Putting Reform On The Backfoot

Lewis Wan, Chairman and Chief Investment Officer, The Pride Group

Lewis Wan, Chairman and Chief Investment Officer, The Pride Group

China, as the world’s second largest country by GDP, generates a substantial impact on global markets. The China story that investors were buying into was the upgrading and marketization of the economy, which might display more sustainable development ahead. However, the government’s reform plans might now have to be put on hold, with their efforts focusing on the volatility of the capital markets. Lewis Wan, Chairman and Chief Investment Officer at the Pride Group

The detour forced out of the market

Although China’s GDP beat expectations and stood at 7% in Q2, its exports dropped 8.3% in July. Despite the effort to change to a consumption-led economy, exports still make up more than 20% of the growth. Lewis Wan, Chairman and Chief Investment Officer at the Pride Group believes the PBoC’s action to devaluate the yuan is a response to the fasterthan- expected economic deterioration. “The deceleration is larger than the government’s expectation,” he says. “And it forces them to put exports maintenance as one of the top priorities. By lowering the value of the currency, it is hoped that exports can gain competitiveness in the global market.”

With the focus now back to enhancing exports, the change towards a consumptionled economy might slow down. “The structural reform on the GDP composition faces more difficulties now with the plunge in the equities market. I still can’t think of how the government can turn it around,” says Wan. “And so it is logical to boost competitiveness in exports first at this time.”

Other than the devaluation, the PBoC has announced the 5th rate cut since November lowering the one-year lending rate by 25 basis points to 4.6% and the required reserve ratio also drops 50 basis points. Wan thinks there is solid ground for the government to go back to conventional methods for stimulation, given the proven results in the past. “Given the weaker-than-expected economic prospects and the low rate of inflation, I do not see why the government should not be pulling out the policies,” he says. “Although the measures might bypass the long-term plans of reform for now, they have proven results. And I believe the government will do it two more times this year.”

Some reforms will have to be on hold until market confidence is back. One example is the implementation of the Shenzhen-Hong Kong Stock Connect. After the launch of the pilot Shanghai-Hong Kong Stock Connect, there was already speculation of the speeding up of the unveiling of the Shenzhen scheme, earliest in September this year. However, it is very likely for the government to wait until the market stabilizes before the scheme kicks in.

Another is the reform in IPO regulations. Wan says this wait might even be longer as the IPO market is totally closed after the market plummet. The planning of the reform will only be implemented after the smooth reopening of the IPO market.

Things are also speeding up

However, not all reforms will be delayed. Wan forecasts more speedy reform for RMB, now that the government is still fighting to join the Special Drawing Rights. The PBoC has emphasized that the sharp mark down of the yuan midpoint is a one-off policy, but speculation remains that the Bank would adopt similar measures in the future. “The RMB market has to be further opened up to be like its international counterparts in order to join the SDR,” says Wan. “The PBoC would at least implement policies to close the gap between the onshore and offshore prices as the first step.”

Challenges ahead

China is now facing three substantial challenges. First, economic growth is slowing down. “We used to use this Chinese saying ‘eight and nine are going to be followed by ten’ because we were expecting China’s GDP to be above 8%,” he recalls. “But now, we use another saying ‘seven go up, eight come down’ because it has slowed down to this level.”

This together with the market volatility creates the other challenge – if a consumption-led economy will be possible in the near future. “The general public in China faces three main issues in their lives, including difficulties having access to education, medical services and properties,” he says. “And if these things are not settled, how do you expect people to spend more?”

To have full access to schools and hospitals in the cities at subsidized urban rates, residents must have an urban ” hukou ” (a household registration that gives people an account to claim benefits from the local government). It is very difficult to change the ” hukou ” and only 36% of China’s total population is urban hukou holder. With the migration of people from rural to urban but not their ” hukou ” s, they have to save up for education, medical and other welfare and are conservative at spending. Reforms are now in place to sever the link between hukou and welfare entitlement so that long-term residents will have equal access to social services and welfare. The government is also lowering taxes and raising the minimum wage to drive consumption.

Don’t lose confidence

Wan tells BENCHMARK he was skeptical about the reforms before the Xi-Li administration, but has now U-turned. One reason is that he sees their willingness to break past practices, sighting the example of the conviction Zhou Yungkang, a former member of the Standing Committee of the Politburo (China’s highest decision-making body). They are also willing to step in to seize the benefits of different stakeholders and break monopolies to support the new economy. “There are thousands of ways you can say Alibaba is doing business which is violating the law, but they won’t take it down. Instead, during a meeting with the company, the government tells chairman Jack Ma that they would make it legal for them to further develop.”

To Wan, the government’s will to break up state-owned enterprises and let private companies lead the economy is another opportunity ahead, given the improvement in efficiency and management. The government would be more accommodative in regulation to provide a more flexible market for the new industries to develop.

“There definitely will be chaos during reforms given the size of the country, but the government will have the legal rules in place when necessary,” he comments. “This is a planned economy after all. The government can use all kinds of administrative means to attain the results once the target is clearly set.” Despite the belief that China is still at the most difficult time of reform, Wan has confidence in the Chinese economy and investment market ahead. BM