There were few surprises at China’s lianghui or “Two Sessions” when the two top legislative bodies, the National People’s Congress (NPC) and the Chinese People’s Political Consultative Conference, met to outline the country’s direction for this year. Concepts such as “dual circulation” had been discussed at length by both media and policymakers before the conference held at the Great Hall of the People.
That is not to say that the meetings were a non-event. The Chinese Communist Party (CCP) has imbued the sessions with significance as the beginning of China’s journey to become a “modern socialist economy”. The 14th Five-Year Plan (14FYP), which sets China’s economic direction until 2025, is the first step in China’s vision of becoming a medium-level developed country in terms of GDP per capita by 2035.
“The period covered by the 14FYP will be the first five years in which we embark on a new journey to build China into a modern socialist country in all respects,” explained Premier Li Keqiang as he delivered the government work report on March 5. “We should ... accelerate our efforts to create a new development pattern to promote high-quality development.”
“[President] Xi believes China is in a historic window of opportunity, both for its place in the world and for making transformative domestic shifts,” says Andrew Gilholm, principal and director of the analysis practice for Greater China and North Asia at Control Risks. “This is largely repackaging existing approaches ... but this updated agenda adds renewed political weight and soon some ambitious targets,” he explains.
Sherry Madera, chief industry & government affairs officer at London Stock Exchange Group (LSEG), sees 14FYP as being more responsive to the outside world compared to previous plans. Traditionally, five-year plans have been more tailored towards domestic conditions. This time, initiatives such as dual circulation, she says, are a response to geopolitical tensions with the US and an increasingly “domestic first” economic strategy adopted worldwide.
Managing growth
Perhaps one sign of change has been China’s reluctance to set a hard growth target following Covid-19 recovery. Last year, when its economy tottered from the pandemic, Beijing abandoned its usual practice of setting a growth target. For this year, even as recovery is well underway, the government opted to set a looser target of “over 6%”.
From the perspective of Nick Marro, global trade lead at the Economist Intelligence Unit (EIU), this is a sign of a more flexible fiscal and monetary policy adopted by China. “We see the GDP target more as a sustainable growth indication that China is aiming for than what it is expecting for this year,” says UOB head of research Suan Teck Kin and economist Ho Woei Chen, who expect China to grow by 8.5% this year, from 2.3% last year. This is similar EIU’s projection, which also sees a longer-term growth rate of 4.5% by 2025.
In a sure sign of recovery, China reported thumping GDP growth of 18.3% for the first quarter this year, albeit given the low-base effect from this time last year. But OCBC economist Tommy Xie notes that this comes up to “5% y-o-y on two-year average after adjusting for base effect”, which is still below China’s projected potential growth of 5.8%–6% for the transitional period to 14FYP.
In other aspects, there are suggestions that the Chinese government is maintaining a cautious stance. Fiscal deficit and local government bond issuance targets were set higher than market expectations, hinting at ample reserves of dry powder to counter downside risks. The 2021 fiscal deficit target of around 3.2% of GDP exceeds the market’s expectation of 3.0%. But with Li emphasising the need for the macro leverage ratio to be kept stable in February 2021, Xie warns of limited room for monetary stimulus.
“Beijing will need to manage the risk of slower tapering, leading to potentially overstimulation of the economy,” says Aidan Yao, senior emerging Asia economist at AXA Investment Managers (AXA IM). China, he says, should use any slow withdrawal of fiscal support to safeguard a stabilisation of private sector leverage growth. Resources should be channelled to innovative and green sectors to raise productivity.
But so large is China’s domestic market, says Refinitiv’s Madera, that she is not too worried about its debt levels if domestic consumption rises too. China’s “Go West” strategy, she adds, promises to open up new domestic markets in the west and centre of the country. Financial liberalisation will also see capital inflows into China to tap into this growing consumption, helping Beijing strengthen its balance sheets in ways that countries that already have open capital accounts cannot. Retail sales grew 4.2% y-o-y on a two-year average in 1Q2021.
“We believe, however, the People’s Bank of China (PBOC) and China’s government will not act to slow growth this year given the still uncertain outlook for the pandemic outside China. We also see little reason for the central bank to start lifting its benchmark interest rates when inflation is currently running below 0%,” says Bank of Singapore (BOS) head of investment strategy Eli Lee.
Strength from within
As expected by most analysts, “internal circulation” will take centre stage for China’s future economic direction under China’s “dual circulation” concept. While the strategy does see a commitment to intensifying external drivers of growth, 14FYP defines “internal circulation” as the main part of its strategy for the next five years.
“Beijing has sought for many years to rebalance growth towards domestic consumption, and upgrade domestic industry and technology with ‘Made in China 2025’ and ‘indigenous innovation’ strategies. However, the 14FYP will mandate even greater urgency in the context of weak global demand and increasing US-led pressure on China,” says Gilholm of Control Risks.
Suan and Ho of UOB expect China to place a stronger emphasis on growing domestic demand, strengthening science and technology and pursuing “a high standard of opening up”. Consumption growth, innovation and modernisation of the industrial system will play “an important role” in the 14FYP.
Stung by the US moves, with the overarching power to stop companies from selling critical technologies to China, the country is stepping up its R&D efforts, which will enjoy a budget growth of more than 7% a year, accounting for a higher percentage of GDP than 13FYP.
This bigger commitment to R&D spending, explains the EIU, is intended to break the dominance of advanced economies for core technologies and secure key supply chains from geopolitical uncertainties. Priority sectors include quantum information, AI, integrated circuits and biomedicine & life sciences.
This R&D drive will be state-led, with 14FYP mandating that R&D expenditure for state-owned enterprises (SOEs) should exceed the national average. However, therein lies a problem. “SOEs are not known for their innovation prowess. They are instead known for being relatively cumbersome, not attracting the best talent out there and then kind of struggling to deliver on some of the breakthroughs,” Marro says. Madera adds that SOE reform rarely tops Beijing’s agenda in times of economic stress. Still, China has provided widespread platforms for the private sector to participate in innovation.
Yet Suan says that SOEs are not incapable of innovation. He observes that technologies such as China’s space programmes, satellite systems and even its upcoming push into commercial aircraft have been SOE-led. Such innovations, he says, will “trickle down” into the private sector, creating new commercial opportunities for businesses.
Opening the economy
China is also looking to further open up its economy. 14FYP aims to increase the overall quantity and diversity in the supply of goods and services, with authorities looking to cut import tariffs on certain consumer goods while supporting the development of cross-border e-commerce and duty-free shopping. Beijing also plans to ease restrictions on cross-border payments and foreign investments in services like medicine, care for the elderly, tourism and sports.
China has also committed to cutting its negative list for foreign investment while formulating a negative list for cross-border trade in services. It is also looking to develop free trade zones like the Hainan Free Trade Port. Beijing also reaffirmed its intention to consider joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).
“My view is that this is RMB internationalisation 2.0,” Madera says. Commerzbank’s 2021 RMB survey of 220 clients in Europe doing business in Asia found that 57% of large companies generate invoices in RMB. Yu Song, chief China economist at the BlackRock Investment Institute, believes that Beijing is more focused on strengthening the economic fundamentals that make the RMB attractive than pursuing currency internationalisation as an end in itself.
Combining self-reliance and free trade may initially appear to be a contradiction. “[China] wants to increase industrial self-reliance including with import substitution, but also wants to retain foreign investment, and position China as a defender of stable trade and multilateralism,” muses Gilholm of Control Risks. He sees policymakers potentially struggling to reconcile these goals.
Yet Suan of UOB notes that the relationship between “internal circulation” and “external circulation” is one of interaction rather than competition. China’s tech industry, for instance, will still require foreign semiconductors to produce even as it seeks to grow its own domestic chip industry. The success of China’s increasing domestic self-reliance is therefore in some ways dependent on its continued engagement with global markets.
China’s new look
14FYP is also looking to change the landscape of China as well. Under its “New Urbanisation” initiative, Beijing is looking to raise its urbanisation ratio to 65% by 2025. China’s current urbanisation ratio of 61% is considered to be relatively low, compared to Japan’s ratio of 77% in the early 1990s when the demographic tide began to turn.
“China’s next phase of urbanisation [will] be a key pillar to mitigate structural challenges of an ageing population and deglobalisation over the next decade,” says Morgan Stanley economist Robin Xing and team. The aim is to make cities faster, safer, greener and more livable so that more people can live there, unlocking untapped labour productivity and consumer demand.
The hukou residency system is expected to be reformed to develop a uniform national market, breaking down barriers between provinces and easing the movement of people to improve talent and consumption pools. But with the target for urban population increase being a relatively conservative 4%, any economic impact is likely to be incremental for now.
Yet EIU warns that the downside of such a policy is greater inequality between regions. Most of the benefits from this policy will likely be felt in urban rather than rural areas as more rural residents move to the cities. The Greater Bay Area encompassing Guangdong, Hong Kong and Macau, and metropolitan areas in central China are seen to benefit most.
Sustainability is another pillar of 14FYP. Four of the plan’s 20 indicators on economic and social developments are related to energy and climate change including half of the “binding targets”. Beijing aims to cut energy consumption and carbon dioxide emissions per unit of GDP by 13.5% and 18% respectively and build new sustainable energy infrastructure nationwide.
Critics lament that some of the targets and China’s proposed carbon emission cap are either too vague or too conservative. But Dr Yang Fuqiang, a researcher at the Institute of Clean Energy at Peking University, tells Carbon Brief this reflects the Beijing’s desire not to “overpromise” for its targets, which China has a good track record of surpassing.
Chinese officials maintain that further details are forthcoming in regional and sector-specific plans and further Ministry of Ecology and Environment targets.
Amid global uncertainty, premier Li struck a confident note of the future. “In 2021, China will continue to face many development risks and challenges, but the economic fundamentals that will sustain long-term growth remain unchanged. We should stay confident, meet challenges head-on, and consolidate the foundation for economic recovery to ensure sustained and healthy economic and social development,” he told the NPC.
Source: OCBC Treasury Research
