China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

Winds of Change in China?

November 7, 2012

On November 8, the National Congress of the Communist Party with more than 2000 delegates will start its convention in Beijing and some days later select its next political leadership for – probably – the next decade – a decade that will be much more difficult to surmount than the previous one.

The powerful politburo will almost completely be replaced by new faces, and probably seven/five out of nine/seven individuals of the even much more powerful inner circle Politburo Standing Committee will have the same change, i.e. that only the – most probably – forthcoming Party  Leader  Xi Jinping and future Prime Minister Li Keqiang will keep their seats in this forum of all important decisions (currently considered as number six and seven).

A lot is currently discussed about the future political, social and economic course of Xi Jinping. But this discussion is too simple-minded since the Party Leader is not making decisions on his own. He has to find consensus himself within the Standing Committee which mostly urges for a “middle-of- the-road position”. This line can only be left in extraordinary cases,  like the opening-up policy by Deng Xiaoping almost 35 years ago. Currently, such moves cannot be seen. I still cannot see Xi as a major reformer, neither in political nor in economic terms. But nobody knows what will happen in the next, very challenging 10 years. Not many scenarios can be ruled out completely.

Political challenges

Discussions about future policy and strategic issues were not taken up in the past months  by  the leading candidates for China’s new leadership. However, it seems to be completely clear that domestic issues will have to /should dominate politics in the future. This may concern amoung other areas

–  institutions  (including the fight against corruption and more application of the rule of law)

–  transparency (also an institutional factor)

–  better environment in all respects (quality of food and water included)

–  acceptable minimum social security standards for the whole nation

–  acceptable health care for the whole nation

–  better income distribution.

All post-war leaders had so far their political legitimacy, lately particularly high economic growth and internationalization. In my feeling, the new Chinese leaders will have to look mainly for acceptable growth – which may be closer to 8-9 percent than maximum growth around 10 percent as seen in the past two decades. But such a development will assume that the above-mentioned political challenges will be taken seriously by the new leaders.

Economic challenges

Many of the future economic challenges have a nexus with politics or globalization. Some of them are mentioned below (but have been described more thoroughly by me in earlier pieces).

They are, for example (without ranking):

–  generally: more marketization and transparency (vs political control)

–  modernization of financial markets (institutions such as the stock exchanges and bond markets, instruments, products for savers, supervision, etc)

–  cleaning up the state-owned banks (and make them more transparent)

–  financial deregulation (domestically, cross-border, sequencing)

–  transparency and the creation of sustainable real total government debt (central and local)

–  modernization of monetary policy

–  modernization of exchange rate policy

–  new growth model (higher share of private consumption in relation to GDP)

–  creation of conditions for improvements of corporate productivity and industrial value chain

–  creation of improved conditions for product quality and services

–  decrease of the state-owned corporate sector

–  decline of regional disparities

–  creation of strategies for gradually worsening demographic conditions.

 

This leads us finally to three crucial questions (which cannot be elaborated in this little blog contribution):

–  Can the new Chinese leaders achieve an appropriate way of combining state intervention and marketization?

–  How sustainable are Chinese current account surpluses in the long run?

–  What happens the day when China’s yuan finally achieves the status of a convertible currency (probably not within the next decade – but serious preparations may start during Xi’s leadership)? How will the U.S. and the U.S.dollar react on such a change?

We stay here for today – predicting no  major changes of wind in the foreseeable future. Gradual and smaller steps forward, however, should continue in the next years. Political, social and institutional strategy considerations should gain political momentum in the next decade – maybe somewhat at the expense of economic growth.

 

Hubert Fromlet
Professor of International Economics
Editorial board

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The Rise of China and its Influence on Commodity Prices

October 3, 2012

Commodity price indices had been in a broad decline in real terms since mid-1800s. The falling real price for commodities was the product of ongoing global economic development and demand growth, but also a positive commodity supply response and ongoing increases in productivity and innovation in the use of resources.

Oil prices were an obvious exception in 1970s, with two sharp upward oil price shocks – but oil prices then fell back to earth in the 1980s and 1990s.

What has changed? The principal difference has been the Chinese growth miracle since early 1980s, which has added a new source of global commodity demand beyond the normal growth pattern in industrial countries. Other emerging markets also caught the policy reform wave, saw their sustainable growth rates and incomes rise, and the demand for commodities followed in tandem.

The rise of the middle class in China and a growing number of other emerging markets was thus the core driver of increased commodity demand and in real prices (that is, with the impact of inflation removed) Since the early 2000s, there has been a structural upward shift in the global prices for energy, metals, food and related key inputs like fertilizer.

Recent global economic developments have had a negative feedback effect on many commodity prices. Global turbulence due to the ongoing euro crisis, the slow US recovery, and slower related economic growth in emerging markets has placed downward pressure on commodity prices as global demand slowed. However, although commodity prices in aggregate have declined over the past 18 months, they generally remain well above the levels of a decade ago. There are, of course, differences among the various commodities – pulp, iron ore and natural gas prices are all facing their own special downward forces.

But in general, each time there is a drop in perceived global economic risk, energy and key metals prices (like copper) rise again, which reinforces the strength of the underlying demand for resources from China and other major emerging markets. Commodity prices in aggregate may not return to the highs of 2007 any time soon, and they may even decline a bit in real terms going forward. But they are also unlikely to return to the historic downward path. Structurally higher commodity prices are the new normal, thanks to the rise of the middle class in China and many other emerging markets.

 

 

 

 

Glen Hodgson

Chief Economist, The Conference Board of Canada

 

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How the Euro Connection could Boost Russian Asset Prices

One of today’s puzzles is the low valuation of Russian equities. On average, these cost just 6 times the expected profits of 2012, while Canadian stocks trade at 15 times earnings and Norwegian stocks at 12 times, to mention just the two commodity producing countries which lie in the same climate zone. The message from the price-to-book ratios is similar: if a company is attractive for investors, the ratio should be well above 1. But Russian stocks average only 0.85 whereas Canadian and Norwegian stocks trade at 1.85 and 1.58.

Creating conditions that bring valuations on par with those of other stock markets would do wonders for the country’s spending on capital goods, including foreign direct investment, the growth rate of real GDP and thus for the standard of living.

One way to achieve this is to create an institutional framework similar to that of the democracies of Western Europe. This is just as important as broadening Russia’s production base and reducing its dependency on raw materials. Indeed, a comprehensive and state-of-the-art institutional framework is probably the precondition for that sort of structural change. Economists emphasize more and more the role of institutions in development, such as independent courts, media, regulators and central banks, a fair and efficient tax system, genuine opposition parties which have a reasonable chance to oust the existing government in secret ballots, an incorruptible bureaucracy, good and affordable kindergartens, schools and universities, a well-maintained infrastructure, and so on.

Russia has serious deficiencies in all these areas and pays the price in the form of undervalued equities and real estate. In spite of its enviable endowment with natural resources it is an unnecessarily poor country.

One approach to improve things is to use the European Union’s “Acquis communautaire” as a guide for institutional reform. Norway and Turkey, very successful economies for some years now, have done this – without being members of the EU. The Acquis covers the EU Treaty, the whole body of laws, decrees and guidelines passed by EU institutions as well as the judgments of the European courts. These are binding for all 27 countries, and new members have to fully adopt them. Dauntingly, the complete edition of the text comprises 31 volumes and more than 85,000 pages. Cyprus and Malta have been able to do it, so Russia’s civil service could certainly do it as well.

For years, Russians did not care much about institutional reform. They were able to increase their spending at a higher rate than production, as export prices have outpaced import prices. The general feeling is that the standard of life continues to improve. Since this is not accompanied by political and institutional progress, the rising middle classes are getting restive, demanding a bigger say in the country’s decision making process.

To rely on ever higher commodity prices is not a sustainable growth model in any case – prices will certainly not go up all the time. Every so often they crash and cause havoc in the rest of the economy. The 8 per cent decline of Russian GDP in 2009, the 80 per cent fall of stock prices between mid and end-2008, the 36 per cent depreciation of the rouble against the dollar during that time, and the collapse of the real estate market were direct consequences of the crash of raw material prices, in particular the oil price which imploded from $146 to $35 in just half a year. To this day, markets are not yet back to pre-crisis levels.

If Russia had more robust institutions and took the rule of law seriously, investors would demand lower risk premiums for holding shares of companies and government and corporate bonds – which is another way of saying that asset prices could be much higher, and the cost of capital correspondingly lower. A big increase in capital spending is needed to wean the country from its reliance on commodities. China’s impressive growth model has at its core very high saving and investment ratios. Anything that helps to boost these must have top priority for policy makers. Right now, the value of Russia’s firms that are traded at the stock exchange is about 19 trillion roubles (€465bn).

If the government could credibly show that it will launch an institutional reform process on the basis of EU standards, this number could easily double, cutting the cost of capital expenditures by one half. Perhaps more importantly, Russia would become a more normal country where people like to live, rather than trying to emigrate.

 

 

 

 

 

Dieter Wermuth
Chief Economist & Partner, Wermuth Asset Management

 

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