Credit Suisse Private Banking
China: Third Plenary Session
Reform Ideas Comprehensive but Lack Details
The Chinese Communist Party has concluded its third plenary session of the 18th Party Congress on 12 November. In the post-event communique, the leaders in Beijing put out an ambitious plan of reforms, though details of reform initiatives are missing at this moment. This is being seen as probably the most comprehensive and ambitious reform architecture in the history of the People's Republic. It remains to be seen however, the details of the policy design and execution in determining the fate of Xi’s reform.
Market Implications (Our Thoughts)
· The market will likely react too strongly on the document yet given its vagueness, it is likely to be seen as very mildly positive, but with a lot of details needed to be filled. We expect more details to be available when functioning ministries reveal specific reform packages in the coming months.
· Fiscal Reform could be positive for Chinese Banks
As momentum gathers on fiscal reform and details to be released over the next few months, it is likely that some expenditure functions such as social security, education, healthcare, will be transferred from local to the central government, and proper local government bonds will be allowed to be issued to replace the LGFV loans.
Currently, local governments receive 52% of fiscal revenue (before extra budgetary revenue, mainly land sales) but account for 85% of expenditure, which creates the need to borrow, especially for infrastructure investments.
Key highlights of the Central Committee Communique worth noting:
1) establishment of a "super agency" under the Communist Party to co-ordinate reforms, suggesting the importance of the reform agenda to the Xi’s Party
2) strong emphasis on the role of market in resources allocation; SOE reform implementation by the government will be important
3) the mentioning of "open-up to promote reform" - the most significant example of such a strategy was China using the chance of joining the WTO in late 1990s.
· The most radical deviation from China's existing establishment comes from Xi's idea of redefining the role of government and market. The party intends to let the market play a "decisive role" in resource allocation, while the government, the current dominating factor, plays a supportive role in managing the country.
· The communique took some space addressing the fiscal/tax reform, which probably has the greatest chance of being launched next year. We also expect some, albeit limited, revenue sources to be passed on from Beijing to local governments.
· Regarding rural reform, the government intends to "grant more right of assets to the farmers", to create a better balance in resource allocations between the urban and rural population. We take this as allowing farming land transaction in market prices and granting farmers the right to access healthcare and education.
· We have two strong impressions from the communique. 1) Beijing is serious about pushing government reform. 2) Reform plans are very broad-brushed. We expect more details will become available when functioning ministries reveal specific reform packages in the coming months, but the market may feel disappointed as it is hard to dig "trading ideas" from general secretary's speech.
UBS Private Banking
3rd Plenum – Taking China Overweight
The full document from last week's Plenum is full of significant reforms. Our colleagues
Tao Wang, China economist, and H-share strategist, Wenjie Lu are both positively
surprised by the scope and tone of the document. We agree with them that
implementation is going to be the real key in future but for now the stock market is
likely to rerate. We move China to overweight in Asia ex Japan.
The full document from last week's Plenum is full of significant reforms. Our colleagues
Tao Wang, China economist, and H-share strategist, Wenjie Lu are both positively
surprised by the scope and tone of the document. We agree with them that
implementation is going to be the real key in future but for now the stock market is
likely to rerate. We move China to overweight in Asia ex Japan.
Looking for a reform driven re-rating
These proposed reforms, if enacted, will take time to play out fundamentally. We
expect the market to continue re-rating before they become apparent. China has derated
in recent years to 9x forward P/E a 20% discount to the region. There are good
reasons for this. But the prospect of reform we think will narrow the valuation gap to
the region. Just how much re-rating is moot - there is no precedent to compare this to.
However looking at previous (albeit different) examples such as the Thatcher and Singh
major economic reforms in the UK and India, and more recently in Japan (Abenomics)
show that market re-ratings happen before the fundamental benefits necessarily
accrue. Implementation and the speed of this are the key risks.
These proposed reforms, if enacted, will take time to play out fundamentally. We
expect the market to continue re-rating before they become apparent. China has derated
in recent years to 9x forward P/E a 20% discount to the region. There are good
reasons for this. But the prospect of reform we think will narrow the valuation gap to
the region. Just how much re-rating is moot - there is no precedent to compare this to.
However looking at previous (albeit different) examples such as the Thatcher and Singh
major economic reforms in the UK and India, and more recently in Japan (Abenomics)
show that market re-ratings happen before the fundamental benefits necessarily
accrue. Implementation and the speed of this are the key risks.
Taking India back to neutral for now. China likely to be in the spotlight
We think the Plenum reforms will likely cause China to outperform Asia ex Japan for
the next few months, and take it overweight. We take India back to neutral from
overweight. We still like India - our thesis of weak capex = higher return on capital still
holds. But it is a longer-term theme and for now we believe a Chinese re-rating is likely
to steal the limelight.
We think the Plenum reforms will likely cause China to outperform Asia ex Japan for
the next few months, and take it overweight. We take India back to neutral from
overweight. We still like India - our thesis of weak capex = higher return on capital still
holds. But it is a longer-term theme and for now we believe a Chinese re-rating is likely
to steal the limelight.
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Some key highlights of the ambitious reform plan but implementation and the sequencing will be crucial.
SOE reform:
Develop mixed ownership structure by allowing more private participation; transfer a portion of SOE shares to social pension funds, raise dividend paid to public finance to 30pct by 2020 (MOF said SOE had 2.1 trillion in profits in 2012. However, this likely does not include mixed ownership companies where the State might be the majority shareholder or strategic share holder.)
Develop mixed ownership structure by allowing more private participation; transfer a portion of SOE shares to social pension funds, raise dividend paid to public finance to 30pct by 2020 (MOF said SOE had 2.1 trillion in profits in 2012. However, this likely does not include mixed ownership companies where the State might be the majority shareholder or strategic share holder.)
This is a positive development, though progress may take time.
Land reform:
Farmers will be given more protection of their property rights and enjoy bigger freedom to sell their land. Good for develop modern and scaled agriculture, and also possibly increase land supply for urban construction. This may lead to more property construction in the short term.
Farmers will be given more protection of their property rights and enjoy bigger freedom to sell their land. Good for develop modern and scaled agriculture, and also possibly increase land supply for urban construction. This may lead to more property construction in the short term.
Hukou reform:
Fully open hukou for small cities, orderly relaxing for medium-sized cities, strictly control Hukou for mega cities (tier 1 cities). Could lead to more property construction, and through better social benefits for migrants, improvement in consumption.
Fully open hukou for small cities, orderly relaxing for medium-sized cities, strictly control Hukou for mega cities (tier 1 cities). Could lead to more property construction, and through better social benefits for migrants, improvement in consumption.
One child policy:
Families with one parent as a single child can have two children (seems a bigger step than we had envisaged). Impact on the overall economy may be limited – birth rate may not rise that much, and impact on labor market will come out much later.
Families with one parent as a single child can have two children (seems a bigger step than we had envisaged). Impact on the overall economy may be limited – birth rate may not rise that much, and impact on labor market will come out much later.
Property tax:Accelerate legislation of property tax and proceed at appropriate time (more definite than before, but still hint a slow pace)
Local government debt and finance:
Reduce flow of future local debt by: making local balance sheet and consolidating budget; linking local official performance with debt increase; moving some administrative authority to the central government; reduce local involvement in production, including by divesting some state-share to private sector (mixed ownership); increase local revenue by requiring a higher SOE dividend and marginal increase in tax revenue; address cash flow issue by issuing more bonds.
Reduce flow of future local debt by: making local balance sheet and consolidating budget; linking local official performance with debt increase; moving some administrative authority to the central government; reduce local involvement in production, including by divesting some state-share to private sector (mixed ownership); increase local revenue by requiring a higher SOE dividend and marginal increase in tax revenue; address cash flow issue by issuing more bonds.
