Saturday, December 22, 2018
HEARD IN BEIJING
"[Our] achievements were hard won."
- Central Economic Work Conference Readout
Some context: That sentence encapsulates the tone of the readout from this year's economic work conference, which concluded on Friday. It's a far cry from last year, when policymakers were touting their economy as the driving force behind global economic growth. More in the Tip Sheet below.
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THE TIP SHEET
DRIVING THE DAY
1. The Party talks economics
China’s Central Economic Work Conference (CEWC) came to a close on Friday. As promised, this is our recap of the key points.
But first, a quick refresher: The CEWC is an annual gathering of Party leadership that takes place in December and discusses China’s economic outcomes from the past year. More importantly, it outlines economic policies that should be implemented over the next twelve months.
With the resurgence of the Party over the past several years, the CEWC has taken an elevated role in setting the direction of economic policy:
It was the 2015 CEWC that first outlined Supply-Side Structural Reform – China’s key economic policy framework since that time.At the 2016 CEWC, there was an increased focus on viewing the economy and financial system through the lens of national security – a prelude to the financial de-risking that took place throughout 2017 and 2018.
Get smart: The CEWC’s rising importance is part-and-parcel of Xi Jinping’s program to reinvigorate Party leadership over the economy, often at the expense of the government.
That’s why we’re focused on it.
Gov.cn: 中央经济工作会议举行 习近平李克强作重要讲话
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DRIVING THE DAY, CONT'D
2. What a difference a year makes
The tone of this year’s readout from the CEWC was decidedly downbeat. Central leaders are clearly focused on the challenges that the economy faces, both now and in the medium term.
Just compare the intro to this year’s readout to last year’s – the difference in tone is striking.
2018 Work Conference:
"We responded effectively to profound changes in the external environment in accordance with the requirements of high-quality development, worked hard to meet difficulties, and accomplished the objectives of macro-control well.""We steadily dealt with Sino-US economic and trade frictions…[and] took new steps towards the goal of building a well-off society in an all-round way.""These achievements were hard won."Now dialing back to the 2017 Work Conference:"Economic strength has reached a new level, with an average annual growth rate of 7.1%. [China’s growth] has become the primary driving force and stabilizer of global economic growth.""Economic restructuring has continued to advance, and the economy has become more dynamic and resilient.""People's sense of attainment and well-being has increased markedly…[and we] have formed the largest middle-income population in the world."The dichotomy between the two readouts tells you all you need to know about how China’s leaders are feeling as the year comes to a close.
That being said, despite the attention on the challenges that China is facing, the readout also put forth a sense of resolve:"The external environment is complex and severe, and the economy is facing downward pressure…[So] we should strengthen our awareness of hardships, seize the principle contradiction, and focus our resolve."
Our take: Policymakers’ increased anxiety around the economy is obvious, and the self-congratulatory tone that authorities struck a year ago is completely gone. It’s clear that China’s leaders expect 2019 to be a difficult year. Businesses and investors should take note.
Gov.cn: 中央经济工作会议举行 习近平李克强作重要讲话
DRIVING THE DAY, CONT'D
3. Macro policy
In terms of macroeconomic policy settings heading into 2019, Chinese leaders were clear that they will do more to support the economy:
"We will strengthen counter-cyclical adjustments.""We will continue to implement active fiscal policy and stable monetary policy, pre-adjust and fine-tune policies in a timely manner, and stabilize aggregate demand."In terms of the policy mix, fiscal policy will be leaned on more heavily, as expected:"We will intensify the effectiveness of active fiscal policy, implement larger cuts to taxes and fees, and substantially increase the scale of local government special bonds."Meanwhile, the focus for monetary policy is on improving the transmission mechanism, not on loosening significantly:"Stable monetary policy should be appropriately loose and appropriately tight, and [it should] maintain reasonable and sufficient liquidity.""We should improve the transmission mechanism of monetary policy, increase the proportion of direct financing, and solve the problems of difficult and expensive financing for private enterprises and small and micro enterprises."
Get smart: Economic support measures are set to intensify going into 2019, with a clear emphasis on fiscal policy over monetary policy. But at this stage, it remains clear to us that there is no large-scale stimulus on the cards.
Get smarter: While increased local bond financing should eventually help to support infrastructure investment, it will take time for a sustainable rebound in infrastructure spending – and therefore a bottoming out of economic growth – to manifest. We expect it to come sometime in Q3 2019.
Get really smart: In terms of monetary policy, many analysts are focused on the fact that the word “neutral” was removed from the description of the monetary policy stance. We agree that this is important, and a quickly decelerating economy calls for monetary policy to be more than neutral.
However, the clear focus is on improving the monetary policy transmission mechanism – i.e. making current policy settings more effective – rather than flooding the zone with new credit. Overall financial and credit conditions are therefore likely to remain relatively tight throughout the year, even as they may be loosened at the margin.
The bottom line: Anyone who is pinning their hopes for the global economy on substantially increased policy stimulus from China will be disappointed.
Some more support is coming, but policy actions will remain measured.
DRIVING THE DAY, CONT'D
4. Structural and social policies
Beyond immediate adjustments to macro policy settings, authorities also focused on structural and social policy priorities for next year.
In our view, the structural policies may be the most important area of focus for next year.
That is largely because authorities realize that macro policy levers have become less effective in recent years. So they have to focus on the more structural deficiencies in the economy.
Areas of focus will include:
"Structural policies should strengthen institutional mechanisms…deepen reform for state-owned enterprises, finance, taxation, land, and market access.""[We should] strengthen the basic position of competition policy, create a fair competitive environment, and encourage small and medium-sized enterprises to accelerate their growth."Meanwhile, policymakers are also focused on shoring up the basic responsibilities of social policy:"Social policy should…give priority to employment and ensure the basic standard of living of the masses."
Our take: Fundamental reforms have been slower moving than almost all observers – both inside and outside China – had hoped since the Third Plenum in 2013. But it’s clear from the tone of the readout that policymakers know they will have to make some tough decisions next year.
We are not certain that they will be able or willing to genuinely push through structural reforms more forcefully in 2019, but we are cautiously optimistic.
DRIVING THE DAY, CONT'D
5. The overarching policy framework
One key message from this year’s CEWC was that the overall framework of economic policy is not set to change, despite the growing uncertainties and increased downward pressure that the economy is facing.
Supply-Side Structural Reform (SSSR) remains as the broad matrix through which economic policy will be formulated:
"Persevering with Supply Side Structural Reform has not moved as the main line [of policy].""We should consolidate achievements in cutting capacity, reducing leverage, reducing housing inventories, and lowering costs for businesses."Get smart: The readout used a short-hand formulation for the four elements of SSSR listed above. But it is clear that those four broad categories – along with addressing shortcomings in the economy’s basic infrastructure – will continue to frame policy choices.
One critical outcome of this is that policymakers have decidedly not given up on their efforts to address financial risk and eventually deleverage the economy.
Within the context of deepening SSSR, several sub-priorities were also emphasized:Establishing fair, open, and transparent market rulesEstablishing a business environment based on a clear legal frameworkPromoting incentives to support high-quality companies, while increasing efforts to push under-performing companies out of the marketPursuing industrial upgradingImproving the financial system's ability to serve the real economyIn addition to SSSR, another key framing device for policy will be the so-called Three Critical Battles:Reducing risks – leaders will pursue structural deleveragingReducing poverty – leaders will continue to focus on China’s poor rural population and increase support for households just above the poverty lineFighting pollution – leaders will remain focused on winning the battle for blue skies
Our take: Despite increased anxiety around the state of the economy, authorities continue to focus on medium-term goals and are not set to radically change policy direction.
DRIVING THE DAY, CONT'D
6. Specific priorities for 2019
Within the context of the overarching economic policy framework – which involves deepening SSSR and continuing to fight the Three Critical Battles – policymakers laid out seven specific tasks for next year.
We list these tasks below and include a summary of key strategies that policymakers will pursue for each goal.
Promote high-quality development in the manufacturingindustry – continue moving up the value chain; increase efforts to push under-performing companies out of the market; and focus on technological innovation.Promote the formation of a strong domestic market – improve product quality; accelerate the development of education…medical care…and other services; and enhance consumption capacity.Promote the strategy of rural revitalization – invest in rural areas; improve technology in agriculture; and increasingly focus on rural land reform.Promote coordinated regional development – build out key geographical clusters in the Jingjinji area, Greater Bay Area, and the Yangtze River Delta; focus on creating economies of scale and network effects to drive growth.Speed up reform of the economic system – better manage state capital; focus on mixed-ownership reform for SOEs; support development of the private sector; improve the financial system; and deepen capital markets. Promote all-round opening-up – fully implement a negative list system; protect the legitimate rights and interests of foreign investors, especially intellectual property rights; and allow more areas to be operated solely by foreign investors.Strengthen the protection and improvement of people's livelihoods – prioritize employment; invest in education; continue to build out the social security system; and develop a long-term solution for development of the property market.
DRIVING THE DAY, CONT'D
7. Additional observations
Taken together, the readout from this year’s work conference provides a few key takeaways,especially when compared to differing points of emphasis in last year’s readout.
Below, we summarize our views on some of the most important signals that Chinese leaders are sending.
Industrial policy is alive and well:
Creating a world-class manufacturing sector, that competes further up the value chain and is focused on creating and applying new technologies, is job one. This compares to last year when the goals of deepening Supply-Side Structural Reform and “stimulating the vitality of all sorts of market entities” featured at the top of the to-do list. To us, this reflects a renewed focus on becoming more economically independent in the context of the trade war and a broadly uncertain external environment. An emphasis on beefing up the domestic market:Chinese leaders are looking to create better products in China that better service domestic demand. They are also intent on supporting consumption as a driver of economic growth. These goals are likely to be achieved primarily through ongoing tax cuts, and potentially, consumer subsidies. Similar to the focus on upgrading the manufacturing sector, this goal indicates that Chinese leaders will focus intently on attempting to unleash the economy’s domestic dynamism.Improving the property market was not listed as a specific task:In the 2017 readout from the CEWC, the need to “develop property rental and sales markets simultaneously” was listed as one of the eight individual priorities for 2018. However, in this year’s readout, efforts to improve the property market were discussed within the broader context of improving people’s livelihoods. And while the phrase “houses are for living in, not for speculation” was reiterated, there was also an acknowledgement that property policy should increasingly be made at the city level. To us, this does not represent a retreat from property control policies overall or the broad focus on housing affordability, but it does suggest more flexibility in property policy on a case-by-case basis next year.SOE reform and fair market competition were emphasized together:SOE reform remains a perennial focus. However, throughout 2018 the strategy largely shifted from better management of state enterprises to deploying state capital in a more effective manner. To us, this reflects the leadership's desire to improve the functioning of SOEs through a focus on profitability and more market-based competition among state companies. Consolidation of the state sector is likely to continue, but the smaller number of state firms will be required to compete more effectively against each other.Opening was described in a different way:What really caught our eye in the section on opening the economy was the statement that foreign companies will increasingly be given greater operational control in the domestic market. Moves in this direction have already been started throughout 2018, but we expect this policy to be further emphasized next year. Foreign companies should be on the lookout for investment deals that come along with greater – or even full – operational control. The trade war got a mention:It was only one sentence. But the fact that China’s leaders – in their most important economic meeting of the year – explicitly emphasized the goal of fully implementing the framework agreement reached between Xi Jinping and US President Donald Trump at their meeting in Buenos Aires was striking. To us, this underscores that Chinese leaders are intent on de-escalating the trade war with the US if at all possible.
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