China to push ahead with reforms

New pilot tax-deferred pension scheme to launch in selected cities 8211; regulator

Govt economist says growth target achievable

China8217;s top financial policymakers expressed determination on Friday to push on with their campaign to reform and rebalance the world8217;s second-largest economy even as growth cools.

Manufacturing activity in China8217;s second-biggest economy has slowed for the past eight months,prompting expectations that regulators could dramatically loosen monetary and fiscal policies to spur the economy,as they did during the last global downturn.

However,top officials who spoke at a financial forum in Shanghai indicated they will maintain the current prudent policy mix,while continuing with reform.

We will forcefully push ahead financial reforms and innovations to promote cohesive development in the economy and the financial industry,central bank governor Zhou Xiaochuan said.

The People8217;s Bank of China will stick to the reforms in interest rates,currency rate and cross-border use of yuan,he added.

REFORMS

China will also expand the financing channels available to banks,allowing them to raise funds overseas and retain higher levels of profit,Shang Fulin,chairman of the China Banking Regulatory Commission,said at the same forum.

The banking regulator is also studying the possibility of letting banks issue preferred shares,he added.

Chinese banks have been in the spotlight in the past year with investors worried that a slowing economy may increase losses from bad loans,especially after the banks loaned some 10.7 trillion yuan 1.68 trillion to local governments following the 2008/09 financial crisis.

Guo Shuqing,the top securities regulator,criticized Chinese and European companies for overdependence on bank finance. He credited the role direct financing 8211; including bond and equity issuances 8211; played in supporting companies in the US and the UK throughout the downturn.

Guo has been working to upgrade China8217;s equity and bond markets but so far the stock markets have not responded positively to the winds of regulatory change. The benchmark Shanghai Composite Index is virtually flat for 2012,after falling for two consecutive years.

Nearly all these reforms,such as boosting institutional investment,are long-term positive factors,and will not immediately push large amount of money into the market,said Cao Xuefeng,head of research at Huaxi Securities in Chengdu.

Early economic indicators suggest growth did not pick up in June,raising doubts over whether China can meet its 2012 growth target of 7.5 per cent,a level many thought the economy would comfortably exceed when it was announced in March.

Jia Kang,chief researcher at the finance ministry,said on Thursday that the economy should stabilise in the third quarter and that the government was confident it could meet its growth target for the year.

DIFFERENT APPROACH

The reform push led by the central bank and other financial watchdogs represents a change in approach by Beijing from the last crisis.

To offset the effects of the global downturn that began in 2008,China unleashed a wave of policy lending,infrastructure spending and other fiscal stimulus. It successfully revived growth but exacerbated existing structural economic distortions,encouraging real estate and stock speculation and enabling local governments to incur the 1.68 trillion pile of debt.

This time around,as global markets sputter and domestic growth slows again,reformers led by Premier Wen Jiabao,Zhou Xiaochuan and Guo Shuqing have seized the opportunity to make deep changes to the way the Chinese economy works.

The government is still aware of the need to maintain short-term growth,and has taken some steps to inject liquidity,including reducing bank reserve requirements three times and cutting interest rates once.

However,economists told Reuters that Beijing8217;s ability to stimulate the economy through another massive stimulus programme is more constrained this time around given the existing debt overhang.

Chinese economic,financial reforms in the pipeline

Chinese reformers have seized the current economic downturn as an opportunity to make deep changes to the way the Chinese economy works.

In the last six months they have pushed through a laundry list of regulatory modifications affecting nearly every aspect of China8217;s financial system. More are in the pipeline.

Following are details of key reforms being contemplated,and their potential barriers. Timeframes below reflect market expectations:

REFORM: Interest-rate liberalisation

IMPACT: A phase-out of government control over interest rates would enable market forces to play a greater role in capital allocation,bolstering long-term growth as capital flows to the most dynamic sectors of the economy.

Such reform would also aid the re-balancing of China8217;s economy towards consumption,as higher bank deposit rates would give households more spending power,while higher lending rates would reduce excess investment.

BARRIER: The big state-owned banks profit massively from the guaranteed spread between lending and deposit rates. State industrial firms also benefit from access to cheap capital. These groups are likely to oppose fundamental reform.

China also needs to put in place a deposit insurance system to protect depositors from losses caused by banking failures.

STATUS: Top central bank officials have said the time is ripe for interest rate reform and that the government has a timeline for implementation.

Premier Wen Jiabao has criticized monopoly profits by large banks.

TIMEFRAME: China took a first small step toward reform when it marginally increased the flexibility of deposit and lending rates in July last year.

REFORM: Open up monopoly sectors to private investment

IMPACT: Allowing private firms to pour money into the railways,banking,energy and healthcare sectors will be a boost for the economy at a time that the government is shunning fresh fiscal stimulus. The potentially lucrative services sectors could help hard-pressed private firms shift from low-end industries.

STATUS: State-owned firms have staged a come-back as they received the bulk of Beijing8217;s massive spending during the 2008/09 global crisis,sparking criticism that the state advances and the private sector retreats.

The government has launched a fresh bid to open up key sectors dominated by state giants under the so-called New 36-Clauses,following repeated failures since 2005.

The National Development and Reform Commission NDRC,the country8217;s top planning agency,is drafting detailed rules. But analysts doubt the reform will take off.

BARRIER: State industrial giants have long enjoyed favourable positions,reflected by hefty profits even during the economic downturn,and they are reluctant to see more competition.

TIMEFRAME: The NDRC has pledged to publish details of the New 36-Clauses,but how quickly they will be implemented remain questionable given the stiff resistance of state giants.

REFORM: Hukou residence permit reform

IMPACT: City dwellers topped 50 per cent of the population for the first time last year but Beijing cannot unlock the potential of urbanisation unless it reforms the hukou system to turn migration into permanent city settlement.

STATUS: The government has been treading cautiously in overhauling the hukou system with experiments in smaller cities. The system,which dates back to the early days of the People8217;s Republic,prevents people from moving freely to find work,resulting in millions of migrant workers who do not qualify for healthcare,schooling for their children or other necessities.

Some analysts blame the system for persistent labour shortages in coastal provinces,which fuel wage rises.

BARRIER: Chinese leaders fear a sudden influx of peasants into big cities could undermine social stability and create slums that plague other developing countries. The system helps enforce economic policies,such as in the present property measures which stipulate that in Beijing,families that already own one or more homes can only buy one more. Those who do not own any,can buy two.

TIMELINE: Unclear

REFORM: Capital-account opening

IMPACT: Liberalisation of China8217;s capital account would allow foreign investors greater opportunity to invest in mainland capital markets and Chinese investors the option to invest overseas. Capital allocation would become more efficient as Chinese financial institutions are forced to compete for funds with overseas counterparts.

Such liberalisation would also add to pressure for interest- and exchange-rate reform,as large cross-border capital flows make tight control of these rates difficult to maintain.

STATUS: China8217;s central bank this year released a report outlining a potential roadmap to capital account reform ending with full convertibility of the yuan. But it is unclear if other parts of the government support the plan.

BARRIER: Authorities believe that capital controls protected the Chinese economy from the volatile international capital flows that devastated its Asian neighbors during the 1997-98 Asian financial crisis and again during the 2008-09 global financial crisis.

TIMEFRAME: Gradual reforms over the next 3-8 years.

REFORM: Bond market reform

IMPACT: A more developed bond market 8211; in combination with interest rate reform 8211; would contribute to more efficient capital allocation,ultimately leading to faster,more sustainable economic growth. It would also help to reduce the current concentration of financial risk in the banking system.

The high-yield bond market,which was launched earlier this month,should widen credit channels for small,private firms now largely shut out of China8217;s state-dominated financial system.

STATUS: China8217;s bond market development is hindered by the fragmentation of the market. Different regulators oversee different types of bonds,which also trade in different markets. However,the central bank has indicated some progress towards greater coordination among regulators.

BARRIER: Bureaucratic turf battles have prevented the unification of China8217;s two main bond markets and the establishment of a single set of regulations governing new issuances.

TIMEFRAME: Unification of the regulatory structure appears stalled.

REFORM: Exchange rate reform

IMPACT: China has pledged to make the yuan exchange rate more market-oriented. Officials announced earlier this week plans for a test zone for the currency8217;s convertibility in Shenzhen.

In April,the central bank widened the yuan8217;s daily trading band against the dollar to 1 per cent on either side of the central bank8217;s daily midpoint fixing,from 0.5 per cent.

BARRIERS: Some government officials worry a freely-traded yuan will destabilise the country8217;s financial system and its economy unless such a move is fully prepared for.

TIMEFRAME: Full convertibility expected in five to 10 years.

REFORM: Equity listings by overseas companies

IMPACT: Shanghai8217;s stock exchange is considering launching an international board that will allow foreign companies and red-chip Chinese companies those incorporated and listed overseas to list and give Chinese investors direct access to foreign firms8217; shares.

BARRIER: This measure is closely linked to capital-account and exchange-rate reform. Regulators are still working out which currency the shares would be denominated in,and currency conversion restrictions would have to be revised to enable foreign companies to transfer capital raised in China for use in other countries.

TIMETABLE: 1-2 years

REFORM: Fiscal reform

IMPACT: A revised tax system would enable local governments to finance their increased social spending obligations 8211; including health care,education,pensions,and low-cost housing 8211; without relying on land sales and fiscal transfers from the central government. A property valuation or transaction tax would also help to reduce over-investment in property.

BARRIERS: The central government may be reluctant to cede revenue to local governments.

Property developers and current homeowners oppose new property taxes,which could bring down the value of their assets.

STATUS: Property-tax trials are already underway in Shanghai and Chongqing and may soon expand to Guangzhou and Nanjing.

The cities of Shanghai and Shenzhen and the provinces of Guangdong and Zhejiang became the first local governments to issue local government bonds in late 2011,and the Ministry of Finance expanded the quota for local-government bond issuance for 2012 to 250 billion yuan 39.6 billion.

Xinhua news agency reported earlier this week the new budget law will not include a provision to ease restrictions on bond issuance by local governments,casting doubt on the future of the pilot programme.

TIMEFRAME: This year for expanded property tax trial. Unknown for broader fiscal reform.

REFORM: Financial and commodity derivatives

IMPACT: China is considering launching a slew of new financial derivatives linked to the yuan8217;s exchange rate,foreign currencies,international bonds and Chinese bank interest rates.

Simulated trading of government-bond futures is already underway on the Shanghai-based China Financial Futures Exchange.

Regulators have also said they will gradually open up the country8217;s commodity exchanges to allow foreign investors to trade on its active copper,aluminium and rebar futures.

Plans by various commodity exchanges to launch new products,such as crude oil and carbon,would also depend on regulators8217; approval.

Plans for crude oil futures on the Shanghai exchange are completed and industry participants say the contract may be the second commodity futures,after gold,to allow foreign investors. The proposal is now awaiting regulators8217; approval.

BARRIERS: Concern about out-of-control speculation lingers as a government bond futures trading scandal in 1995 is still fresh in the minds of many officials and traders.

Such fears are supported by the fact that China8217;s tightly controlled interest and exchange rates have offered domestic financial institutions little experience managing related risks.

TIME FRAME: Individual products will be launched gradually.

REFORM: Tweaks to resource pricing,taxes

IMPACT: The National Development and Reform Commission NDRC has said it will press on to accelerate reforms to its energy pricing system,which aims to have domestic fuel and gas prices be closer in line with international rates. Such reforms would likely lead to more frequent changes in retail fuel and power prices.

The NDRC said it will perfect the fuel pricing mechanism by this year,with media reporting that the Beijing is also studying a trial plan to allow state-owned oil majors to set oil product prices when international crude is set between 40-130 a barrel.

On power,the government has kicked off a tiered power pricing for residential customers in June,which would charge higher prices for heavy users. Analysts expect the tiered pricing system to be gradually extended to industrial users 8211; which account for some 80 per cent of total power use.

BARRIERS: Inflationary pressure could prompt authorities to hold off on introducing reforms that would push up prices in the short term.

TIMEFRAME: Some changes are likely to be enacted by this year.