China 'to focus on reform, openness'

China 'to focus on reform, openness'

CHINA will consider easing restrictions on interest rates and currency conversion as part of a highly-anticipated raft of market reforms that could be unveiled at a key Communist Party meeting this week.

Observers say Beijing's focus at the summit will allow for domestic consumption to power growth, shifting the country's economy away from an export- and investment-led model that is losing steam after three decades of rapid-fire growth.

Unlike more unwieldy issues such as reforming the household registration, or hukou, system, the anticipated financial overhaul has reached a point - with projects like the Shanghai free trade zone (FTZ) already launched - where there is likely to be a road map, they add.

"The main theme (of the summit), if without surprise, is to deepen economic reform and openness," Mr Zhu Haibin, chief China economist at JPMorgan Chase said.

"The aim of financial reform is to remove price distortion in the financial market, such as in interest and exchange rates, and to improve the efficiency of capital allocation within the country and across the border."

Just how to do this will be discussed during the four-day meeting - officially called the third plenary session of the Communist Party Central Committee, or the Third Plenum for short - beginning this Saturday.

Economists say Beijing will likely tackle areas such as liberalising bank deposits and speeding up the development of capital markets. The exact timeline for implementation, however, remain fuzzy.

Bank of America Merrill Lynch China economist Ting Lu said Beijing might try to tackle the debt racked up by local governments, which poses a risk to the stability of the nation's financial system.

This could see Beijing replacing the short-term bank and trust loans of local governments with longer-duration bonds.

These short-term loans, with higher funding costs, have increased loan servicing fees, accelerating the risk in China's debt accumulation.

He expects Beijing to gradually loosen restrictions and eventually allow local governments to issue bonds.

As for the exchange rate regime, the daily trading band of the yuan to the US dollar could be widened by the end of this year, said Mr Zhu.

The establishment of a deposit insurance scheme - a prelude to a gradual freeing up of deposit rates - could also be introduced in the next six to nine months.

On the fiscal front, the central government may allow local governments to keep a bigger share of taxes. Local governments now keep about half of taxes collected and other revenues, but are responsible for more than 80 per cent of public spending.

Beijing may also expand the use of value-added tax in the services sector, replacing the current business tax levied on some industries, which would ease the tax burden on them.

It was at a third plenum 35 years ago that Chinese patriarch Deng Xiaoping shook up the course of China's economy, laying the groundwork that propelled it to second largest in the world.

Mr Deng announced a policy of "gaige kaifang" - or reform and opening up - ending the self-imposed isolation of the Cultural Revolution and exposing the Chinese economy to market forces.

Associate Professor Gu Qingyang of the Lee Kuan Yew School of Public Policy said he believes the upcoming plenum will have as far-reaching an impact as the 1978 one, with a fresh set of measures that can similarly guide China's economic transition for the next 30 years.

But Beijing-based University of International Business and Economics professor Chen Shengjun cautioned that with Mr Li notably absent at the launch of Shanghai's FTZ and little indication of major reforms in the state-owned enterprise (SOE) sector, pro-reform policies are clearly meeting resistance from various groups and the plenum may not achieve as much change as hoped for.

Markets could be disappointed because the new leadership, still in its first year in office, is not yet ready to deliver a comprehensive reform package with specifics on how they can be executed, experts add. Mr Lu said markets might find, in many cases, only very small steps made with future progress "quite uncertain".

He said: "Regarding some truly sensitive and tough areas such as reforming SOEs and breaking barriers to entry to many monopolised sectors, we believe the third plenum could at best pay lip service."

POSSIBLE CHANGES

Liberalising deposit rates

•Capping deposit rates has guaranteed fat profits for big state banks. •Freeing up the rates will subject banks to greater competition, forcing them to pay savers more to retain them, and to manage risk better. •Specific timelines are not expected but some expect it to be completed within three years. Liberalising foreign exchange rates

•An essential step for transforming the yuan into an international currency. The trading band of the yuan to the US dollar may be enlarged by the end of the year. Experts say the yuan will eventually be allowed to float freely.

Easing of capital controls

•Will allow easier investment abroad by Chinese investors. Currency convertibility and capital account liberalisation are expected to proceed gradually and be completed around 2020. Developing a multi-channel financial market

•Local governments could be allowed to sell bonds. Right now, their huge borrowings are largely hidden from view and pose a risk to the financial system's stability. •A new initial public offering (IPO) approval scheme could be announced before the year end to restart the IPO market. Regulators suspended IPOs in October last year due to volatility in the stock market and pledged not to lift the ban until new rules are in place to curb misconduct.

•Other reforms could include allowing foreign firms to list in the A-share market - which covers stocks only traded in onshore China and denominated in yuan - as well as the approval of private banks. International treaties

•Progress towards a bilateral investment treaty with Washington and a similar pact with the European Union could be made as proof of China's intention to further open up its economy.

esthert@sph.com.sg


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