Tuesday, March 15, 2011

China embraces next stage of reforms

Even as India debates and prevaricates on its next generation of reforms, China appears to have taken the plunge with its next stage of reforms and growth. The latest Five year Plan (2011-15), unveiled recently, seeks to address some of the fundamental imbalances within the domestic economy. It may mark the first major step in a fundamental course correction to the Chinese economy - the shift from an imbalanced export-driven growth to more balanced domestic consumption centered economic growth.

For some time now, critics have accused Beijing of promoting a policy of export-driven economic growth that in many respects run counter to balanced development at home. They point to China's massive current account surpluses (now at 5% of GDP) and $3 trillion plus forex reserves (most of which is inefficiently deployed in low return assets) which stand in stark contrast to its extra-ordinarily low household spending of 36% of GDP.

They also claim that internally the Government favors businesses and discriminates against its own workers. This is evidenced by the poor working conditions, low wages and almost non-existent social safety net. In contrast, businesses benefit by their low cost of labor and subsidized inputs.

Critics are right to argue that while Beijing buys billions of dollars (with its attendant cost of carrying) to manipulate the renminbi's exchange rate and favor exporters, it is loath to spend small amounts to increase the purchasing power of the vast majority of its citizens. Such policies are unsustainable and forces China into problems externally and internally.

It is these imbalances that the 12th Five Year Plan seeks to atleast partially address. It is estimated that these measures would raise household spending to a range of 42-45% GDP by 2015 from 36% now. One of the biggest components of this plan is the proposal to build 10 million affordable homes this year and 36 million units (enough to house the combined populations of France, Australia and Canada) over the five year period. As the Times writes, "In theory, millions of Chinese will no longer have to save for an exorbitant, market-priced home, leaving more spending money in their pockets."

The Plan also contains proposals to gradually raise the proportion of national income going to labor,broadening pension and health insurance coverage, especiaally in private sector, and lowering taxes. Social outlays are projected to increase by 14% this year. Among the reforms will be tax policies aimed at boosting rural purchasing power, measures to broaden rural land ownership, and technology-led programs to raise agricultural productivity. Stephen Roach of Morgan Stanley Asia claims that it could "spark the greatest consumption story in modern history".

Apart from providing housing, this will also help sustain China's voracious appetite for cement, steel, copper, and other commodities, and also prop up its spectacular investment rate of 48% of GDP. The overall boost to the economy from the wealth effect and resultant increased purchasing power of especially the nearly 50% of Chinese living in cities, could provide a powerful boost to the economy. Given the scale associated with China, it could easily help replace exports as the new growth locomotive for China's economic growth.

And all this could have a salutary effect on China's external policy and the larger issue of global macroeconomic imbalances. It would reduce Beijing's incentives to indulge in aggressive currency manipulation. More importantly, it would focus the Government's energies on improving the internal vibrancy and breadth of the Chinese economy. And for China's trading partners, it could provide a double boost - fairer competition with Chinese exporters and the alluring prospect of accessing the massive Chinese domestic market.

While these are far from adequate, they are a belated and welcome acknowledgement of a fundamental challenge facing the Chinese economy. And given the reputation of policy makers in Beijing to execute once the agenda is set, it is not out of place to expect these targets to be easily met and exceeded. The Chinese consumer, it appears, may finally be woken up! Are policy makers in New Delhi listening?

No comments: