China’s Central Bank Faces Policy Redirection By Investigation

THE ANTI-CORRUPTION INVESTIGATION of Fan Yifei, one of the six deputy governors of the People’s Bank of China, may suggest that all does not bode well for the central bank as Xi Jinping starts his second decade of leadership.

Xi has been investigating more than two dozen financial regulators, state banks, insurers and investment funds since last year to assert Party authority over a financial sector that Xi far from trusts. Fan is the most senior of several financial officials detained over the past year.

Fan spent most of his career as a banker with the Construction Bank of China, so there may be skeletons not as deeply buried in his cupboard as he may have thought. Over-closeness of party cadre to private sector business is now deeply out of favour.

Yet there a clues that there may be policy motivations behind his investigation. Earlier this year, the Central Commission for Discipline Inspection, the country’s top graft-buster, criticised the central bank for failing to meet Party objectives.

The central bank’s top leadership has been a stronghold of economic reformers and advocates of internationalisation of the Chinese financial system, a policy direction for which Xi has little instinctive enthusiasm.

The PBOC’s internationally respected governor, Yi Gang, and its party secretary, Guo Shuqing, were removed from the Party’s central committee during the 20th Party Congress last month. That is seen as a prelude to them leaving their positions early next year when senior government jobs get reallocated.

Their replacements are likely to be men who will ensure that the central bank — and the financial sector it regulates — fall into line with Party goals, just as the technology sector has been ‘rectified‘. This Bystander expects to be hearing more about financial inclusion for common prosperity.

Fan’s case is the more interesting because he was the vice-governor responsible for payments and financial technology, which involved overseeing the development of the central banks’ digital currency, the e-CNY or digital yuan. It is an area in which the PBOC has built a substantial lead over other central banks. Fan’s last public appearance, in September, was to announce a further expansion of its trial.

Stability Concerns Will Drive China’s Economy in 2022

THE CENTRAL ECONOMIC WORK CONFERENCE that concluded this week does not appear to have brought anything to suggest other than the controlled slowdown of the economy will continue next year with an emphasis on authorities ensuring financial and social stability. 

That implies a continuing effort to ensure that the private sector aligns with the public interest as defined by the Party and that the efforts to wean the economy off its dependence on the property sector will continue in the drive for more consumption-based, sustainable and inclusive growth.

That, in turn, suggests that the regulatory crackdown will persist for some time, notably in non-SOE-dominated technology sectors. The reining-in of anti-competitive and big-data collection power will go on, and capital-market activity will also continue to be tightly if flexibly regulated. That, at least, is this Bystander’s interpretation of the cryptic mention in the Economic Work Conference of the promise of ‘traffic lights for capital’.

Those may all be measures to tackle the long-term headwinds of rebalancing and decoupling. More immediately, while the economy has rebounded from the worst of the pandemic-related disruption in 2020, it has slowed in the second half of this year due to global economic conditions and policy deleveraging, including cooling the property market.

Slowing exports to the United States and the EU in November indicate choppy waters in international trade that could get rougher if the Omicron variant causes a new wave of disruptive infections. 

Nor has the property crisis gone away. Beleaguered developer Evergrande has been declared in restricted default by the credit rating agency Fitch after the expiry of the grace period for a missed international bond payment. 

Authorities have the administrative and financial resources to prevent it from becoming a systemic risk, but the ‘restructuring’ of Evergrande still has to be managed in a way that ends the implicit guarantee of state bailouts for overextended property developers and their investors but does rescue the individuals and families who have bought their properties, built and unbuilt.

As the property sector accounts for 25-20% of GDP, this inevitably cannot be done without slowing growth. The People’s Bank of China has cut the reserve requirement ratio for banks by 50 basis points to an average of 8.4% to boost lending to generate some stimulus. The central bank offset this by repaying liquidity injections through its medium-term lending facility, indicating its concern about the risks of financial instability.

Signalling that stability is a macroeconomic priority suggests that policy in 2022 will be to continue the orderly management of deleveraging and the slowdown in GDP growth. Unemployment and the associated risk of social unrest, rather than GDP targets, are policymakers’ ultimate concerns. Those will determine the extent to which authorities will tolerate slower growth.

This year, the official GDP growth target is 6%, down from 6.0-6.5% in pre-pandemic 2019. The recommendation by the Chinese Academy of Social Sciences (CASS), the country’s leading research institution, that the government lower its 2022 target to 5% — to allow a ‘focus on promoting reforms and innovation and pushing for high-quality development’ — will be reflective of official intent.

China’s Property Tax Edges Closer But Is Still Distant

IT HAS BEEN a decade since a property tax was piloted in Shanghai and Chongqing. However, on October 23, the National People’s Congress announced that these pilots would be extended to other cities in a five-year test, although details have not been made public.

The decade-long gap is indicative of how much resistance there has been to bringing in a property tax nationally in the meanwhile.

Unaffordable home prices are a significant grievance among the urban middle class, especially for younger members struggling to get on the property ladder. Yet, it is also the primary means of accumulating wealth, particularly for the subset of the middle class who are officials. According to the rating agency Moody’s, property accounts for about 70% to 80% of household wealth in China.

The current five-year plan (2021-25) promises the introduction of a property tax within its term. However, when President Xi Jinping called for a property tax earlier this month, albeit couched in terms of curbing property speculation and limiting excessively high incomes under his ‘common prosperity’ rubric, there was scepticism about whether this latest attempt to introduce it more widely would be any more successful than previous efforts.

A property tax would be instrumental in reforming China’s fiscal model in a way that would support more balanced development and reduce local authorities dependence on land sales to raise revenue — and the associated opportunities for pocket lining by local officials. More than 20% of provincial and municipal government revenue comes from land sales to developers, totalling some $1.3 trillion last year.

A property tax would have to replace that and more. The limited schemes being tested in Shanghai and Chongqing accounted for an estimated 5% of local tax revenue at most last year. Sticking our fiscal finger in the air, we reckon that a national property tax, like property taxes in most countries, would have to extend far beyond the superwealthy to raise the revenue that would be needed.

The political obstacles to a property tax remain high, although arguably the least high of any point in the past decade. For many, officials in particular, it will not be so much the taxes to be handed over to the central government as the disclosures of properties for tax assessment.

There is also the significant risk that, if mismanaged, it would exacerbate the slowdown in the property market triggered by the Evergrande crisis.

There is some headroom for growth to slow and still meet official targets of around 6% growth. Yet, a prolonged or significant slowing of the economy beyond that could cause politically troubling social instability.

The expanded trials of property tax will likely start small and be implemented gradually. Wealthy Zhejiang province has been floated as a possible candidate. Other reports speak of up to 10 cities being selected. First-tier and core second-tier cities would be the most likely to be chosen. What the tax rate would be, what it would be applied to and when it would start has still probably to be argued out. Similarly, what, and more importantly, who gets an exemption or preferential rate.

If Xi throws his weight behind pushing through a property tax, it will be a litmus test of how powerful he is. However, as he has given himself five years for the expanded pilots, we may well know the answer to that by other means by then.

China’s Growth Strong Enough For Now To Allow For Structural Change

CHINA’S ECONOMIC GROWTH is slowing. That much we know. The question is whether it is slowing to the point that policymakers run out of headroom for long-term structural change. 

Despite third-quarter GDP growth coming in at 4.9% year-on-year and showing barely any change, a mere 0.2% increase from the April-May quarter, the answer appears to be not yet. 

Monetary, fiscal and regulatory tightening has kept the pace of recovery measured. This has been further dampened by a combination of disruptions to industrial output, which grew by just 3.1% year-on-year in September, the slowest since Covid-19 hit in early 2020. 

The two most severe disruptions have been localised lockdowns to combat Covid-19 outbreaks and power shortages resulting from central government’s orders to provinces and municipalities to cut carbon emissions in support of national commitments to lowering carbon emissions. 

Similarly, the property sector crisis weighed on growth during the quarter. Private and public sector fixed investment slowed, and housing starts fell for six months to September, the longest run of declines since 2015. Home sales were down 16.9% year=-on-yer in September, following August’ 19.7% decline.

Like power shortages, the troubles of Evergrande and other developers, if brought on in large part by their own expansionism, have been triggered now as a result of policy. 

Deleveraging the property sector is a central part of removing financial risk from the system overall. Lowering house prices is a core pillar of President Xi Jinping’s drive to reduce inequality under the rubric of ‘common prosperity’.

Making progress on both goals and keeping full-year growth on track to be well above the ‘about 6%’ official target will make policymakers comfortable enough that they need not change course. 

Growth for 2021 will probably turn out to be 7-8% as it gets a last hurrah base effect from 2020. As the chart above shows, the third-quarter growth rate was pretty much in line with the quarterly growth rate throughout 2019. The economy has long been managed onto a glide path of slowing growth. 

One signal of policymakers’ confidence that they can maintain course was the statement from the People’s Bank of China last Friday that any contagion from Evergrande to the financial system was controllable. It was surely no coincidence that the central bank broke its silence on the Evergrande crisis ahead of the GDP figures being announced.

Another is the publication by Qiushi, the Party’s leading theoretical journal, of Xi’s August 17 speech to the Central Financial and Economic Affairs Commission on common prosperity. 

This puts in the public realm more detail of what is coming to look like the foundational policy for Xi’s third term and the moral and political case for economic rebalancing for China’s next stage of development.

The emphasis on wealth redistribution, which has already seen a crackdown on the country’s tech billionaires, is clear. More affordable homes will be a big part of that, as will be inescapable taxes on the rich. 

Xi does not want to see the collapse of China’s new middle class or risk the social disintegration that could come with it — along with the inevitable challenge to the Party’s legitimacy to monopoly political rule.

None of this is to say that the challenges of managing the growth transition will be easy, and if anything, it is getting more difficult. Beyond the imminent issues of the power crunch and the property market’s woes, the international economic environment is uncertain, with the downside risks increasing, and the domestic recovery remains unbalanced. 

The structural changes needed to promote domestic consumption over savings, the provision of centralised social welfare services and safety nets, and the concomitant changes to a regressive tax system, including the introduction of property taxes, are also significant policy challenges as they hit many vested interests.

China’s demographics are turning unfavourable faster than anticipated, and the middle-income trap is bearing down. Between them, Trump and Covid-19 have cost Beijing precious years in the race for China to get rich before it gets old. What riches it is creating will have to be more widely shared.

Wealth Redistribution With Chinese Characteristics

TENCENT’S NEW 50 BILLION YUAN ($7.7 billion) ‘common prosperity’ fund — the name is no accident — provides a high-profile template for corporate China’s compliance with President Xi Jinping’s stricture that high-income groups and enterprises return more to society. In his first public appearance since the annual Beidaihe leaders retreat, always a symbolic event, Xi told a meeting of the Central Committee for Financial and Economic Affairs earlier this wee that ‘common prosperity’ is the essential requirement of socialism.

In April, Tencent, which owns the leading social media platform, WeChat, announced a similar-sized fund to support ‘sustainable societal innovation’. Taken together, they suggest that ‘common prosperity’ is more than a slogan and that Xi sees addressing resentment over inequality, which is extreme in China, as the next Party campaign to ensure its monopoly grip on power. 

New taxes on wealth and the superwealthy are likely, eventually. Meanwhile, firms and wealthy individuals will be making similar ‘donations’ to Tencent’s to head off the continuing regulatory assault on business, or worse, asset confiscation, and to put themselves in good political standing.