With China Panic Calmed for Now, Leaders Face Reform Test

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Were Markets Expecting Too Much From the G-20 Meeting?
  • Focus switches to National People's Congress starting March 5
  • Policy makers seen balancing capacity cuts with fiscal support

Chinese officials’ success in calming global fears over their policies and growth trajectory still leaves hard work ahead, as focus shifts to the national legislature’s annual gathering.

Weeks after world markets were roiled by a plunge in Chinese stocks and unexpected currency moves, policy makers hosted top global finance officials in Shanghai without complaints from their counterparts. U.S. Treasury Secretary Jacob J. Lew said after the gathering China communicated its policies well, and International Monetary Fund Managing Director Christine Lagarde said officials expressed no intention to devalue the yuan.

How long the good vibes last will depend on how well Premier Li Keqiang and other key officials address concerns about the economy. There’s little sign its slowdown has bottomed, and while consumption continues to help cushion a contraction in much of the industrial sector, areas of strength haven’t been sufficient to stop record capital outflows.

"There is a fine line between sounding upbeat and confident and then just crazy," said Christopher Balding, an associate professor at the HSBC School of Business at Peking University in Shenzhen. "It is a double-edged sword. If it stimulates the economy, it racks up debt two to three times ‘official’ GDP growth and if it doesn’t, GDP growth will absolutely collapse."

Window of Opportunity

With global policy makers’ concerns seemingly assuaged -- for now at least -- after reassuring comments on monetary, currency and fiscal policies from Finance Minister Lou Jiwei, central bank chief Zhou Xiaochuan and Premier Li, China has a window to restore faith in its economic stewardship.

The National People’s Congress is scheduled to convene its annual gathering on March 5 in Beijing. Premier Li will get proceedings started by outlining a draft of his work report, which looks back at the past year and outlines 2016 plans on everything from economic growth to health and education policies. Lou on Friday gave a clue to its tone, flagging more fiscal firepower is on its way.

Provincial governors, city mayors and party bosses will be joined by teachers, farmers and factory workers to discuss the plans, and seek to push the case for policy tweaks. Some time in mid March, the legislature will vote on the work report, which is then adopted for the year.

New Plan

This year’s NPC will also debate the nation’s 13th five-year plan, which will touch on wide-ranging sectors, such as closing unprofitable state-owned zombie companies, boosting innovation and clearing up smoggy skies.

A shift in sentiment on China was on display in global markets even ahead of the G-20 meeting, with a 6 percent tumble in the CSI 300 Index of Chinese shares Thursday failing to trigger declines elsewhere -- unlike at the start of the year. Resilience in industrial metals prices in recent weeks is another "encouraging sign that the panic over China may have peaked," Julian Jessop, chief international economist at Capital Economics in London, wrote in a note Friday.

Going forward, "investors will want to see a Chinese budget that promotes new sources of growth rather than just keeping zombies alive," said David Loevinger, a former China specialist at the U.S. Treasury and now an analyst at fund manager TCW Group Inc. in Los Angeles.

Fiscal Support

Fiscal policy support will likely be reflected in increased investment and social spending, tax cuts and reforms, and increased quasi-fiscal spending on infrastructure, strategic industries, and social welfare, UBS Group AG economists led by Wang Tao wrote in a recent note. Infrastructure projects such as railways, subways, pipelines, water projects, environmental and new energy projects will continue to be boosted, they wrote.

The analysts said a 10 percent reduction in six over-capacity sectors would lead to about 2 million direct job losses. While that’s only around 3 percent to 4 percent of the total non-farm workforce, lost jobs would likely be concentrated in a small number of sectors and localities, they wrote.

That’s where central government fiscal support comes in, to help provincial authorities relocate laid-off workers. The upshot: more debt.

"China will face a big test of its reform pledges next Saturday," said Shane Oliver, head of investment strategy at fund manager AMP Capital Investors Ltd. in Sydney. "The policy focus in China has shifted to boosting growth -- this can be seen in the widening budget deficit and the easing bias in monetary policy. Reform will continue, but only if it can be shown to help growth."