Cross-posted from Kate Mackenzie at FTAlphaville.
China’s State Council has announced intentions to carry out some potentially quite big reforms. From Bloomberg:
China signaled it will propose plans this year to allow freer flows of its currency in and out of the nation as part of measures to loosen control over the yuan and interest rates.
The plan on yuan capital-account convertibility will also include a way to let individuals make overseas investments, the State Council said in a statement yesterday after a meeting led by Premier Li Keqiang on the focus of economic reforms in 2013. Other measures include improving controls on risks from local- government debt, expanding trials of value-added taxes on companies and pushing forward changes to the country’s household-registration system.
Wow! That’s quite a list. Chinese officials have been talking about a 2015 goal for “full yuan convertibility” since at least late 2011, but many sceptics have noted that this can’t really happen while (for example) the yuan trades within a still-narrow band, or while lending and deposit rates are still tightly controlled.
If these reforms were delivered in full, it would be a big step towards removing the financial repression that has kept Chinese households’ share of economic growth relatively low, which in itself is a key contributor to the imbalanced economy.
And truly reforming the household registration system (hukou) would get rid of many constraints on the effectiveness of China’s urbanisation efforts.
HSBC’s Qu Hongbin and Sun Junwei say this means there’s no need to worry that financial risks (which keep being highlighted by various authorities and most recently, the powerful Politburu Standing Committee) will mean reforms will be put on hold.
Other observers have been impressed, too, but have noted the lack of precise timing given for many of these goals.
Diana Choyleva of Lombard Street Research agrees the statements are a crucial move in the right direction, although she cautions the jury is still out as to whether the plans will be quickly acted upon.
If they are, however, she says the implications will be profound — not just for China, but for the world. Here’s her list of those implications:
China
· China’s short-term growth prospects will be negative, but the medium-term growth prospects will be improved as consumers are much more likely to become an independent growth driver.
· The risk of bank and provincial government financial distress will be brought forward.
Luckily China isn’t over-indebted at present (a separate note will follow outlining our estimates and arguments) which gives the authorities a window, albeit narrow, to clean up the banks and take on the debt.
· The pressure on the yuan will be down as capital outflows are more likely to exceed capital inflows given China’s reform challenge and likely US growth outperformance.
· Domestic interest rates will rise, but this should help the rebalancing towards consumer spending with the bulk of household financial assets in interest-bearing deposits. Corporate defaults, however, will have to be allowed.
· House price inflation will abate, while the equity market will be hit during the worst of the adjustment phase, but the improved growth and profit outlook could then spark a longer bull market run.World
· America’s medium-term growth story remains intact as China re-prices its capital and energy which still supports the re-shoring story.
· It will be positive for the US dollar, US stocks, US real estate and negative for US Treasuries.
· The medium-term commodity outlook, especially metals, remains negative and commodity countries will suffer.
· Europe’s plight unlikely to be improved and could worsen.
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