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The new normal: China’s holistic development of its economy moves beyond long-time focus on GDP

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South China Morning Post
Comment›Insight & Opinion
China Economy
2015-10-23

David Wong

David Wong is confident that efforts on multiple fronts to restructure the economy will turn President Xi Jinping’s ‘China Dream’ into reality

The key to sustainable growth in China is financial, fiscal, and administrative and social reforms.China has grown rapidly for more than a quarter of a century by following a strategy of high investment, strong export orientation and resource-intensive manufacturing. While this growth has lifted hundreds of millions out of poverty, it has also increased income disparity through unbalanced growth, environmental degradation (including air, water and soil pollution), corruption and unsustainably high local government debt.

In May last year in Henan , President Xi Jinping used the term “new normal” for economic development. This is a development strategy not based on gross domestic product growth alone, but includes economic, political, cultural, social and environmental development. The strategy is now playing out in China’s economy, with the shift in the balance of growth from export-driven, heavy industrial investment towards domestic consumption. This shift is particularly evident in the services sector, with an emphasis on innovation.

China’s economic growth has slowed, due to an ageing population, a decreasing rural workforce and more rigid energy, resources and environmental constraints. The expected growth rate in 2015 is below 7 per cent, with the rates for 2016-2020 expected to be around 6.5 per cent, and those for 2021-2025 around 5.7 per cent.

However, we need to remind ourselves that 7 per cent growth in 2015 is equivalent to a 14 per cent growth rate in 2007.

The key to sustainable growth in China is financial, fiscal, and administrative and social reforms.

First, China must continue to loosen control over interest rates and cross-border capital flows with full rate liberalisation as the ultimate objective. The People’s Bank of China has made great progress by implementing a deposit insurance system and freeing domestic interest rates. However, China’s financial system remains bank-dominated, with development in the bond and securities market lagging behind. Truly risk-based, market-driven corporate bond and securities markets will certainly enhance the efficiency of the financial markets in the allocation of capital.

The calibrated opening of the capital account – through the qualified foreign institutional investor scheme, the renminbi qualified foreign institutional investor scheme and the qualified domestic institutional investor scheme, plus the Shanghai-Hong Kong stock connect – were good moves but more needs to be done. The drive for renminbi internationalisation for trade and investment must continue for its eventual recognition as a convertible currency in the International Monetary Fund’s special drawing rights basket, which is of symbolic significance.

The reform process must continue in the privatisation of the financial sector for underserved customers like small and medium-sized, and rural, enterprises. The implementation of the loan-pledged relending programme in Guangdong and Shandong , which has now been extended to Shanghai and other parts of China, will help local banks to provide targeted financing for SMEs and rural clients.

Second, since the mid-1990s, local governments have had responsibility for spending but few sources of revenue, resulting in the increase of local government financing vehicles and incidents of land grabs. What is needed now is to grow the Ministry of Finance’s balance sheet and reduce borrowing by local governments. The central government will need to transfer funds to provinces for social programmes of priority. As such, the municipal bond market will have significant growth potential. The ministry’s plan to restructure 1 trillion yuan (HK$1.2 trillion) of local government liabilities through debt/bond swaps will lower their borrowing costs and offer short-term relief.

Third, reform of the hukou system of household registration that restricts the movement of rural workers to urban centres will affect at least 300 million citizens. The second-class status of these migrant populations restricts their consumption power, as a greater percentage of their disposable income has to be set aside for health care, housing, children’s education and retirement savings. As such, reform of the hukou system and urbanisation will help release consumption power.

The “new normal” will evolve with slower but more balanced growth. China has had to cope with the challenges of boosting domestic consumption, supporting the growth of the services sector and generating sufficient employment growth to maintain social stability.

As a result, the share of GDP growth by domestic consumption has increased from around 35 per cent in 2007 to more than 50 per cent today. Such consumption will continue to grow due to rising wages, the increasing share of the services sector and the trend of lower household savings.

In the past, the depressed costs of production has in effect produced subsidies for the corporate sector but “taxes” on households. However, this pattern has begun to change with rising labour costs. This will redistribute income from the corporate sector to households.

Another positive development is that the share of the services sector has now overtaken the industrial sector. This will drive employment, especially in SMEs, which will in turn further boost domestic consumption. With the implementation of social reforms, including a stronger social safety net and a better government-funded health care system, there will be less need for precautionary savings. In addition, land reform together with hukou reform will drive the urbanisation process, especially in the second- and third-tier cities, which will further encourage consumption spending.

On the fiscal front, the debt restructuring process has started, with local governments deleveraging and central government borrowing increasing to ensure transparency and discipline. Local government revenue will come from fiscal revenue and bond issues by the provincial governments.

In addition, public-private partnerships will become an important alternative funding channel for infrastructure investments. More government-owned assets are expected to be injected into these platforms to help in the deleveraging process of local governments.

China’s “one belt, one road” initiative and establishment of the Asian Infrastructure Investment Bank (AIIB) are great ways to export excess domestic capacity and create an external economy. The economic and geopolitical dividends are significant. China will be able to help meet the real need for infrastructure development among emerging economies in Asia and Africa.

Today, China is a net importer of oil and gas, minerals and food from Africa, Brazil, Russia, Malaysia and Thailand. As such, these countries would be its natural partners.

China is a net importer of oil and gas, minerals and food. Photo: APWith the liberalisation of interest rates, cross-border capital flows and internationalisation of the renminbi for outbound direct investment, bond and securities markets will remain robust. Financial institutions, banks and asset managers would be able to participate in the origination, underwriting and distribution of the financial flows from these transactions.

Professional firms, including legal, accountancy and consultancy services will benefit as well.

As an international financial centre, Hong Kong will have a major role to play in China’s new growth strategy.

The growth of consumption expenditure in health care, education, medical, and general services driven by urbanisation and the ageing population will create opportunities for private companies in the services sector. Hong Kong, well known for its excellence in services and business experience, is well positioned to capture potential opportunities in the growth of China’s services sector.

Countries that enjoy a trade surplus with China will be well placed to work on joint infrastructure development projects through the AIIB and the roll-out of the Silk Road plan. Here again, Hong Kong, with its expertise, capacity and experience in debt and equity capital markets, will be able to lead the financing through project bonds and investment funds.

China is at a stage of major structural transition. Time is short, the political and social pressure is strong, and the risks are significant. However, as long as the central government keeps the pace and direction of change, the reforms should be achievable. This will result in a more equal income distribution, and a more balanced economic structure, with slower but more sustainable growth. I am confident that the “China Dream” could become a reality.

Dr David Wong, former deputy CEO of the Bank of China (Hong Kong), is currently chairman of Halftime Hong Kong, with the mission to help business leaders transit from success to significance

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