Beijing's Latest Plenum: What's In It?

The plenary session of the Chinese People's Congress (the Communist Party congress) took place last week.  The Congress put the final touches on the next five-year plan - a Soviet-style planning holdover of the command economy - as well as 2016 policy goals.  China's five-year plan and the 2016 targets will officially be instituted and announced at the People's Congress (the government legislature) next spring in March or April, but announcements and a communique have laid out some broad themes.

Over the years, Beijing has found it easy to successfully meet goals laid out in past five-year plans.  Most of those goals have been output-related and in modern times coincided with tremendous economic tailwinds.  Implementing the next five-year plan will be far more complicated with difficult and risky reforms announced in tandem with a robust 6.5% growth line drawn in the sand.

The plenum themes are not very new, and most reflect an extension of reform goals already laid out by Xi's government.  In a nutshell, the overall goals of this plenum seem to be: moving growth to a more sustainable and inclusive balanced growth rate, promoting high-tech innovation, improving quality of life issues for rural and middle class citizens, and pushing for further integration with the world - using policies like the "One Belt, One Road" initiative.  

But not all plans seem to be moving the country forward.  On the social front, the plenum plans include tightening controls over culture and art, "purifying" the internet, and strengthening socialist core values.  Xi wants to liberalize the economy, but is keen to tighten control broadly.

So far, here are some of the most important issues addressed:

Full yuan convertibility by 2020

Chinese leaders have promised full yuan convertibility by 2020.  Historically, capital market liberalization and free-floating a currency are often risky and messy reform moves, which eventually pay off for an economy.  Giving up control of the currency is particularly difficult for policymakers that have used the significant control over the yuan as a policy tool to steer the economy.  So, I would expect the next five years of opening the capital account will be characterized by bouts of turmoil, some significant currency interventions, and occasional temporary roll-backs of market freedoms.  But, Beijing will push forward; open capital markets and a freer-floating yuan are a necessity for long-term global ambitions and domestic economic health.

Plans to free up the yuan are in tandem with explicit goals to get the yuan into the IMF special Drawing Rights (SDRs), a basket of four currencies used as an international reserve asset.  The SDR inclusion is not in itself a meaningful event.  Inclusion in the SDRs will be a stamp of approval for the yuan's use as a global reserve currency.  The end goal is not to become a small slice of the $280 billion SDR basket.  The end goal is to be a large slice of the $11 trillion reserve currency asset market.  

Even without the IMF's endorsement the yuan has become the fourth largest global payment currency, and central banks and sovereign wealth funds have been buying RMB-denominated assets.  That trend will accelerate with an IMF SDR endorsement, capital account liberalization, and improved convertibility of the yuan over the next five years.

China's leaders want the yuan to eventually be a major reserve currency for both political and economic reasons.  That is a goal that is possible in the long-term, but in the near-term the use of the yuan as a reserve will be limited by the size and depth of China's onshore bond market; roughly $5 trillion compared with $36 trillion in the US.  China will need a larger and deeper sovereign bond market to challenge the USD as the world's dominant reserve currency at 63% of all global reserve assets.

Robust 6.5% growth to 2020

The Party has pledged to double the real GDP between 2010 and 2020.  That will require 6.5% growth for the next five years.  Xi has effectively identified a lower bound for GDP growth over the next five years of 6.5%.  That will be a challenge for an economy already struggling to stay above 6.5% as headwinds - like corporate debt of 125% of GDP, a shrinking labor force, and weak global demand -  drag down prospects.  We will likely see next year's target reduced, meaning less reflation and weaker industry over the next year.  But, to reach long-term goals, expect Beijing to make serious attempts to hold the line at 6.5% at least until 2020.

Whether China puts Xi's growth pledge above other reform pledges is a big question mark.  When push comes to shove, will Beijing let messy and risky capital market and asset market liberalizations push forward if robust growth is jeopardized?  Will Beijing allow large debt-burdened industrial corporations and state-owned firms to fail in order to ensure investment capital flows to the fast-growing service and consumption sectors?  Given the buildup of economic headwinds over the years, it is possible that policymakers will need to choose between letting growth goals or restructuring goals go unmet over the next five years.

Addressing inequality and social welfare

A slew of social improvement intentions were announced: Plans to pull 70 million people out of poverty, increase the minimum wage, improve the medical system, make changes to the household registration system, further regulate the price of medications, allocate state-owned assets to the social security system, expand pensions, phase out fees for vocational education, and more.  

Social welfare reforms will probably have a positive effect on consumption by improving social safety nets and government services, allowing households to put more savings to work.  If these initiatives are funded by borrowing or an improved market or regulatory environment, then they will be stimulative to overall growth.  If they are funded by public funds or SOE proceeds, then they will constitute a shift to improved household and government consumption without a meaningful lift to broad growth.  

Social initiatives should also improve social stability.  However, small improvements to social and welfare issues will be a moot point if economic growth collapses, unemployment rises significantly, or deadly pollution is not improved. 

Addressing environmental concerns

Beijing has committed to raising non-fossil fuel share of energy production from just over 11% this year to 15% by 2020.  Increasing green energy is an area where policymakers have really pushed forward, expanding investment dramatically after pollution became the largest source of protests in 2013 (see my blog postings Recent Study: 1.6 million deaths each year across China can be attributed to air pollution. and also Structural Growth Headwind: Water Problems).  After Li Keqiang announced his "war on pollution" two years ago China has attacked the issue of deadly pollution with massive investment outlays, building renewables faster than anyplace on earth.  According to Bloomberg, China led the world in renewable investment last year with $89.5 billion deployed, almost one out of every three dollars spent on green energy in the world.  For more details about renewable energy investment see my blog posting China's ambitious renewable energy investments. 

Other environmental plans worth a mention: A real-time pollution monitoring system for citizens, expanding alternative energy vehicles, the broad goal of reduced carbon emissions, and the establishment of a Green Development Fund to expedite environmental efforts.

These plans are good for alternative energy tech industries of all kinds, but continue to be a sizable negative for the world's coal exporters.  China has driven its rapid growth by burning more coal than nearly the rest of the world combined.  But environmental plans are slowly making coal enemy number one.

Changing the one-child policy to a two-child policy

China's leaders announced they would allow married couples to have two children, rolling back the decades-old one-child policy.  In a country where nearly ever aspect of life was once controlled by the Communist Party, the change reduces the Party's control and intrusion into an important and intimate household decision.  The effect on the economy in the short-term will be muted, but the change has the potential to accelerate rebalancing to consumption in the near-term and mitigate demographic problems in the long-term.  

When Mao's Communists took over in 1949, he encouraged families to have as many children as possible in order to boost the ranks of farmers, factory workers, and soldiers.  As a result, China added 260 million to its population by 1970.  To contend with fears of overpopulation, the Party instituted the one-child policy in the 1970s.  

The one-child policy has left China with an aging population to support and a workforce already shrinking from its peak in 2010.  China's aging population is on track to become a significant burden over the next few decades.  Before this week's policy change the population of 60-year-olds and over was expected to rise from 36 million to 245 million by 2020; from 3% of the population to roughly one-fifth.  Not only will the retired population eventually be a significant burden, but older workers require more money and benefits and will add pressure to China's low-cost manufacturers.  The policy change should mitigate some of those demographic headwinds.

See my blog posting here for details: Decades-Old One-Child Policy Ended