Is a year a year in China? With an economy growing three or four times faster than most developed countries, it might be said a year in China is equal to three or four in the West. By that count President Hu Jintao and Premier Wen Jiabao have been running the show for seven or eight years.
Hu's predecessor, Jiang Zemin, seems a distant memory, yet he casts a long shadow with his people playing a significant role on the Politburo until the 17th Party Congress in 2007, when Hu (and Wen) can replace them with associates. In the meantime, they tread carefully. Jiang's era was a transition to consensus politics from the one-man shows of Mao and Deng. Hu and Wen have to spend more time and resources building support for policies, inevitably entailing horse-trading and compromise.
"This has been India's problem," observes Ben Simpfendorfer, a JPMorgan economist in Hong Kong. "If China had been like this 20 years ago, it might not have grown the way it has."
So caution defines their tenure so far. Policy has evolved in some areas and continued unchanged in others. "I haven't seen any major changes between Jiang and Hu-Wen," says Andy Xie, Morgan Stanley's chief economist in Hong Kong. "China's growth is still good, so there's no real need to change policies."
Challenges are proliferating. Ratcheting high-speed growth down to a strong cruising speed without stalling the economy is proving a tough balancing act – and the strains are showing: people increasingly vent their frustration over broken promises and lawbreaking by officials. Further opening required by China's WTO commitments will add to the strains in financial services, telecoms, and agriculture – where the challenge of massive restructuring collides with initiatives aimed at reducing the growing urban-rural income gap.
And the pressures will mount from without as much as from within: rising dependence on foreign oil and mineral resources to keep its economy steaming ahead has also required China to put on a friendlier face as it builds relationships around the world, often with countries like Sudan and Iran, which the United States considers rogue states.
So far, Hu Jintao and Wen Jiabao have largely succeeded in juggling their difficult briefs. They have so far kept the lid from blowing off China's pressure-cooker economy. They have made visible steps towards reform of the economy, to root out the corrupt and inefficient, and to include the excluded in China's impoverished interior taking early stabs at tax and land reform. In the middle of the country's energy shortages, they took steps to address safety issues in China's deadly coal mining industry. By and large they have succeeded in maintaining the peace in the streets while winning more friends than enemies abroad.
Jiang signed China into the World Trade Organization, leaving Hu and Wen to make good on all the promises. That they have largely done, though the tough part is yet to come – when services and telecoms opens to foreign competition in December 2006. Right now, China benefits most because it has an export-driven economy," says Paul Denlinger, principal of San Jose-based consultants China Business Strategy.
Intellectual property rights (IPR) violations remain a big blot. But even here there has been some progress with better laws and officials taking IPR cases more seriously. Shanghai Vice-Mayor Yan Jun Qui is on record as saying the metropolis now recognizes IP protection is an essential component of a knowledge-based economy. "Our objective," Yan said, "is to make Shanghai prominently known for its IPR management standards and protection." For now, the city is still known for pirate DVD stalls, but it IS getting harder to find them.
Economic opening up and old-guard resistance to the WTO (of the sort that always threatened to undermine Jiang's front man, Premier Zhu Rongji, every time he returned from accession talks with more apparent concessions than victories) has subsided noticeably. Soaring trade surpluses, the increasing sophistication of products with "Made in China" stamped on them – and with FDI topping US$50bn in 2004, the accelerating pace with which the world's manufacturers are migrating to China – all make the case against WTO membership increasing difficult to argue, even if badly run domestic retailers, distributors, banks, hotel chains, services, manufacturers and other big players have to improve or die to stay in the game.
While many may look back fondly on the days of the safety nets that the vast state enterprises provided, few today would argue that they are the best economic model: they are less efficient than the alternatives – foreign-run, publicly listed and privately owned. More people cherish the hope that China's growth is moving fast enough to lift them up, too. By fighting corruption and trying to level the playing field (by, for instance, stopping SOE executives from stealing state assets), Hu and Wen have succeeded in keeping that hope alive – and good for them, for their leadership might now be in question had they failed.
"China is happy with globalization as it interprets it – it's more unhappy with the unilateral quotas imposed by the EU and US," says Robert Broadfoot, managing director of the Political and Economic Risk Consultancy in Hong Kong. Just last month the European Union and China averted a major showdown by signing an accord that limits export growth depending on the item to between 8% and 12.5% until 2008.
China initially responded to the restrictions by scrapping temporary export duties to curb exports. Hu and Wen took their chances taking a hard line, but a tough posture presumably strengthens their position with Jiang's circle.
Ironically, the surge in exports to the EU and US was partially caused by importers buying huge volumes because they saw tariffs inevitable. "China and the US should have known the textile issue was coming," says Professor David Zweig, director of the Centre China's Transnational Relations at Hong Kong University of Science and Technology HKUST). "American importers anticipating closure of the quotas, bought in bulk." The leadership has also used WTO compliance as a useful scapegoat for unpopular domestic policies – and a useful bat to beat banking, pharmaceutical and other industries into improving their game. "Initially Beijing took quite a conservative approach, believing it would be bad for the economy," says JPMorgan's Simpfendorfer. "But what Beijing has realized is that market forces can be useful for forcing structural change. There is a recognition of the benefits the WTO can bring."
WTO compliance lifts restrictions on foreign players entering the services and telecom sectors from December 2006. HSBC (most notably with its 19.9% stake in Bank of Communications), Citibank (starting with Shanghai Pudong Development Bank) and other banks have not been slow at buying up significant minority stakes in domestic banks. Foreign banks are not going to have a completely free hand even after December 2006. But that may not be such a problem: McKinsey & Co notes that China's wealthy account for only 2% of the bank sector's customers but for 50% of revenues – and, most compelling, they remain badly served by China's largest banks.
Telecoms are quieter, remaining largely the province of state-controlled monopolies. But that is about to change to some extent as WTO provisions kick in, giving foreign players greater access.
Hu and Wen have to balance off growth that is fast enough to keep things together – a minimum 7% GDP growth is often mentioned as the base requirement – but not so fast as to cause overheating and risk hard landing scenarios. Not an easy task, and there are indications that the economy may now be beginning to pull off its record streak of 9-10% annual growth rates.
Still, Hu and Wen have continued with the opening of China's economy, making it, despite some overplayed horror stories, an easier place to do business than some of its neighbors. "Overall China's economy is so much more open than Korea and Japan. People are making money over there [China]" says HKUST's Zweig.
"No other government in the world has ever handled such a grand problem as the Chinese government is facing: a population, more than the total of all developed economies combined, has been brought from largely an agrarian society into a modern society and a globalized, fast-changing world," Gao Shi-Ji, a development specialist at the State Council's Development Research Center, has said. The challenges are unimaginable." Hu and Wen, he contends, have been managing the problem well.
2. The currency
When, or even if, China will unpeg the renminbi has become perhaps the biggest question for Hu and Wen. Hardly a day goes by without the United States threatening China with some sanction or other if it does not loosen its currency. Hu and Wen are indeed pushing China towards a more flexible exchange rate at a higher valued level than at present. But they insist that the currency arrangements are no one's business but China's.
?They are right in not bowing to political pressure," says China Business Strategy's Paul Denlinger. "This is an economic issue, and should be treated as an economic/trade problem."
The pressures for a currency liberalization are immense, both domestic as well as international. On the other hand, the pressures from the conservative group, including many state enterprise bosses, take time to overcome, and there is an argument that China's system is currently not yet ready for the stresses a more flexible currency rate would generate. The reluctance to reform the currency regime could easily be as much based on fear of the unknown as on a desire to keep Chinese exports cheap. China's banking sector, riddled with inefficiencies, certainly needs more time to get in shape for a floating renminbi.
"I believe that Hu-Wen have run into passive resistance from junior and mid-level management in the banks to the reforms they want to make," says Denlinger. "This has delayed their plans to revalue [because] it is impossible to revalue the yuan without a good risk management system in place."
Letting the renminbi go on a longer leash could see it rise, making imports cheaper, keeping Chinese exports competitive, and easing inflation. But eventually it could also sink. The hot money that submarined into the stock and property markets in recent years to take advantage of a yuan revaluation, could exit, putting downward pressure on the yuan.
That leaves Hu, Wen and their advisors balancing a delicate equation, one they are widely expected to answer cautiously in the coming months. Such caution is their trademark, but markets are pushy things.
3. Interest rates
Brushing aside the cobwebs, Hu and Wen pushed the interest rate levers up a notch in October 2004, nine years after they last moved. Benchmark one-year lending and deposit rates rose 0.27% each, jolting markets. The People's Bank of China gave few hints of the hike. China is still learning the art of monetary policy, forging the tools and writing the manual as it goes.
Hu and Wen cannot take credit for personal innovation here. China has been working on interest rate reform for years, a largely technical development that continues regardless of who sits in Zhongnanhai. Inflation and runaway growth fears were the key factors triggering the rate rise. Given that rates had been static for nearly a decade, the small rate move was experimental, allowing central bankers to get a feel for the impact and to help China get used to the concept of interest rate shifts.
It also showed that small rate adjustments are pretty ineffective, neither growth nor inflation having slowed. "Investment decisions – and current consumer investment decisions – are not interest sensitive," argues Professor David Wall, an analyst with London think-tank Chatham House. Until the Hu-Wen team feels comfortable with taking more than baby steps, administrative edicts (to stop or slow lending) look likely to remain the primary tool of choice.
Bigger hikes, of course, bring bigger risks, and greater pressure on the indebted loss-making state-owned firms that keep tens of millions fed. "They are unwilling to deprive these enterprises of state cash," says Simpfendorfer. "That is the biggest obstacle." They also hurt the burgeoning middle class homeowners and property speculators.
Few among China's 70m stock market account investors can be happy with Hu and Wen, even though a high proportion of those accounts have been dormant for years. Since they took over in 2003, the four-year stock market losing streak has been extended to six years and more. Already whacked by the impact of sloppy regulations and woefully opaque company operations – where company assets could be bolstered in bogus prospectuses or siphoned off without a word – small investors have continued to take it on the chin and in the pocketbook.
For almost two years the new leadership has steered clear of one of the toughest issues facing the government – cleaning up the stock market mess. There is considerable irony in this: the world's fastest growing large economy also happens to have the world's worst performing stock market. Neither president nor premier could be blind to the possible consequences for very long. Well-regulated markets, after all, could start doing justice to cheated investors. As in others areas, Hu and Wen have had to move cautiously due to powerful old-guard elements who benefit from the status quo. But in May, Hu and Wen finally announced government shares in four small firms, amounting to 1% of the state's portfolio, would be sold.
A few weeks later the CSRC and SASAC urged large firms, like Baosteel and Sinopec, to draw up plans for selling their government-held shares. Right now, the state holds about 65% of listed company shares, worth about US$245bn. Baosteel and a handful of other respectable companies aside, investors are unlikely to buy shares in these dinosaurs, not at current prices. So the markets can fall further, which means more pain for trapped shareholders. On the other hand, there is a market value level where investors, both domestic and foreign, will feel it is worth coming in. The sooner China's markets reach that level, the sooner the turn-around can begin, no matter what level the markets fall to first.
Time is not on their side. For one thing, the renminbi seems certain to trade more freely, making it harder for Beijing to control outflows to well-run foreign stock markets, where quality Chinese firms list. Everyone talks about the US outsourcing its manufacturing to China; much less coverage is given to how much China has outsourced its own financial sector," says Paul Denlinger, China Business Strategy principal in San Jose.
Implementing stringent listing rules along the lines of better regulated markets elsewhere risks putting some important noses out of joint but Hu and Wen need not feel lonely at the top: their reforms would win wide support from domestic and foreign investors alike.
To work properly, of course, stock markets also need hedging machinery like a futures market, an area Hu and Wen have hardly begun to focus on; ditto for corporate bond markets. The sooner they put into place all the pieces of a full-fledged capital market, the sooner investors will have more reason to cheer. But that assumes they will implement sophisticated regulation so that the scams that forced Premier Zhu Rongji to shutter the futures market in the mid-1990s do not recur.
Commodities futures and government bond markets have already been proven to work over the Hu-Wen tenure, which pundits anticipate will give the leadership the courage to take the next step into stock futures and corporate bonds. But much work remains to be done, says Tao Dong, CSFB's chief economist for Asia in Hong Kong. "You need infrastructure, ratings agencies, auditing, yield curves, interbank markets. It's not as if the government says they want a corporate bond market [and] it can happen overnight."
As with much else, the leadership's latitude for action is limited until the 17th Party Congress in 2007, when Hu-Wen should be able to increase the proportion of their people in the Politburo. That cannot come too soon, because if trial sales of state shares do not work out, radical, unpopular choices may have to be made. "At the end of the day, the Chinese taxpayers are funding a situation which has no chance of being turned around," says China Business Strategy's Denlinger.
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