To fund the urbanization plan, local governments would issue long-term bonds to finance spending on roads, housing and social safety nets, Reuters reported in March, quoting sources with ties to the leadership.

But a fiscal overhaul is needed because local governments don’t have steady tax revenues to back the issuance of bonds. Under China’s tax structure, in place since 1994, the central government gets most receipts while local governments do the spending, forcing them to rely on land sales for survival.

To support the process, Beijing needed to overhaul its land and tax codes as well as free up the rigid residency registration, or “hukou”, system to give migrant workers access to education, health and other services where they work, experts have said. Li wanted more detail on these sorts of reforms in the plan, the sources said. [Source]

While Reuters also reported that Li and President Xi Jinping preferred reform to any short-term economic stimulus, The Economist asks why they can’t pursue both:

Just as structural reforms have implications for demand, the converse is also true: efforts to boost demand can affect the course of structural reform. China’s 2009 stimulus lending was successful in reviving demand. But it also had some damaging structural side-effects. It further skewed the economy in favour of investment, especially property construction; it made a mess of local-government finances; and it forced China’s banks to serve government ends, thus delaying their evolution into commercial lenders.

The stimulus had one other damaging side-effect—on China’s economic philosophy. Many analysts now seem to believe that all stimulus measures delay reform, if only because they ease economic pain without which policymakers will not act.

That is a mistake. Stimulus does not need to be at odds with reform. Cutting taxes or increasing social spending would both stimulate the economy and help rebalance it towards consumption and services. Likewise, many structural reforms, such as removing barriers to entry in industries now dominated by state-owned enterprises, would also simultaneously help to boost spending. The Chinese economy clearly needs reform and may soon need revival. There is no reason why the leadership cannot do both. [Source]

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Liu He, who leads the party’s Central Leading Group on Financial and Economic Affairs, has been given the task of preparing a seven-point blueprint for the Third Plenum of the 18th Communist Party Congress, which is due in about October, according to a source with close ties to several members of the Politburo Standing Committee.

If executed as intended, the new reform program would go some way to answering doubts about whether China can continue underwriting the Australian economy, including huge gas and other resource investment plans over the next decade.

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Some hedge fund managers say China’s has reached a “zugzwang” moment, referring to the predicament when a chess player must make a move but prefers to pass.

“In China policy is made when the pain of inaction is higher than the pain of action, and we’ve reached that point,” said David Hoffman, managing director of the Conference Board China Centre for Economics and Business.

[Source]

China reported disappointing first quarter GDP growth of 7.7 percent last month, as slumping factory output and soft consumption pulled the economy back from the 7.9% growth figure posted in the final quarter of 2012. But while TIME’s Michael Schuman wrote that “China’s growth model is broken and can’t be so easily fixed,” emerging markets investor Mark Mobius told the Vancouver Sun last week that concerns over China’s economic slowdown are overblown:

Q. The most recent news we’ve seen from China has focused on lower inflation and a slowdown in their economy. How much does what goes on in China weigh on the overall emerging markets sector?

A. It has an impact in Asia, of course, because you’ve seen more and more trade and investment between China and the rest of Asia. (But) China is just one part of the whole equation. Because you’ve got a huge Indian economy, you’ve got a very big Brazilian economy, a big Russian economy, the so-called BRICS. Then you’ve got Indonesia, you’ve got Thailand, many other countries that are doing quite well, and are having an impact on what’s happening around the world.

Q. What are we missing (in Canada) by focusing so much on China and the appearance of their slowdown?

A. First of all, the slowdown is kind of a misnomer because if somebody goes from 12-per-cent growth to eight-per-cent growth and they are the second largest economy in the world, that’s not a big, big problem, because they’re growing at a rapid rate. At eight per cent, in a huge economy, the actual dollar amount of increment is greater than it was five years ago.

[Source]

BBC’s chief business correspondent Linda Yueh wrote this weekend that while the services sector has grown more rapidly than other parts of the Chinese economy this year, concerns still linger:

One worry expressed to me about rebalancing towards services and focusing on consumers came from one of China’s best-known economists and the former World Bank chief economist, Justin Yifu Lin of Peking University.

He stresses that consumption should not be pursued for its own sake. The bursting of the credit bubble in America makes that point vividly. Instead, he says, consumption supported by income growth, not borrowing, is key.

He also points out that it’s not exports which are the important factor for future growth, but more government spending and investment for productive uses.

It’s all about finding the right balance. China’s economy is now fairly equally driven by services and industry, while maintaining its position as the world’s largest exporter of goods. Manufacturing is growing and not declining. China is not giving up on exports, it’s simply becoming more balanced.

[Source]

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At Crocs, 65% of its colorful shoes are expected to be made in China this year through third-party manufacturers, down from 80% last year. Coach will reduce its overall production in China to about 50% by 2015 from more than 80% in 2011 so the handbag maker isn’t too reliant on one country, a spokeswoman says.

Some migration of apparel manufacturing from China is expected, and even encouraged by the government, as the country’s economy matures. As other Asian nations become efficient at mass manufacturing, China must embrace research and high-technology production to transform its economy as South Korea and Japan once did. But healthy economic growth requires that China expand its service sector and create higher-skilled manufacturing jobs at a rapid clip to compensate.

“If costs continue to rise, but China is unable to become more innovative or develop home-grown technologies, then the jobs that move offshore won’t be replaced by anything,” says Andrew Polk, a Beijing-based economist for the Conference Board, a research group for big American and European companies.

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Bloomberg reports that, quite contrary to media speculation that China-North Korea relations would soon sour, a new bridge set to open next year is being built by China with hopes of deepening economic ties between the two countries:

Across the Yalu River dividing China and North Korea, towers that will support a sleek suspension bridge rise south of one that U.S. bombers targeted during the Korean War to prevent China from supplying its ally.

The bridge into the northeastern Chinese city of Dandong, set to open next year, is a bet that trade will swell even as the U.S. pressures Communist Party leaders to exert economic leverage on the North to abandon its nuclear program.[...]

[...]The three-kilometer bridge, which the official Xinhua News Agency said will cost 2.2 billion yuan ($356 million), will speed commerce through a city that now handles 70 percent of the two countries’ trade. The span illustrates how the North is binding itself even tighter with China as it limits economic ties with South Korea, including by temporarily suspending work at the jointly run Gaeseong industrial facility.

As new sanctions are placed on North Korea in response to its nuclear threats, the country becomes increasingly reliant on China for trade. China, for its part, wants stability on the Korean peninsula, and worries that cutting off economic ties with the country  would work against that desire. The Washington Post reports:

So why would China still support North Korea, despite all its recent misgivings? China’s policy for the Korean peninsula can be summed up in six little words: “No war, no instability, no nukes.” Those are Beijing’s priorities, and in that order. Chinese leaders don’t want nukes, which is why they’re upset about Pyongyang’s recent nuclear brinksmanship. But even more than that, they don’t want the North Korean state to collapse into chaos or devolve into war, and they know that economic support and cross-border trade are good ways to maintain the status quo. And it’s the status quo that China appears most interested in.

China also has a desire for North Korea to embrace economic reform, and sees an opportunity towards that goal in maintaining strong economic ties with the country. The problem is, business with North Korea is not what China wants it to be – many Chinese businesses are reluctant to invest in the Hermit Kingdom. Reuters reports on the recent history of China’s economic relations with North Korea, and explains that, while China may be frustrated with its geopolitical behavior, North Korea holds quite a few cards in the Sino-North Korean dialogue:

The problem for Beijing is twofold: getting Pyongyang to buy into the idea of economic reform and the reluctance of Chinese businessmen to venture into one of the world’s riskiest investment destinations.

While China is frustrated with Pyongyang over its threats to wage war on South Korea and the United States, its efforts to build economic links with North Korea from places like Jilin help explain why Beijing is unlikely to crack down hard on the reclusive state.

Since then-Premier Wen Jiabao went to North Korea in 2009 – just months after Pyongyang’s second nuclear test – China has sought to stabilize the Korean peninsula by stepping up its effort to steer the North toward economic reform. China is not about to give up that goal even though it’s under U.S. pressure to get tough after North Korea’s third nuclear test, on February 12.

“It’s not even shepherding anymore. It’s more of just inundating North Korea with all of these influences from the Chinese side where the idea is to essentially corrupt them, show them what it tastes like to make money,” said John Park, a North Korea expert at the Massachusetts Institute of Technology and the Harvard Kennedy School.[...]

For more on China’s relationship with North Korea, see prior CDT coverage.

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“Corruption and the reputation of our government are as incompatible as fire and water,” Mr. Li told reporters at the Great Hall of the People.

Speaking on the final day of the legislative session that installed a new generation of leaders, Mr. Li vowed to ease impediments to private investment, rein in the powerful interests that dominate large sectors of the economy and scale back an unwieldy, intrusive bureaucracy that he acknowledged often frustrated entrepreneurs and citizens.

The new government, led by President Xi Jinping and the Communist Party’s Politburo Standing Committee, will impose a moratorium on the construction of government buildings and reduce spending on official vehicles, public meetings and overseas travel, Mr. Li said. The government’s sprawling work force, he warned, would be trimmed to increase spending on social welfare.

“Reforming is about curbing government power,” he said in his opening remarks, which were broadcast live on television. “It is a self-imposed revolution that will require real sacrifice, and it will be painful.”

Specifically, Li mentioned the problems that accompany China’s rapid urbanization, according to the South China Morning Post:

“Urbanisation will usher in a huge amount of consumption and investment demand, increase job opportunities, create wealth for farmers and bring benefits to the people,” said Li, who began exploring the topic as a doctoral student at Peking University.

But he also cautioned that it was also a “complex systemic project” that must be bolstered with various reforms.

In carrying out the project, the government would have to consider the different stages of development between cities and regions, he said.

“Urbanisation is not about building big, sprawling cities,” he said. “We should aim to avoid the typical urban malady where skyscrapers coexist with shanty towns.”

Li also discussed ways to free up the market in China to allow businesses more leeway to operate. From the Wall Street Journal:

The 57-year-old Mr. Li also said the government should give markets greater room to operate, including allowing private businesses to compete on an equal footing with state-owned enterprises. In finance, the market would play a greater role in setting interest rates and the exchange rate, and companies would have greater access to funding through the bond and equity markets, he said.

“Talking the talk is not as good as walking the walk,” he said. “We need to pursue market-oriented reforms.”

The premier’s annual news conference is the only time the Chinese public gets to see the leader who steers the world’s second largest economy being quizzed by the media, even if the questions and answers are mostly scripted.

Mr. Wen had sought to portray an avuncular man-of-the-people image, although he had a somewhat stiff manner on the podium. Mr. Li has a more informal style, and a down-to-earth delivery that resonated on China’s social networks, where many noted his absence of official airs.

Some observers have noted that Li’s targets for reform are less ambitious, but more specific, than those of his predecessor, Wen Jiabao. From the Financial Times:

The key question is not whether a Chinese leader is a reformer – but rather what kind of reformer he or she is.

The contrast between Mr Li’s programme and that of Wen Jiabao, his predecessor, is illuminating. Mr Li’s agenda, which he outlined at the end of China’s annual parliament on Sunday, is more limited and more singular in its focus on economics. It also appears to be more concrete and therefore more achievable.

Overall, Li’s style is more direct and less florid than Wen Jiabao’s, and received mixed reviews, according to the South China Morning Post:

The performance gained Li mixed reviews among critics and internet users, with some saying that they preferred his down-to-earth manner to Wen’s more florid style, while others said Li’s remarks were “flat” and avoided touching on sensitive issues.

Li kicked off the two-hour press conference by vowing that he would remain loyal to the constitution.

He also did not recite any classical Chinese works, which Wen often referenced to describe his personal feelings.

The most notable remark by Li in summing up his philosophy was: “Follow the great way, put the people first and benefit everyone.” It is a line he said he has learned through life experience.

Read also:
“Profile: Li Keqiang: a reform-minded premier” from Xinhua and “Li sets out strategic mission for next 5 years” from China Daily.

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The debate was unusually broad, ranging from the need for property taxes and agricultural support prices to the role of the state in influencing returns to firms and labor. Given the lack of details and firm targets, it’s not clear whether this plan will effectively tackle the sources of inequality that are most harmful to development.

Rapidly growing economies tend to experience widening disparities. China’s growth has lifted some 600 million out of poverty even as its Gini coefficient, a measure of income inequality, has soared to 0.47 today from 0.25 in the mid-1980s. Although high, China’s Gini is comparable to that of the U.S. and other relatively successfully Asian economies such as Singapore and Malaysia.

The Gini number is less important than the reasons behind it. Inequality is positive when it emanates from productivity increases, entrepreneurial risk-taking and structural changes that produce sustained growth. Harmful inequality comes from distortions that ultimately undermine the development process.

It is the latter kind of inequality that Beijing has been slow to address. First, policy distortions have exaggerated geographical disparities. Second, the government budget has failed to provide equal access to social services. And finally, links between government-party officials and commercial activities have led to excessive rent-seeking.

For The Diplomat, Eve Cary writes that time will tell if the Communist Party can execute on its plan and preserve its legitimacy:

Indeed, the plan, in development for several years, is quite ambitious. It is the specific points–such as garnishing more profits from SOEs and spending more on social services–that have a better chance of success, though at first they may face considerable political pushback. It will be interesting to see how far these reforms go, considering that the new Politburo Standing Committee is dominated by the Jiang faction, with 6 of the 7 protégés of the former president, according to Brookings Institution scholar Cheng Li. Of those 6, 4 are princelings, or sons of Chinese Communist Party revolutionary heroes. In general, Jiang’s faction- sometimes referred to as the Shanghai gang- and the princelings promote the interests of the middle class, entrepreneurs, and the coast, as opposed to the populists, who tend to promote the interests of the common people.

There are other reforms in the pipeline, as well. Last November the State Council backed policy changes that aim to strengthen the property rights of farmers, including such measures as identifying and registering land, and issuing land ownership certificates to farmers. This policy was pushed through by outgoing populist premier Wen Jiabao. Affordable housing has also been a hot issue: in 2012, the central government allocated 37.1 billion dollars (233.26 billion yuan) for subsidized housing projects, up almost 40% from the previous year.

Of all the problems that China faces in the next 25 years, the income gap–and all of the associated issues–is perhaps the most dangerous for the Communist Party and future social stability. For example, in its 2013 Social Development Blue Book, the Chinese Academy of Social Sciences notes that there have been 100,000 “mass incidents” (large protests) every year for several years, and that half of these protests are related to land grabs.

It has become a commonly-held belief among China watchers that the CCP has remained in power through a Faustian bargain with its people–it retains power as long as it maintains economic growth. With so many left behind, there is a growing contingent who are left out of this deal, and they are become increasingly vocal. Despite the elitist bent of the new Standing Committee, one hopes that they have the foresight to continue to focus on this critical issue, and develop effective solutions to it.

See also previous CDT coverage of China’s income inequality.

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Here’s my case for Xi as a reformer.

First, it’s in his genes. His father, Xi Zhongxun, was a pioneer of economic restructuring and publicly denounced the massacre of pro-democracy protesters in 1989. Xi’s mother chooses to live in Shenzhen, the most capitalist enclave in the country.

Xi is also one of the first Chinese leaders to send a child to the United States as an undergraduate. His daughter is a junior at Harvard, reflecting her parents’ emphasis on learning English and their admiration for American education.

It helps that the bar is low for Xi: he follows President Hu Jintao, who is widely regarded in China as a failure. Even government ministers complain that he squandered his 10 years as leader. Today there is pent-up demand for change.

Kristof does acknowledge that Xi is more nationalistic than Hu, and in the case of a confrontation with Japan over the Diaoyu Islands, “all bets are off.”

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This October, China’s Eighteenth National Congress ushered in a new generation of leaders that will set the agenda for the second-largest economy in the world, provoking myriad questions about what we’ll see out of the country in the coming year. CFR’s Adam Segal predicts continued international concern for China’s cyber policy, while CFR’s Elizabeth C. Economy weighs its challenges of keeping “foreign policy front and center” against a heavy list of domestic concerns. Claremont McKenna’s Minxin Pei adds that China will be forced to respond to calls for greater political openness, facing a delicate balancing act. CFR’s Yanzhong Huang points out that despite China’s highly publicized health-care achievements, reform hasn’t fundamentally solved the problem of access and affordability.

Since Xi Jinping took the reins as CCP general secretary, domestic policy has been front and center: we have seen a symbolic trip to the south emphasize the leader’s commitment to economic reform, and have heard the powerful princeling identify the eradication of party corruption as a major policy goal. Also in question are the prospects for political reform – potentially divisive as the influence of previous party leadership lingers. A reform-minded new leader and an anti-corruption campaign both made Sinocism curator Bill Bishop’s list of “8 Trends to Keep an Eye On” in 2013, published at the NY Times’ Dealbook blog:

NEW LEADER Xi Jinping has moved quickly in his first three weeks to project an image of change. The government faces a growing expectations gap with its citizens and needs to rebuild public confidence. Mr. Xi is talking a lot about the Chinese dream and the “great renewal of the Chinese nation” — nationalist concepts with significant appeal. Mr. Xi’s choice of Shenzhen for his first domestic inspection trip is a symbolic tribute to Deng Xiaoping’s 1992 southern tour that restarted reforms after 1989. Mr. Xi’s visit is most likely a signal that he is serious about pushing forward with changes. Expect renewed energy around overhauls, primarily economic and administrative but possibly some political ones.

CRACKDOWN ON CORRUPTION The new leadership has begun a public crackdown on corruption. One relatively senior official and several minor officials have already fallen. Internet exposés brought down the minor officials, but there are reports that the Communist Party’s central disciplinary inspection commission has started new investigations into money laundering through Macau. Expect this antigraft campaign to ensnare more senior officials and to be the most effective in recent memory, yet ultimately stop short of addressing the systemic issues that have allowed corruption to flourish.

There are those, including CFR’s Elizabeth C. Economy and Bill Bishop above, who stress the importance of China’s foreign policy in the year to come. CNBC talked to Daniel Franklin, editor of The Economist’s “The World in 2013“:

The relationship between China’s new leader Xi Jinping and President Barack Obama “is absolutely the crucial one now for global politics,” Franklin tells The Daily Ticker.

Franklin says both men need to keep U.S.-China trade flowing. China is the second largest trading partner of the U.S. Last year $503 billion worth of goods were exchanged between the two countries. 80% of those items were U.S. imports from China.

Franklin says both countries also need to work on resolving disputes between China and other countries over ownership of islands in the South China Sea. Many of those countries, including Japan, South Korea, Taiwan and the Philippines, are allies of the U.S.

“This is something that has to be handled, adjusted to, and it will be awkward, no doubt about it,” says Franklin.

China’s English-language press also offers us a forecast into the Year of the Water Snake. Xinhua describes rural development efforts to be expected in 2013, and the Global Times cites World Bank data predicting that GDP growth, which fell in 2012, will rebound:

The World Bank raised its 2013 economic growth forecast for China Wednesday, citing the government’s fiscal stimulus plans and faster approval of large investment projects.

China’s growth is projected to recover in 2013 to 8.4 percent due to the combination of monetary easing, local government fiscal stimulus, accelerated approval of investment projects and an upswing in the business cycle, the World Bank said in its East Asia and Pacific Economic Update published Wednesday.

The bank also forecast that growth will reach 7.9 percent for 2012, significantly down from 9.3 percent in 2011.

For more on the economic front, Bloomberg reports that China plans to increase its budget deficit by 50 percent in 2013, which could help to boost urbanization and consumer demand.

Next year may also bring further changes to China’s role in the global economy. While foreign firms invested 3.6 percent less in China compared to last year, Chinese firms invested 25 percent more abroad. Chinese FDI has long landed primarily in the developing world, but firms are also beginning to invest seriously in developed countries. Forbes predicts that this trend will continue, and identifies 13 Chinese companies that will “go global” in 2013:

Chinese foreign direct investment has long been characterized as focusing on securing raw materials in emerging markets like Africa and Latin America. But as the list of the top 13 Chinese companies going global below demonstrates, this is no longer the case. Chinese investment continues in strategic natural resources like oil and gas; however, companies in industries ranging from consumer electronics, entertainment, athletic apparel and even luxury boating are all pushing beyond the borders of the Middle Kingdom. Through expansion overseas, they aim to gain access to new distribution channels, international managers, brand recognition and technological expertise in global markets.

While some of the names appearing on the top 13 for 2013 are well on their way to becoming househould names, a few of the others may come as a surprise…

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Economists reacted positively to the data, according to The Sydney Morning Herald:

“The export slowdown shows external demand faces uncertainty due to concerns over the fiscal cliff in the US,” said Zhang Zhiwei, chief China economist at Nomura in Hong Kong. “Nonetheless it does not change our view that growth is on track for a strong recovery in Q4, as (growth) is mostly domestically driven.”

…

“The Chinese economy is now in a sweet spot and can stay in the sweet spot through the first half of 2013,” Ting Lu, an economist at Bank of America-Merrill Lynch, said before the trade figures were released. “Beijing will be happy to sustain the current policy stance.”

With China likely to post its slowest full-year of growth since 1999, however, Chinese leaders concluded the annual Central Economic Work Conference in Beijing on Sunday by warning that the world’s second largest economy is not yet out of the woods. With Europe’s debt crisis still raging, and with the U.S. economic recovery still uncertain amid the ongoing “fiscal cliff” deadlock in Washington, The Wall Street Journal adds that China’s new leaders “sent their strongest signal yet” that they will focus on retooling the economy to rely less on export growth and more on domestic demand. Here, the China Daily reports that top policymakers continued to pledge reform - from cutting taxes to enabling greater mobility for rural workers, and providing more support to agriculture and innovation – to keep economic growth stable.

But was anything new put forth following the conference? The Financial Times’ Jamil Anderlini checked in from Beijing today with a resounding “no”, writing that the leaders revealed an economic agenda “largely in line with that of the outgoing administration.” Similarly, Keith Bradsher of The New York Times reports that the government released a lengthy statement calling for continuity, at least for now:

The statement endorsed tax cuts, continued curbs on real estate speculation and a broader effort to increase domestic consumption and wean the economy from its dependence on exports and investment.

“The opportunities facing us are no longer the traditional ones of simply entering the international division of labor, expanding exports and accelerating investments, but rather new opportunities forcing us to expand domestic demand, improve innovative capacities and promoting the transformation of the mode of development,” the statement said.

…

While China has many economic opportunities, “we must soberly recognize that there are still many risks and challenges confronting our national development,” the overview released by Xinhua said. “Problems with imbalances, ill-coordination and lack of sustainability remain pronounced.”

“The contradiction between downward pressures on the economy and relative overcapacity in production is deepening,” the statement continued. “Business operating costs are rising while innovative capacities are inadequate. There are latent risks in the financial sphere.”

Expectations of reform have indeed been heightened of late, as new Communist Party chief Xi Jinping retraced Deng Xiaoping’s 1992 “Southern Tour” with a similar trip of his own last week. The Chinese Academy of Social Sciences even warned last week that China’s economic imbalance had reached alarming levels that would hamper growth in the absence of bold action. Such a warning comes as a new survey indicates that China’s Gini coefficient, or measure of income inequality, may be far higher than previously thought.

While China will need reform to ensure that growth returns to the 8% level that the state-run Bank of China predicts for 2013, not everyone has bought into the rhetoric. MarketWatch’s Craig Stephen wrote Sunday that “once again it looks as if talk is easier than action when it comes to economic reform in China.” The Financial Times’ Kate Mackenzie echoed that sentiment today:

Don’t be misled by the proclamations of ‘reform‘ or ‘quality growth‘ from China’s central economic work conference at the weekend. It’s more of the same, at least for the time being.

The more concrete message was that economic and monetary policies would “remain stable for year ahead”. In other words: keep pursuing for just a little longer the brittle policies of property price inflation, more infrastructure investment, and looser money and credit.

Dr. Robert Lawrence Kuhn, however, does see some key reforms on the horizon. From Forbes India:

I expect substantial changes in the economy in the months following March. In China, it is a (cultural) tradition of new governments to carry on with policies of the earlier regime for a long time. Any change is thought to be disrespectful. But this time, it seems, the risk of not reforming is much higher than the risk of change. For example, there have been a series of corruption scandals. The new leaders will be under more pressure to change much quicker. While I do not expect much change on international policies—the rigid nationalism and tough rhetoric—there will be quick changes on the economic front. Xi Jinping’s opening speech showed this. The address was rational, without the usual political jargon, and offered hope. One feedback I got from his aides is that “the biggest concern now is high expectations”. The seven top leaders are the first batch not picked by Chairman Mao Zedong or Deng Xiaoping. This marks a very important transition for China.

One question I am asked very often is for how long will China be able to retain its edge in manufacturing? From the leadership’s standpoint, the answer is clear: Wages have to go up. The economic divide is at several levels—the coastal population versus those living inland, urban versus rural, basically rich versus poor. For decades, rural wages have been increased by moving population to the cities. In the past 40 years, about 500 million people have moved to urban areas. So, the rural population has halved, while income levels have doubled. It is only possible to increase workers’ wages if the margins on manufacturing go up.

The bottom line, according to Asia advertising executive Tom Doctoroff, is that reform is no longer a luxury and all eyes are on Xi Jinping and his new regime to inspire public confidence in his blueprint for economic progress:

Many now ask whether the contradictions of society — between rich and poor, urban and rural, young and old, politically connected and “small potatoes” — are approaching the breaking point. While crisis is not imminent, loss of absolute confidence in the future of the country has manifested itself in many ways, from 200,000 local protests to a slowdown in sales of luxury goods, real estate and autos. According to C-trip, bookings mid-level travel destinations such as Hainan island, usually popular amongst the new middle class, are down dramatically. Job-hopping, perhaps the greatest indicator of economic optimism amongst ambitious Chinese, has slowed, a sign of diffused anxiety.

…

However, until Mr. Xi outlines specific, incremental steps of structural reform — intra-party checks and balances, independent commercial courts, urban residency reform, rural land-ownership reform, further strengthening of the welfare net and other institutional mechanism to safeguard the economic interests of individuals — consumer confidence will wane. If so, “rebalancing” will remain a long way off, and the China’s potential under-realized. China will certainly not flirt with Western-style democracy or laissez-faire capitalism. But the Chinese, supreme pragmatists that value stability above all else, know the status quo is unsustainable.

Have China’s Trade Statistics Been Inflated?

November export growth of 2.9% may have disappointed, especially when compared to robust figures of 9.9% and 11.6% in September and October, respectively, but what explains the big swing? Forbes’ Gordon Chang points to a couple of reasons why fake transactions may have distorted the trade data:

Are we to believe China had an export boom lasting just two months?  Anything is possible, but a more likely explanation for the anomalous September and October figures is that they were distorted by fictitious transactions.

Anne Stevenson-Yang of J Capital Research in Beijing, in one of her November e-mail alerts, suggests that the uptick in exports may have been partly due to hot-money inflows caused by currency speculation.  Exporters, she notes, are overstating sales, allowing them to book revenues in dollars.  They then use the paperwork to get permission to sell dollars for renminbi.  The result is that exporters made money with their currency transactions, but the byproduct is that the Ministry of Commerce’s trade figures overstate China’s exports.

Tom Holland of the South China Morning Post reports an even more ingenious scheme that has artificially pushed up Beijing’s trade statistics.  There is, he notes, legitimate trade where goods go from one part of China to another through Hong Kong.  For example, it makes sense to transport through Hong Kong components manufactured in Shanghai for final assembly in Shenzhen.  Since 1997, Hong Kong has been part of the People’s Republic, but it is not considered as such for customs purposes.

Other News:

• Japan may have overtaken China as the largest holder of U.S. debt, according to The Wall Street Journal.
• The Wall Street Journal reports that as part of its push to boost domestic demand, China will lower tariffs on a range of imported items next year.
• Bloomberg reports that power consumption posted its biggest monthly gain since February.
• MarketWatch’s Craig Stephen writes that China’s regulator is taking steps to heal its sickly stock markets.
• The State Administration of Foreign Exchange has removed the $1 billion limit for foreign sovereign wealth funds, central banks and monetary authorities investing in China through the QFII program, according to Reuters.

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In the first official report on Xi’s southern tour, Xinhua said Xi met local officials and business chiefs from state-owned and private companies and stressed that the restructuring of the economy “admits no delay” if China is not to lose out internationally. Xinhua did not mention other activities on Xi’s southern tour.

Xi was quoted as saing: “We should acknowledge the economic and social achievements we have made so far this year and recognise the long-term fundamentals will remain sound … meanwhile, we should recognise that adverse domestic and overseas effects will be long-term, complicated and winding. We should not run from conflicts and cover up problems.”

Xinhua said Xi interacted intensively with those at the meeting, who raised problems with tax, financial and land policies, the bleak trade outlook and difficulties faced by small businesses. He also told them not to read from prepared scripts.

The New York Times looks at the importance and potential impact of the Shenzhen trip:

Mr. Xi, known as a skillful consensus builder, has kept his ideas carefully veiled throughout his career, but his trip to Shenzhen is the strongest sign yet that he may favor more open policies. In a speech in Beijing on Nov. 29, Mr. Xi spoke of the “Chinese dream” of realizing the nation’s “revival,” which, besides being a call for renewal, also signaled strong nationalist leanings.

Mr. Xi’s father, Xi Zhongxun, was a revered senior official handpicked by Mr. Deng to help shape the new economic policies and oversee the creation of the Shenzhen zone. Mr. Xi’s mother lives in Shenzhen, and he visited her on his trip, according to Hong Kong news reports.

“If he indeed went to Shenzhen, that means he intends to make reform a subject of priority,” said Li Weidong, a liberal political analyst. “That would really be a phenomenon.”

Mr. Li cautioned, though, that the so-called reform policies that followed Mr. Deng’s 1992 southern tour, in his view, “ended up being fake” because China’s boom resulted in widespread corruption and the expansion of state enterprises at the expense of private entrepreneurship.

Corruption is indeed the major challenge facing the new Xi administration, which he has confronted so far by requiring simpler and humbler government. For the Council on Foreign Relations, Elizabeth Economy looks at three other strategies Xi and his colleagues may take to try to curb official excesses.

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Post tags: Deng Xiaoping, economic reform, high-level corruption, Shenzhen, Xi Jinping
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A member of the first group of students admitted to university after late paramount leader Deng Xiaoping ordered the resumption of the university entrance exam in 1977, following the chaos of the Cultural Revolution, Li studied law under Professor Gong Xiangrui , an expert on Western constitutional law who had studied in Britain in the 1930s. Li followed that with a PhD in economics under Li Yining, the mainland’s market reform guru.

[...] Li reportedly plunged into campus politics as reformist ideas galvanised students, befriending freethinkers who went on to become dissidents in exile, and helping to translate The Due Process of Law by famed English jurist Lord Denning.

[...] Former classmate and prominent dissident Wang Jintao [sic], who has lived in exile in the United States since 1994 after being sentenced to 13 years in jail for supporting the 1989 Tiananmen Square democracy movement, said Li was outspoken and quick-witted on campus.

[...] ”On campus, Li Keqiang was a student with an active mind and sharp words,” Wang wrote in a memoir. “He has his own independent thinking and preferences. But he will not challenge authority on major issues. He is also a person who wants to have big personal accomplishments.”

In his discussion with delegates from Shandong Province during the 18th Party Congress, Li made his intention to push through reforms clear. From People’s Daily:

Li Keqiang said on Thursday that China should lose no time in deepening reform in key sectors and resolutely discard all notions and systems that hinder efforts to pursue development in a scientific way.

[...] Li noted China remains in an important period of strategic opportunities for its development, the period that is full of unprecedented risks and challenges.

Under such circumstances, he said, China should accelerate improvement of the socialist market economy and facilitate the change of growth model to complete the building of a moderately prosperous society in all respects as well as deepen reform and opening up in an all-round way.

The Party needs to properly handle the relations between the regulators and the market and implement a more proactive opening up strategy to boost the momentum and vitality of development, he said.

Several of his classmates have expressed their hope that Li has not abandoned his early political beliefs. One of his classmates tells Jeremy Page at the Wall Street Journal that Li is believed to have ”a clear understanding of the weakness of China’s legal system as many of his close friends are lawyers, judges and law professors”. Given his relatively vague political reform agenda, more believe Li will tackle economic reform as job number one. From Simon Rabinovitch at Financial Times:

He is also believed to have played a role in the China 2030 report authored by the World Bank and the Development Research Center, a think-tank under the Chinese cabinet, that recommended limiting the power of state-owned companies.

[...] “Li Keqiang will be more effective than Wen Jiabao,” said Bo Zhiyue, an expert on Chinese politics at the National University of Singapore. “Wen Jiabao tried to promote too many things – political reform, social reform as well as economic reform. Li Keqiang will be more focused.”

Some analysts, however, see Li Keqiang’s grassroots background as an obstacle for him to implement his reformist ambitions. From Keith B. Richburg at the Washington Post:

Li’s father was a mid-level county official — “a small potato,” said one classmate — in Anhui province, one of China’s poorest areas. And unlike Xi and the other princelings, whose upward path was eased by family connections, Li was admitted to Peking University on the basis of his scores on the national entrance exam, or “gaokao,” when it was first reinstated in 1977 after being suspended during the Cultural Revolution.

[...] Li Datong, who was fired as an editor of a China Youth Daily supplement for pushing the boundaries of official censorship, met Li Keqiang in the ’90s and considers him a reformer — even though, like others, he said the incoming premier’s hands may be tied by the system.

[...] “If we can expect any democracy, it will be democracy within the system, and Li will help Xi in doing this,” said Yan Huai, a former official with the Communists’ now-disbanded Young Cadres Bureau, who joined the 1989 protests and then left for the United States. “How far Xi walks will determine how far Li can go. He won’t walk in front of Xi. And neither will he lag behind him.”

As some analysts see his early liberal education and his fluent self-taught English as hints of his western-leaning political beliefs, other more skeptical observers are questioning his political integrity based on his dealing with the AIDS crisis in Henan. Christopher Bodeen at Associated Press wrote last week:

Li, to be promoted within the leadership’s top council after a pivotal party congress closes later this week and expected to take the economy-focused post of premier from outgoing Wen Jiabao next spring, was governor of the agricultural province of Henan in 1998 during an unusual explosion of AIDS cases.

Tens of thousands of people had contracted HIV from illegal blood-buying rings that pooled plasma and re-injected it into donors after removing the blood products. But Beijing hadn’t acknowledged the problem yet, and Li oversaw a campaign to squelch reporting about it, harass activists and isolate affected villages.

[...] ”He just tried to escape from this crisis” at first, said Wan Yanhai, a prominent Chinese AIDS activist who fled to the United States with his family in 2010 following increasing police harassment. “He’s probably not a bad guy, but he’s not shown himself to be very capable of managing crises in a strong and responsible way.”

Andrew Jacobs at the New York Times also questions Li’s administrative capacity based on his unremarkable achievements as vice premier for the last five years:

As vice premier in charge of economic development, food safety and health care, Mr. Li has overseen an expansion of the medical insurance program. But his other signature project, which seeks to build 36 million low-cost apartments, has been criticized by some for poor planning and shoddy construction. And some analysts say his commitment to the commonweal has been tested by his brother’s role as the top official in China’s State Tobacco Monopoly Administration.

[...O]ne former official turned businessman thought it would probably take a crisis to compel Mr. Li and other leaders to embrace a substantial loosening of political and economic controls.

“I think in the end, events will force them to change, even if they don’t want to,” the businessman said. “Smart leaders will reform because they want to. Idiots will reform because they have to.”

See also a video on Li Keqiang, China’s “effective second fiddle?”, via CNN. See more on Li Keqiang via CDT.

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“The result represents people’s perception of society. They acknowledge what China has achieved over the past 10 years, recognize the 18th CPC National Congress as the linchpin of China’s development, and are aware of the changes China is facing at home and abroad,” said Zhang Shuhua, a scholar at the Chinese Academy of Social Sciences.

As to what China should do in terms of political reform, more than 70 percent of the respondents said they believed that the government should further accept public supervision from the public and the media. Strengthening anti-corruption efforts and increasing transparency in government information came as the second and the third, with 69.3 percent and 66.5 percent respectively supporting the measures.

“The results of this poll echo previous investigations, which represent what people have been paying attention to, and what they anticipate in terms of political reform,” said Zhang.

Some 85 percent of respondents believed that China is likely to face more challenges in the future.

On the topic of political reform, more than 70 percent of those surveyed thought that the government should allow increased oversight from the public and the media, while anti-corruption policies and government transparency also topped the list of desired changes. Elsewhere in the survey, 27 percent pinned the biggest problem in China’s economy on industry monopolies, while 23 percent pointed to the wealth disparity between the coastal and western provinces.

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It’s remarkable that so little is known about what will actually happen during the upcoming conclave. A Service Guide for Journalists notes helpfully that Western-style snacks will be served in the Press Center but there is no real detail about actual events. As of Monday afternoon, an online guide to the upcoming Party Congress had listed only two events directly related to the Communist gathering: a cocktail party for journalists on Nov. 6 and a press conference the day after. Like most press conferences in China, it’s certain Wednesday’s event will be a scripted one in which random journalists won’t be allowed to fling questions at the 18th Party Congress’ spokesperson.

Even the date when the Congress will end is not clear, although many people suspect it will be Nov. 15. “We have no detailed information of the schedule of the 18th Party Congress,” Yue Xiaosong, an official at the 18th Party Congress Press Center, told TIME on Monday. “I don’t know the date when the Congress will finish.” Yue’s only suggestion to TIME was that we should look at previous Party Congress schedules as a general guideline. But he quickly cautioned that we shouldn’t draw too many conclusions from the past. “It will depend on how well the 18th Party Congress goes,” he said, when pressed on just when the confab will end. No details were provided on what he meant by the meeting going “well.” A TIME colleague suggests the wording on the cap in the press swag bag should be changed to: “Somebody I know went to the 18th Party Congress, and all I got was this stupid hat.”

Despite the heightened restrictions in Beijing, The South China Morning Post’s Keith Zhai notes that ordinary mainlanders are “gripped by an overwhelming sense of apathy” and feel little connection to politics. The Telegraph’s Malcolm Moore reports that in contrast with American voters, the Chinese public “remains utterly cut off from the political process,” and those that do care are left to sift through official speeches and state media coverage for hints of what will happen and who will comprise the Politburo Standing Committee:

Indeed, while we know that the leadership change will happen at the 18th Party Congress, which opens on Thursday, we do not know exactly when the new leaders will be unveiled or when the congress will end. Those in China cannot even search for the phrase “18th party congress” on the internet: it has been removed by the censors.

All we can be sure of is that, at some point in the near future, a group of men – and they are all likely to be men – will walk on to a dais in the Great Hall of the People in Tiananmen Square. These will be the seven members of the politburo standing committee, the Chinese equivalent of the Cabinet, selected (by an essentially mysterious process) from among the 25 politburo members originally elected by the party’s 300-strong central committee.

The lack of any real information, however, hasn’t stopped the rumor mill from churning about last-minute horse trading at the top of the party. Sources have told Reuters that ten finalists are vying for seven seats on the Standing Committee, and The New York Times reports that China’s “beleaguered liberals” have their fingers crossed in hope that the reform-minded Guangdong party chief Wang Yang is one of them. Cheng Li of the Brookings Institution provides more details on the “tussle” taking place between the “populist” and “princeling” factions, and what it might mean for regime stability going forward.

Peter Ford of the Christian Science Monitor, meanwhile, spoke to several China analysts who think that closed-door power-broking may give way to a succession protocol based more on consensus under future leadership transitions. Reuters echoed that sentiment in a Tuesday article as well, and went even further, quoting sources who hinted that the Communist Party may not wait until the next generation to adopt a more democratic process for choosing its leadership:

Under their proposal, there would be up to 20 percent more candidates than seats in the new Politburo in an election to be held next week, the sources said. It was unclear if competitive voting would also be extended to the Standing Committee.

“Hu wants expanding intra-party democracy to be one of his legacies,” one source said, requesting anonymity to avoid repercussions for discussing secretive elite politics.

“It would also be good for Xi’s image,” the source added.

Orville Schell writes that the incoming generation of Chinese leaders will not have the rubber stamp of legitimacy that Deng Xiaoping bestowed on Jiang Zemin and Hu Jintao, nor the mandate typically provided by democratic elections. Instead, he says China “finds itself floating terrifyingly in a gravity-less political world” that continues to spin. From the Asia Society’s China File:

The problem is compounded by the fact that, having relieved through its own reform process of the kind of Big Leader rule which allowed megalomaniacal visions to so often wreak havoc on the country—paradoxically just as the West tirelessly challenged it to—China now finds itself without precisely that kind of bold decision-making power at the top that characterized Deng Xiaoping’s quite extraordinary tenure (June 1989 not withstanding) and enabled him to be such a bold reformer.

With no entitled big leader, no confirmed political system capable of conferring legitimacy on new leaders, and no set plan for the future, China nonetheless still finds itself forced somehow to choose a new leadership team. This has left “the people,” who have no real role to play in this process, feeling quite shut out and nervous about what the future holds for them.

Although it is impossible to know what is actually going inside the black box where China’s leaders wrangle over their future, people hear that the process has been intense, even acrimonious. And, since they do not even know what each leader or faction actually stands for, a climate of uncertainty and anxiety has been increasing. Such feelings are hardly surprising, for here in China everything is veiled, hidden, and opaque. And yet, this whole amazingly dynamic proposition continues to hurtle down the tracks, just as I am doing now, even as everyone knows that somewhere ahead, the tracks end. Nobody, especially the present leadership, seems to quite know how to resolve this crisis in confidence, how to pick those who will follow them and write the script for the next act that will set China’s future course.

The information vacuum also hasn’t stopped the Chinese press from saturating the newspapers and airwaves with stories about the congress. Danwei’s Barry van Wyk surveyed the front pages on Monday and found predictable yet “utterly uniform” coverage, though some papers broke ranks to report on Bo Xilai’s expulsion from the CCP and other news. Elsewhere, David Bandurski of The China Media Project has made “fruitless” searches for “18th Party Congress” within the realms of Chinese social media. Today, he highlighted a post on Sina Weibo which speculated about the lineup of the congress and was deleted by censors.

Reform remains the key buzzword in the press as the opening of the congress draws closer, but McClatchy Newspapers’ Tom Lasseter spoke to several academics who suggested that the West should temper its expectations of major political changes. The biggest policy developments, they say, will likely come in the economic arena. Caixin has published a list of 18 recommended economic reforms that the incoming leadership should pursue, a list that includes SOE reforms, environmental protection and tax cuts among other more ambitious requests such as downsizing the government itself.

Finally, beneath the pomp and circumstance that is sure to blanket the congress, The Guardian’s Tania Branigan reminds readers that the Communist Party does have a bit of governing to do as well:

The Chinese leadership “knows the legitimacy of the party now depends on performance, in terms of delivering services and improvements in living standards”, said Steve Tsang, an expert on Chinese politics at the University of Nottingham.

The result is what he calls “a consultative Leninist system … They want to know what people think so they can take away the causes of discontent and potential challenges to the party. That’s not the same as the accountability we would talk about and expect in Europe or North America; it’s more of a safety valve and has an element of [the Maoist injunction] ‘from the masses, to the masses’.”

See also a Reuters’ primer on the congress, which details the likely agenda and ponders potential new policy initiatives that the delegates may introduce, and previous CDT coverage of the 18th Party Congress.

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But has China’s factory sector really rebounded? Not so fast, according to The Financial Times’ Kate MacKenzie, who breaks down the individual components of the official PMI and sees a mixed underlying story. Input prices have jumped, and both new export orders and employment continue to contract (albeit both more slowly than in September). MacKenzie writes that such details “stand out to us as taking the shine off the overall positive figure”. The Wall Street Journal also scanned the analyst community and found a mixed reaction to the manufacturing data, though some wrote that the readings validated the government’s current approach to policy easing.

As observers continue to debate the direction of the Chinese economy after September and third quarter data also generated cautious optimism, Peking University’s Michael Pettis remains at the center of the debate. The self-proclaimed “China skeptic” has long-highlighted the constraints of China’s growth engine and stressed the likelihood of  a sharp and necessary slowdown as the economy shifts away from an investment and export-led model, and this past week he took on two “China bulls” in separate conversations on the subject.

NPR’s Rachel Martin interviewed Pettis and CLSA’s Andrew Rothman, who took the view that China’s rebalancing process has already commenced thanks to “significant steps” taken by the government:

ROTHMAN: Well, actually one of the reasons why I’m bullish about China is because it is slowing down. It’s very positive that the leadership of China has recognized that the two decades of 10 percent growth are no longer sustainable. And they’ve made a lot of adjustments to slow it down while still keeping income growth high. But it’s always going to be slower, a little bit slower every year for the future.

MARTIN: Michael, I assume you’re not as optimistic as Andy.

PETTIS: Well, China’s economy has been driven primarily by very high investment. Every country that has had very high levels of investment for many years has run into the problems that, at some point, additional investment creates economic activity but it actually destroys wealth. The problem is if you bring investment levels down, you need something else to replace it. And that something else is normally consumption.

But it’s extremely difficult consumption rates up quickly enough to replace declining investment rates. So we’re going to see many years of much, much slower growth as China rebalances away from investment.

With growth already retreating from the double-levels enjoyed before the financial crisis, The Wall Street Journal also asked Pettis and expert Nick Lardy if 7%-8% economic expansion is “the new normal” or if the slowdown will continue. Lardy argued that consumption has already begun to contribute more prominently to GDP, and wrote that he expects incoming leaders Xi Jinping and Li Keqiang to accelerate the pace of reform and stave off any further deterioration in China’s economic performance. Pettis, however, challenged the assumption that household consumption can continue to grow at such a strong clip and instead suggested that overall economic growth “will slow substantially in the next few years”. From Pettis’ response to Lardy:

Global and Chinese conditions are not nearly as good anymore. This means that it will be hard to maintain 7% household consumption growth even in the best-case scenario. But rebalancing in China means by definition that household consumption growth has to outpace GDP growth by at least 3 or 4 percentage points every year for the next decade just to bring Chinese consumptions levels to rates equivalent to the lowest consuming countries in the world.

This is just another way of saying that the growth contribution of investment has to drop so sharply that GDP growth cannot exceed 3% – 4% if China is to rebalance. Any higher GDP growth cannot be consistent with even a minimal rebalancing of the Chinese economy unless there is some way to force much greater growth in household consumption – i.e. much greater growth in household income – in spite of much worse global and Chinese economic conditions.

The arithmetic simply doesn’t work. China must rebalance its economy because its over-reliance on investment has become toxic. For China even to maintain GDP growth rates of even 7% to 8% implicitly requires that household consumption grow by 10% – 12%, something never before achieved even under much better economic conditions. Without a deus ex machine that turbocharges consumption growth, high GDP growth rates are incompatible with rebalancing.

Big Bad Loans

Broader economic data may point to a rebound, but disappointing corporate earnings results have blunted that outlook to an extent. From oil refiners to construction and heavy machinery giants, and from the auto industry to airlines, a number of big names have seen profits slump in the just-completed quarter.

Why? There are plenty of reasons – slumping global demand and rising labor costs, to name a couple. But The Diplomat’s James Parker also writes that China is “addicted to credit”, and notices the sharp increase in accounts receivable (money owed but not yet paid to a company by its customers) on the balance sheets of Chinese companies:

During a slowdown, it is common for payments to be delayed as everyone hangs on to cash. Some companies, though, can be tempted to avoid curtailing production by offering reluctant customers much easier credit to encourage sales, the hope being that the slump will soon end and “natural” demand will pick up again. The trouble of course is that if the slowdown is prolonged, or the recovery weaker than expected, these accounts receivable might turn “un-receivable”, and thus have to be written down as losses. An increase in A/R is expected, but such a large increase suggests that some companies have been staying in operations through this vendor financing.

The Wall Street Journal also reports that China’s state-run banks, despite enjoying double-digit profit growth in the third quarter, are bracing for an uptick in non-performing loans. Even The China Daily admits that bad loans are weighing on China’s biggest lenders, and Forbes contributor Gordon Chang goes so far as to call the Big Four banks “China’s Enrons”:

Whether they cooked the books or not, Chinese bankers have a lot to hide. To avoid the effects of the global downturn, Premier Wen Jiabao, beginning at the end of 2008, made the banks go on a spree by forcing them to abandon lending standards. That permitted China to bulk up on “ghost cities,” towering government offices in rural villages, and magnificent airports in the middle of farmland. Even after central officials supposedly reined in the loan-a-thon in 2010, lending has continued at a fast pace: new loans were up 23.7% in Q3, compared to the same quarter last year.

As a result of this “directed” lending, the banks are now carrying “assets” that cannot, in the normal course of business, be paid back. “The Mother of All Debt Bombs” is how Minxin Pei of Claremont McKenna College characterizes the risky situation. Chanos puts it this way: “Imagine a credit python,” he said. “The U.S. is the pig at the end of the snake, and China and Asia are the pig entering the snake in terms of deleveraging the banks.”

Other News:

• The China Daily reports that analysts expect the Renminbi trading band to be broadened this year.
• Real estate developers have turned their eyes back towards Beijing and Shanghai, according to Bloomberg, as opportunities wane in 2nd-Tier cities.
• Crude steel output slowed sharply during the first nine months of 2012, according to data provided by China’s National Development and Reform Commission (NDRC)
• Search engine giant Baidu reported a 60% rise in third quarter profit amid growing advertising revenue.
• China announced new measures aimed at supporting its ailing solar industry, which has suffered U.S. duties on exports over dumping claims.
• As sales growth slumps for Nike, Lee jeans and others, one private equity partner tells The Wall Street Journal that “the hypergrowth era for the apparel industry in China is over, period“.
• Toyota misfired with Chinese buyers, and the problem runs far deeper than the recent anti-Japan protests, writes Reuters’ Norihiko Shirouzu.
• Bloomberg reports that China has suspended operations at some coal mines to avoid any safety disasters in the run-up to this week’s 18th Party Congress.
• Tobacco giant Philip Morris is trying to raise its profile in China.
• Reuters reports that a Chinese sovereign wealth fund has taken a 10 percent stake in the holding company which controls Britain’s Heathrow Airport.

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Post tags: Andrew Rothman, bad loans, China PMI, credit crisis, economic growth, economic reform, economic slowdown, employment, exports, GDP, Li Keqiang, manufacturing, michael pettis, Nick Lardy, Xi Jinping
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That the relatives of a powerful Chinese politician have used their connections to enrich themselves probably surprised nobody – the staggering net worth of China’s top public servants is well known – but the timing of the report, with the 18th Party Congress just two weeks away, clearly rankled a Communist Party hoping for a smooth path into its once-a-decade leadership transition. Furthermore, Wen had championed himself as a reform-minded man of the people from humble roots.

The report also did no favors for a Communist Party trying to distance itself from the fallout of the Bo Xilai scandal, a tale of corruption that the party would like to convey as isolated and not indicative of systemic impropriety at the upper levels of its leadership. And as The Economist points out, Li Keqiang “will be among those squirming” as he gets set to take over for Wen. A recently-published Brookings Institution report claims Li faces a conflict of interest as he pursues healthcare reform while his younger brother maintains an influential role in China’s tobacco industry.

Chinese censors worked overtime to quash the Wen story over the weekend, and Wen’s family lawyers issued a statement challenging its allegations, as the story diverted a fair amount of attention away from the debate over whether China’s economy has indeed turned a corner and begun to stabilize heading into year-end. HSBC had published its flash purchasing managers index (PMI) data for October, which showed that China’s factory sector had remained in contractionary territory but had shrunk at a slower pace than in previous months. So is the glass half full? The Financial Times’ Kate MacKenzie dove into HSBC’s summary, which showed falling inventories and rising input and output prices, but also showed a shrinking labor force, and concluded that “it’s a little too early to say if manufacturing is truly recovering” on the mainland.

Also for The Financial Times, guest contributor Linda Yueh of Bloomberg TV took a step back from the manufacturing data and asked whether China is destined for a cyclical turnaround or whether it has reached a “new normal” as it continues to structurally evolve to suit its next phase of growth:

Along with getting closer to the technological frontier, which is associated with a growth slowdown as the “catch up” phase begins to end, another reason for China is demography. RBS’s Louis Kuijis, the former Beijing-based World Bank economist, estimates that the working-age population is growing at 0.5 per cent per annum, a third of the previous pace when an 8 per cent growth rate was thought to be necessary to maintain employment. He infers that the trend growth rate may now be around 7.5 per cent.

But, it’s hard to discern if a slowdown is structural or still predominately cyclical. Another difference with 2008/9 is that the current export slowdown was expected so firms could adjust and there is a more flexible renminbi to help the adjustment in the real economy. It appreciated by a record 4.4 per cent in 2011 alone against the dollar and a wider trading band has helped to better insulate against a balance of payments shock. Export falls require more real adjustment if the currency is less flexible as China’s was in 2008/9.

Elsewhere, The New York Times had more on the reaction to the data among the foreign analyst community:

Analysts said the improvement in the October reading reflected the effect of a steady drip of stimulus measures introduced by Beijing. A gradual improvement in overseas demand in recent months also has helped. A subindex measuring new export orders, for example, rose to a five-month high of 47.3 points as orders for the Christmas season came in.

The reading provided a “positive sign,” and “further evidence of a pickup for the fourth quarter,” economists at Australia & New Zealand Bank in Hong Kong wrote in a research note. At the same time, however, the October number was still below 50 points — the level that separates expansion from contraction, showing that the companies polled in the survey still faced considerable challenges.

Analysts on the mainland also maintained an optimistic tone and suggested that the central government would retain a cautious stance with regards to any near-term fiscal or monetary policy action. Their comments echo a recent front page article from the People’s Bank of China’s self-published newspaper, which argued that policymakers have “no grounds for further loosening of monetary policy” to spur growth. And a Bloomberg survey conducted from October 18-22 predicted that China’s central bank would likely forego any further cuts to benchmark interest rates or the reserve requirement ratio:

With growth momentum improving and inflation picking up toward the end of the year, “the likelihood of further interest-rate cuts in the rest of 2012 is diminishing,” JPMorgan’s Zhu said in an Oct. 18 research note.

“In addition, the busy political agenda going ahead also implies that the prospect of meaningful monetary policy easing in the near term becomes more remote,” Zhu wrote.

Finally, reform has become as big a buzzword as any as the state propaganda machine churns its way toward next month’s party congress. A China Daily piece over the weekend argued that the government should pursue reform to seek new sources of growth, and Xinhua cited a senior official as pledging reforms for state-owned enterprises, from railway, telecom, power and natural sectors as well as others, to lower the barriers to entry in such industries.

A key focus for investors will also be the extent of reform in China’s securities industry. The China Securities Regulatory Commission (CSRC) is eyeing new regulations governing credit ratings of bonds traded in the inter-bank market, according to Reuters, and The Global Times reports that the CSRC is also considering a new dividend tax scheme intended to discourage short-selling. Last month, vice premier Wang Qishan spoke of reform in a meeting with the CSRC’s International Advisory Council. From The China Daily:

Despite the rapid development and huge changes achieved by the country’s capital market in recent years, it still appears comparatively immature, he told the 20-strong delegation.

Wang said China’s capital market would learn from successful international capital markets, accelerate institutional innovation, strengthen market regulation and take active and steady steps to open up further to the outside world.

He also called for the protection of investors’ interests.

Other News:

• From Dongguan in Guangdong province, The Globe and Mail’s Mark MacKinnon highlights the efforts Chinese companies are now taking to entice workers increasingly seeking better pay and working conditions.
• Bloomberg reports that Chinese aluminum stockpiles have hit their highest level in two years, as supply outpaces demand.
• Caijing warns that local government debt has reached an “alarming level” and should be watched closely ahead of a repayment hike in the next two years.
• Canada’s Nexen expects its takeover bid by state-owned CNOOC to close by year-end, according to Reuters.
• Three ratings agencies from China, The United States and Russia announced that they will jointly launch a new agency to challenge the current global ratings system dominated by the “big three” US agencies.
• Bank of China’s profit jumped 17% in the third quarter, helped by an improved lending margin, and China Construction Bank similarly beat profit estimates.
• A Commerce Ministry think tank expects 2012 exports to rise 6-7%, and remain below 10% next year, according to Reuters.
• The China Daily reports that farmers in Wenzhou can now use pigs and cows as collateral to help obtain loans.

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Post tags: 18th party congress, Bo Xilai, corruption, economic reform, fiscal policy, income gap, Li Keqiang, manufacturing, monetary policy, PMI, securities law, state-owned enterprises, Wen Jiabao
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