China: Will the major conference held every 5 years bring policy breakthroughs?

News analysis video: Biden Officially Drops Out of Race - Major Changes in China's Economy

Last week, the major event for China's economy that occurs only once every 5 years: 20th Central Committee Plenum has taken place. 

FYI: Usually, there will be significant and long-term changes to China's economy after each of these conferences, for example:

• 1978: Market-oriented economic reforms => ending the era of subsidies

• 1984-2008: Each year there were positive changes in property rights, price reforms, wages, rural economy…

  => By 2008: China joins WTO, officially changing the game in international trade.

• 2013: Allowing the free market to allocate resources – expanding agricultural land ownership rights - easing the one-child policy – encouraging privatization of state-owned enterprises 

  => Marking the beginning of the flourishing of private economy and capitalism in China.

• 2018: Mainly reorganizing the government, military, and public agencies… 

  => The anti-corruption campaign was intensified.

This conference was originally scheduled for 2023, but was postponed by 1 year from the plan. However, it can be said that the conference took place “at the right time”, when Chinese leaders in the first half of 2024 have deeply realized the severity of the real estate crisis over the past 3 years.

(Preliminary data on China's economic situation will be presented below the article.)

It's not wrong to say that the Asian financial community in particular and the world in general want to know more about the content of this most important conference in China. Therefore, Viet Hustler's weekend Macro Economics column will dedicate this article to comment on China's economic situation. Content includes:

1. Preliminary on the recent macroeconomic situation in China

2. What reforms were proposed in last week's Central Committee Plenum?

3. Accompanied by comments from Viet Hustler.

Disclaimer: Some views below are the personal opinions of the author – and not investment advice.

Preliminary data on China's Macroeconomic Situation

For a brief comment on the context of the world's second-largest economy ahead of this conference, Viet Hustler believes:

Despite struggling for a while, China still cannot escape the 3-year-long real estate crisis.

This economy may even be starting to bog down into a lost decade, as deflation and disinflation have lasted ~1.5 years!

Latest Preliminary Macroeconomic Data for China

Economic growth stagnating:

• China's Q2/2024 GDP only grew +4.7% (annualized) - lower than the 5% target.

• If looking at the chart over the past 30+ years: it's easy to see that China may have reached the end of its miraculous growth period (similar to Japan before).

Real estate crisis continues, domestic demand weakens

• Real estate prices in China continue to fall — even at a faster rate than before.

• Investment in real estate has also plummeted accordingly:

  

• But more importantly, declining real estate values make people tighten their belts even more:

  => China continues to bog down in disinflation (previously deflation) as domestic consumption is weak:

  

Chinese companies seek markets abroad — but also heat up geopolitical tensions as the US and Europe protect their domestic markets:

• Chinese enterprises are relying on foreign markets to offload excess produced goods:

  • Trade surplus surges due to increased exports and decreased imports!

  

• This has led to a series of countries (mainly Europe and the US) criticizing China for dumping. 

  • Europe and the US begin strong anti-dumping measures and protection of domestic markets.

  

On the international financial market: intensified sell-off of US Treasury bonds

• China has sold off 42.6 billion USD US stocks and bonds in May/2024 — record monthly sell-off in history.

  •  And breaking the previous record of ~39 billion USD in Q1 2016.

  • ~50% of the financial assets sold are US Treasury bonds.

  • Total sell-off value in the first 5 months of the year is 79.7 billion USD.

  

Read more: China - GDP and retail growth weak, housing prices drop sharply

And as mentioned above, the important 5-year conference to propose long-term economic policy reforms for China: Central Committee Plenum the 20th took place last week (July 15-18, 2024) right after the above data was released.

Reforms from the 20th Central Committee Plenum and views from Viet Hustler

Below are the highlights of this Central Committee Plenum's content (collected from Bloomberg and Xinhua):

1. Topics mentioned: increased discussion on security and technology - ignoring the real estate (BĐS) crisis.

Topics on security (security) and technology increased compared to the 2013 meeting, including issues:

1. Military modernization (military modernization), 

2. Technology breakthroughs (technology breakthroughs) for private enterprises.

• FYI: Commonly mentioned phrases…

But this conference reduced mentions of economic (economics) or market (market) topics… 

• … amid slowing economic growth, ongoing deflation/disinflation, and declining BĐS values.

  

In particular, the real estate crisis issue was mentioned only once in the 4000-word communique of the Plenum with content: 

• BĐS is “undergoing positive changes” and promises of new real estate policies afterwards...

Viet Hustler’s opinion:

• While BĐS once accounted for more than 1/4 GDP of China in the 2010-2017 period…

  

• … and the severe decline in BĐS value is the cause of all current nagging economic problems in China…

=> The lack of much mention of the BĐS market shows that the Chinese government still does not have strong and clear measures for this crisis. 

2. High quality development (high quality development)

Xi Jinping sets the goal:

Viet Hustler’s opinion:

• By emphasizing technology, China wants to use technology as a springboard to increase productivity and industrial output

• However, China's problem is not production but consumption:

  • Because China's labor productivity is now higher than the pre-Covid trend….

  • … while domestic demand is weakening (domestic sales lower than pre-Covid trend)....

  

3. Short-term tasks incorporated into long-term policy conference

Chinese policymakers emphasize short-term economic goals:

“… actively expanding domestic demand… ” (“… actively expanding domestic demand…”)

Note:

• This is the once-every-5-years policy conference for reforms and medium-to-long-term economic goals.

• China has only explicitly stated short-term economic goals 3 times in such Central Committee conferences.

• In the past, only the 1998 and 2008 conferences mentioned short-term economic goals – when economic growth was also under “severe pressure” as now.

Viet Hustler’s opinion:

Emphasizing this short-term goal is completely understandable because this short-term goal can also turn into medium- or long-term goals… if China's economy truly enters a lost decade like Japan!

• Therefore, the biggest task for China's economic policy right now is still to stimulate domestic consumption!

4. Public debt and room for fiscal policy

Han Wenxiu (China's Central Commission for Finance and Economy) outlines government spending reform plans, including:

• Local government funding sources will increase and tax revenue sources will be expanded.

• However, the central financial expenditure ratio will increase in total public spending. 

• Will study tax regulations “compatible with new sectors”.

Viet Hustler’s opinion:

• Strengthening local governments' coffers to fund economic plans stimulating demand through fiscal policy is understandable.

However, from the above statement, can it be interpreted that China will increase tax collection? 

• However, increasing tax collection when businesses halt production and people tighten their belts and refrain from spending will counteract the fiscal policy aimed at stimulating growth!

Can China increase local government funding through borrowing?

• Borrowing is becoming increasingly difficult as LGFV (a form of local government debt in China) ranks as the top 1 riskiest investment for investors in Asia!

  

  • And in reality, many LGFV debts have not been refinanced/rollover in the last 3 quarters.

  

Summary

• Statements from Chinese government members remain vague.

• Usually, a more detailed conference report will be released in a few days to announce key policy changes.

• Specific measures to implement the above changes will be announced at the end of this month after the meeting of China's Politburo consisting of 24 key members.

Update on the latest resolution on 07/21 (just issued this morning): key policy changes!

Public debt issue:

Allow ctransfer tax revenue from the Central government in Beijing (where there is a fiscal surplus) to local governments in deficit.

• Through allowing local governments to retain a larger share of corporate tax revenue…

— The following comments reference Bloomberg! —

FYI: This is considered the 3rd largest domestic fiscal and tax reform in recent decades.

• Previous reforms include:

  • 1994: increased the central government's revenue share relative to local governments

  • From 2013: allowed local governments to issue bonds themselves…

However, the central government's fiscal surplus may not be sufficient to cover local governments' deficits!

Regarding fiscal reforms, other commitments from China include:

1. Increase transfer payments for public expenditures

2. Gradually allow localities to collect additional consumption tax

3. Optimize the sharing of shared taxes between the Center and localities

4. Expand the scope of use of local government special bonds  to fund projects

5. Allow localities to regulate the levels of certain taxes related to city maintenance and education

6. Allow localities to manage more non-tax revenues

Viet Hustler’s opinion:

It can be said that what Viet Hustler guessed above is quite accurate (Viet Hustler wrote the above part before this resolution was announced this morning):

• That is, China is really addressing the public finance problem through increasing tax revenue + increasing borrowing!

Real Estate Crisis Issue: 

1. Allow local governments autonomy in regulating the real estate market

2. Establish a housing buying and renting system + more housing subsidy programs. 

=> As Viet Hustler noted above: these measures are not strong enough to resolve the real estate crisis!

Income policies: 

1. Regulate the salary and bonus regime for management levels at state-owned enterprises.

2. Establish a mechanism to control the asset accumulation of these management levels. 

Financial market policies:

Allow the free market to play a decisive role in resource allocation (decisive roles in resource allocation)

CONCLUSION

As the macroeconomic data figures at the beginning of the article show, it can be said that the real estate crisis in China has not only not subsided… but has become more severe. This could lead to prolonged mild deflation or deflation in the upcoming period.

Meanwhile, at the 5-year Central Conference last week, China failed to propose a convincing measure to revive the real estate market and consumption. The highlight in the policy for the real estate sector is granting freedom to local governments in regulating this industry. However, this is a double-edged sword: because previously, local governments collected more revenue from … selling land… than from developing infrastructure!

It can be said that the major bright spot of the reform policies in this conference is the local government public debt issue: when China decides to change the tax revenue sharing ratio between the central Beijing authorities and the localities.

The remaining 2 decisions on public finance: increase collection of certain taxes + increase debt issuance both have limitations:

• Option 1 will reverse the loose fiscal policy to boost consumption

• Option 2 is not very feasible because many local government debts (LGFV) cannot be reinvested!

In particular, the above Conference continuously emphasizes technology development. This is also a bright spot in the current global technology competition context. But this is also a dead end if China keeps chasing labor productivity increases without addressing the key issue of demand!