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China's grand makeover plan a work in progress; fuzzy on implementation

People walk along a busy street at Pudong financial district in Shanghai, March 27, 2013. REUTERS/Carlos Barria
People walk along a busy street at Pudong financial district in Shanghai, March 27, 2013. REUTERS/Carlos Barria

By Kevin Yao and Benjamin Kang Lim

BEIJING (Reuters) - China's leaders will lay out plans to transform the world's second-largest economy at a key party meeting in November, leaving the question of how to do it largely unanswered as much of the reform agenda is still a matter of heated internal debate.

People familiar with the discussions say that out of a long list of reforms that the Communist Party's 200-member Central Committee is set to announce, only a mooted financial overhaul has reached a point where there is a plan and a roadmap.

Fiscal, land and residency registration reform - all key ingredients of China's declared goal of boosting its urban population - are the major sticking points as politicians debate how to implement the changes and as they also face resistance from powerful interest groups, such as state-owned monopolies.

Still, the November meeting, the third plenary session of the Communist Party's top body, is being billed as a watershed for China's development, just like one in 1978 when Deng Xiaoping unveiled his historic reforms to open China to the rest of the world or in 1993 when the party endorsed a "socialist" market economy.

"The meeting will deepen reforms in all fronts," said a senior economist with a government think-tank in Beijing, which has been involved in drafting the reform blueprint.

"The focus will be economic reforms - financial reform, tax and fiscal reform, resource pricing reform, and there will be reforms in related areas, such as social welfare and income distribution," said the economist who declined to be identified because discussions of reform plans remain confidential.

The changes will layout how China intends to overhaul the economy to allow greater domestic consumption to drive growth, shifting away from an exports- and investment-led model that Beijing says has run its course after three decades of breakneck expansion.

A major part of that is an urbanization plan aimed at drawing hundreds of millions of Chinese to live in towns and cities. But to do that, China needs to overhaul land and household registration policies that currently make many rural Chinese reluctant to move.

Progress in working out those and other reform details will serve investors and observers as clues on whether and how soon China's promised Great Transition will become a reality.

GOVERNOR'S LOBBYING

Financial reform is further along because it is already a work in progress. China has been gradually relaxing restrictions on the currency and in July freed up bank lending rates.

Thanks to the efforts of China's veteran central bank governor, Zhou Xiaochuan, there is broad support for reforms to help correct economic distortions, such as over-investment at the cost of household consumption, surging local government debt and property bubbles.

"The direction on financial reforms is clear and a consensus has been reached on how to push ahead," said Xu Hongcai, a senior economist at the China Centre for International Economic Exchanges (CCIEE), who is involved in the reform talks.

It is already clear that the next step will be creating a deposit insurance scheme, possibly by the end of this year. That will allow the central bank to free up deposit rates, which are now subject to administrative caps. Beijing worries some smaller lenders could go under as banks compete for deposits under a more open regime, so wants insurance in place first.

Government economists say Premier Li Keqiang has thrown his weight behind a free-trade zone in Shanghai, China's financial center, as a testing ground for opening up financial services to foreign investors and lifting restrictions on the yuan.

There is less clarity about other parts of the reform agenda, which has been in the works since early this year and now is open to feedback from provincial leaders and selected policy advisers.

For example, Finance Minister Lou Jiwei is resisting calls from local governments to give provinces a greater share of revenues, sources close to the ministry say. He is worried they will use the money to fund grandiose schemes rather than much needed public services.

Right now local governments get half of tax and other revenues, but are responsible for more than 80 percent of public spending. The mismatch, together with a relentless pursuit of economic growth by local officials and Beijing's stimulus launched in 2008, has driven many local governments to sell land to developers, fuelling a property frenzy, and rack up over 10 trillion yuan ($1.75 trillion) in debt.

"It will be problematic if they (local governments) embark on a construction spree. So, we need to be cautious," said Sun Gang, a researcher with the Finance Ministry.

To ease the spending burden on local governments, Beijing is willing to assume greater responsibility for spending on social security, healthcare and education and take over expenses on environmental protection and food safety, people familiar with the discussions say.

Some provinces may be allowed to issue bonds to help cover expenses linked to the urbanization push but most indebted local governments will be shut out of the debt market, they say.

To try to remove key obstacles to the urbanization drive, Beijing will loosen the grip on residence registration, or hukou, which prevents migrant workers and their families from getting access to education and social welfare outside of their home village.

Beijing is also pushing land reforms that would allow farmers to sell land when they leave villages. Currently, they cannot sell their land freely and often get a fraction of the market value as compensation from local governments. Many do not leave their farms for fear of land grabs by local governments for development.

Beijing wants to expand a property tax to help cool the red-hot sector, is considering an inheritance tax to help reduce the yawning rich-poor gap and an environmental tax to punish polluters, government sources say.

Political reform and an overhaul of China's state-owned enterprises will be low on the agenda, think-tank sources familiar with the discussions say. Beijing sees reform of state giants - a key pillar of national security and a major employer - as less urgent, analysts say.

Under political reform, Beijing might propose some steps to streamline government administration and crack down on official corruption, the think-tank sources say.

When it comes to reforming China Inc, Beijing prefers an incremental approach of opening up key sectors to private competition. Economists say the approach is flawed though because private firms lack the access to state banks that state firms enjoy.

At the end of the day, government analysts expect Beijing to move slowly and carefully, employing Deng Xiaoping's gradualist formula: "cross the river by feeling the stone".

"The fear is that it could be chaotic if you push changes in all fronts and you may fall off a cliff if you take too big a stride," said Zhang Bin, an economist at the Chinese Academy of Social Sciences (CASS), a government think-tank.

($1=6.12 yuan)

(Editing by Tomasz Janowski and Neil Fullick)

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