Desperately Seeking China Reform, One Analyst Looks Past Turmoil

  • New policy push will tackle overcapacity, boost productivity
  • Credit Suisse China economist Tao Dong says shift long overdue

Look past China’s current market-turmoil firefighting, and focus instead on the Communist leadership’s commitment to addressing overcapacity in the economy.

So says Tao Dong, Credit Suisse Group AG’s chief regional economist for Asia excluding Japan, who was among those calling attention half a decade ago to China’s fundamental shift toward stoking wages.

When China’s top policy makers in December promised a wave of reforms to shake up the economy, it was somewhat of an echo of past pledges that went unfulfilled. What may make things different this time is that the Communist leadership is coming to grips with diminishing returns to old-style monetary and fiscal stimulus.

"I am increasingly feeling desperate that the policies are not delivering the jobs they are supposed to deliver," said Tao, who’s been covering China’s economy for two decades and is based in Hong Kong. "China needs to get rid of excess capacity in order to get out of the current mess and that is exactly where the supply side prescription could help."

The need to address deflationary pressures generated by years of debt-fueled investment into manufacturing capacity that’s going unused is so large that policy makers will be forced to pursue reforms even as they struggle to cope with current market ructions, according to Tao’s thinking. "They will stick with the plan," he says.

Services Warning

Recent data highlight the challenges, with signs that authorities cannot take for granted the new dynamos of consumer spending and services. A private gauge of the non-manufacturing sector on Wednesday slumped to the second-lowest reading since the series began a decade ago, and close to the level signaling contraction. The official manufacturing gauge contracted in December for the fifth month in a row and economists say the government will be lucky to have hit its 2015 growth target of about 7 percent.

The weakness in the world’s second-largest economyremains even after the People’s Bank of China has cut interest rates to record lows and authorities pumped hundreds of billions of dollars into the economy.

Along with tackling chronic spare capacity in industries like steel and coal, Tao said China needs to break up monopolies, run down housing inventory, cut taxes and allow space for private sector companies to flourish, among other measures.

Making Changes

Some changes have already been announced: the nation’s infamous one-child policy became a two-child policy and new rules were announced that may make it easier for companies to list shares. Changes to the residency registration permit system have also been floated that may further free up the movement of labor.

President Xi Jinping said Wednesday in Chongqing that supply-side reforms are needed to curb production overcapacity, according to an official Xinhua News Agency report.

In the bloated and underperforming $16 trillion state-owned enterprise sector, China Minmetals Corp., the nation’s biggest metals trader, will buy China Metallurgical Group, a government-owned engineering and mining group. The move will combine two state enterprises with about $96 billion in sales.

The supply-side push was formally agreed on at a gathering of the nation’s top economic planners in December, the Central Economic Work Conference. Embracing these kinds of changes would fit a broader objective of the government to rein in borrowing in an economy where total debt had soared to around 282 percent of gross domestic product by mid-2014, according to a McKinsey & Co. report.

Debt Legacy

Much of that debt stems from a $586 billion program to boost growth in the depths of the 2008 global credit turmoil, a move that opened the floodgates for a record debt surge.

"Stimulus has a negative connotation nowadays in Beijing," said Louis Kuijs, head of Asia economics at Oxford Economics Ltd. in Hong Kong.

Delivering on the promised new wave of reforms won’t be easy. The government will need to brush up against vested interests, especially among state-owned enterprises, Tao said. To muster up the courage, they need to draw inspiration from former supreme leader Deng Xiaoping who unleashed sweeping economic reforms.

"These are the kind of supply-side measures that brought China where it is today," Tao said. "That should be the inspiration."

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