ICOR) has doubled since the 1980s. That means, according to CLSA Asia-Pacific Markets, it takes twice the investment to generate the same return. Aiming for 7% growth will demonstrate that China’s new leaders are serious about ditching the investment-driven growth model for one more reliant on domestic consumption. 

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