What looks like a duck, quacks like a duck, but doesn’t walk like a duck?
A lame duck, of course.
Watch tomorrow’s state of China address and the policies announced by the National People’s Congress to see if Chinese Premier Wen Jiabao fits that description.
My bet is that with Wen and President Hu Jintao both scheduled to step down from their posts atop the Communist Party and to retire from their government positions in 2013 at the end of their ten-year terms, the jockeying over who will replace them has already begun. And that means that Wen doesn’t have the clout he needs to push through the reforms he has repeatedly told the country it needs.
If so, that’s got hefty implications for investors.
Wen made his most recent argument for reform on February 27 when he said that China’s current economic policies are creating increasingly dangerous distortions in China’s economy. A policy that emphasizes investment in manufacturing and growth in exports and that discourages domestic consumption is inflating property and stock prices, and threatens to produce runaway inflation, he said.
Recent government actions, such as subsidies for rural consumers and requirements that banks keep higher reserves, echo Wen’s critique.
But Wen has talked of the need to do much more—and on this front I think he’s likely to be frustrated by opposition from factions inside the Communist Party that profit handsomely from the status quo. The leaders jockeying to replace Wen will be bidding for the support of these factions and will do their best to win that support by blocking any of Wen’s reforms that might hurt those groups.
So, for example, Wen and Hu see the need to close inefficient factories and to shut off their access to cheap loans from local governments that keep technically bankrupt businesses in operation. They’d also like to rein in loans to state-owned companies that aren’t invested in the business but are instead used to speculate in property and stocks.
To fix those problems China needs an effective bankruptcy law, tougher enforcement of environmental and labor laws now on the books, and a thorough overhaul of a tax system that has left local governments dependent on land sales and taxes on industrial production for revenue.
None of those reforms are on the agenda for this year’s National People’s Congress. And in what looks to me like a shot across the bows of reformers, on the day before Wen’s address China’s Ministry of Finance announced plans to sell $29 billion in bonds on behalf of cash-strapped local governments so they can fund infrastructure projects.
Of course, that kind of spending is exactly what Wen has said distorts the economy. And it’s exactly this local government cash that has found its way into the pockets of the big state-owned companies that like the current system just as it is, thank you very much.
China’s local governments are prohibited by law from taking on debt directly. But this kind of bond offering gives them an officially sanctioned way around the prohibition.
You should be able to judge the current state of the race to replace Wen and Hu by watching to see how much emphasis Wen and the National Congress give to plans to crackdown on investment companies set up by local governments to unofficially get around the ban on official local government debt.
And by looking to see if the Congress sets up some kind of schedule for a new national tax system.
My bet is that the National People’s Congress won’t do anything to rock the boat even slightly this year.
That will be a relief to financial markets and to the big Chinese companies that reap the benefits of the current system. You can get easy one-stop exposure to this part of China’s economy in the iShares FTSE/Xinhua China 25 ETF. The exchange-traded fund, which is in Jim’s Watch List https://jubakpicks.com/watch-list/ , is down about 10% from its early January 2010 high. You can place an even more concentrated bet on business as usual by buying the pink-sheet traded ADR of a big industrial construction company such as China Railway Construction (CWYCY). Be aware though that you’ll be giving up liquidity by going down that route. Daily volume for the ETF is around 10 million shares but less than 10,000 for the China Railway ADR.
The only question is When? I’m inclined to buy in the days right after Wen’s address when markets are still focused on his argument for reform and haven’t yet recognized how unlikely any major change will be.
Full disclosure: I own shares of FTSE/Xinhua China 25 ETF in my personal portfolio.
regarding China, I went ahead and took a small position in DGW
Great analysis.
Regardless of the National Congress, China has to move strongly into the electric car field. BYDDF is the leading electric car company in the world and will benefit from policies that grow infrastructure (e- grid) or a domestic market.
THe issue is not that whether the current Chinese leaders want to leave a legacy behind and therefore push for reform, but whether the future leader jockeying for power will let them.
More backround on Jims post:
“China parliament examines growth, living standards”
http://www.reuters.com/article/idUSTRE62219L20100303
ICBC, Bank of China Plan to Slow Lending This Year From Record
http://www.bloomberg.com/apps/news?pid=20601087&sid=aqhBIgumZB3k&pos=7
Wen Warns of Bank Risks, Pledges Property Crackdown (Update1)
http://www.bloomberg.com/apps/news?pid=20601087&sid=akCaCkBYN5yA&pos=1
Alex, 我不大了解. late expo 是甚麼意思?
Chinese tradition never allow a deviate local goverment, even just from this, we can expect some strong action this year, it,s just when. Likely around late expo?
Nice post Jim…
I think that with history of China’s Presidents and Premiers wanting to leave behind a legacy – We might actually see significant reforms from Hu and Wen. If you see Hu’s profile and career over the years, he has been trying to push reforms and modernize both China and the politburo.
I wonder if Jim smiled as he wrote “the Chinese keep technically bankrupt businesses in operation”. If strong countries have no choice but to do this, what does this say for the prospects of weaker countries, such as the good ol USA?
2013 is still a long time away, he’ll out last Obama’s first term.
I have to give you credit Jim. You didn’t pull any punches in that post.
One question I have: How does this bode for China’s exporters? Guessing from what you wrote, I’d say the successful ones will keep going as before.
Another port for FSUMF ?? (But not till 2015)
“Western Australian Government Eyes New Deepwater Port For PilbaraFont”A1:13 AM ET 3/4/10 | Dow Jones
MELBOURNE (Dow Jones)–The Western Australian government said Thursday that it has identified Anketell as the next major deepwater iron ore port for the resource rich Pilbara region amid expectations of continuing booming demand for the commodity.
In a statement, Western Australia Premier Colin Barnett said that Anketell precinct could ultimately include a port with more than 350 million metric tons export capacity, and would be developed to accommodate a range of users and different mineral commodities.
“The strength of WA’s iron ore exports and the growth plans of current users are testing the capacity of the existing Pilbara ports,” Barnett said.
“The Anketell port and industrial precinct will provide opportunities for new exports and processing of iron ore and other minerals.”
The port, which could commence operations by 2015, will be built by a private proponent under agreement with the state government and noted that three significant iron ore projects are potential foundation investors in the new precinct, he said.
Barnett pointed to API Management for its West Pilbara Iron Ore Project, Fortescue Metals Group Ltd. (FMG.AU) for its Solomon project and China Metallurgical Group Corp. for its Cape Lambert Iron Ore Project.
“The government will work with these companies, or an infrastructure provider to develop the project, with plans to commence operations by 2015,” the Premier said.