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September 9, 2013

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10 things you need to know about Third Plenums

The Third Plenum of the 18th Chinese Communist Party Central Committee will likely meet in November. We expect the meeting, chaired by Party Secretary Xi Jinping, to approve a document laying out the broad principles of China’s next stage of economic reform. Hopes are running high that this document will mark a significant breakthrough in policy across a range of economic issues.

Here, we present 10 things you need to know about third plenums and our thoughts about what the 2013 one will bring. The bottom line: We think the package will be significant, and it should boost medium-term confidence as details are rolled out in the coming months. A document full of old ideas and vague language would disappoint.

1. The Third Plenum is about big-picture economic policy.

The Central Committee is appointed for a five-year term. During that period, it holds a number of meetings, or plenums, at which it discusses and approves big policy decisions. Other plenums deal with areas such as ideology and propaganda, but the third one usually focuses on economics.

In addition to the party secretary reporting on the state of the country and the party’s agenda, the Third Plenum usually approves at least one big document focused on the economy. The document can range into other areas, and these meetings sometimes also approve political, legal and social decisions, which are not always published. The names of these documents do not make the pulse race. For instance, the last Third Plenum, in 2008, passed the “Decision on Some Important Questions in Promoting the Development of Rural Reform.”

Formal preparation of the 2013 Third Plenum document began early this year. This involves a complex drafting process in which hundreds of organizations provide background papers, drafts and comments. Over the summer, at the Beidaihe seaside meetings, the senior leadership may have seen and discussed the economic ideas in a rough draft.

2. This is a party meeting and a party document.

Important decisions are taken by the party leadership, or the Central Committee, from which the Political Bureau is selected, from which the Politburo Standing Committee is chosen. The seven-man standing committee is the key decision-making authority. Drafting of the economics section of the plenary document is coordinated by the Central Economics and Finance Leading Group, a party body beneath the Central Committee. Other sections of the document, such as politics and law, are overseen by other senior party bodies.

Any document approved at the party plenum leads and informs subsequent government policy decisions and plans. It is therefore critical that Party Secretary Xi and Premier Li Keqiang are fully agreed on the goals and strategy. So far, we see ample evidence that they are.

While the process is led by the party, government officials will have been closely involved in preparation work for the document. Many ministries and official bodies, including the People’s Bank of China and the Ministry of Finance, have likely been involved in preparing the report’s economics section. Ministries provide suggested content, and ministers make speeches and comments in the key drafting meetings.

3. Sometimes the Third Plenum is a big deal.

The most-talked-about Third Plenum in China’s history took place in December 1978 and marked the beginning of market reform. The meeting itself passed few concrete resolutions or detailed reforms; its significance lay elsewhere.

In 1976-77, after the Cultural Revolution and Mao Zedong’s death, China’s leadership attempted to reinstate central planning over the economy and thus boost growth.

Targets were drafted, investment targets set, production and price tables prepared. Heavy industry was the focus. Some 120 mega-projects in oil, steel and power were selected to lead the recovery. A massive ramp-up in oil exports was planned to supply the foreign currency needed to pay for imports of project equipment. However, the plan imploded in 1978 when China’s actual oil situation became clear -- it had far fewer oil reserves than had been assumed -- and the high cost of this great investment push bit. The 120 projects were budgeted at US$12 billion; total exports in 1978 were only US$10 billion.

Throughout the year, Deng Xiaoping, whose 1975 economic reform plan was the basis for many of these ideas, criticized the leadership of Premier Hua Guofeng and maneuvered to install his own people in positions of influence. Deng triumphed at the Third Plenum. Premier Hua was effectively demoted, and a new economic reform strategy was determined and approved by the plenum.

Another comrade of Deng’s, Chen Yun, joined the Politburo Standing Committee, took over economic management and chose agriculture, not industry, as his focus. Soon after the plenum, grain procurement prices were raised, communes were quietly disbanded and households were allowed to farm their fields and sell their own produce. It is worth noting that this controversial policy -- allowing farmers to farm their own land -- did not appear in the Third Plenum document, a lesson to which we will return below.

4. Sometimes it is a bit of a letdown.

While the 1978 meeting is celebrated as engendering real change, the Third Plenum of 2003 is seen by many as a fizzle. That plenum, the first under the leadership of Hu Jintao and Wen Jiabao, focused policy on“rebalancing” the economy and on rural development.

The two subsequent five-year terms should not be written off as a lost decade, in our view. There were significant improvements in rural areas during the 2003-13 period, social insurance infrastructure was rebuilt, growth spread inland and a real middle class emerged. However, in contrast to the Jiang Zemin-Zhu Rongji period from 1989-2003, no big institutional reform was achieved.

Instead, China’s growth in the 2000s was generated by the state enterprise, urban housing and WTO reforms of the 1990s. Many of the imbalances identified in the 2003 document worsened. And then there was the 4 trillion yuan stimulus package of 2008-10, which was allowed to continue for too long and compounded many of the economy’s underlying problems.

The reasons why the 2003 Third Plenum failed to engender real change are still being debated. But the likely lessons for the current leadership are that detailed plans are needed to support broad

policy goals, executive bodies such as members of the State Council have to be on board and strong, coordinated party leadership of the agenda is vital.

5. We expect the 2013 Third Plenum to herald significant change.

Which of these two precedents will the November 2013 Third Plenum follow more closely? While we do not expect it to achieve the tectonic shift seen in 1978, we are confident that it will not be the disappointment of 2003. There are several reasons for our confidence:

• Party Secretary Xi and Premier Li appear to agree on economic policy, both seeing the current growth model as unsustainable.

• We believe Xi carries enough weight in the party to push through painful changes. This may not have been true of his predecessor.

• Extensive thought and research have gone into this agenda, with the State Council’s Development Research Center playing a critical role.

• Reformers head some of the most significant ministries, for example Zhou Xiaochuan at the People’s Bank of China, Lou Jiwei at the Ministry of Finance, and Liu He at the National Development and Reform Commission. This should help reduce opposition, though there may be resistance at lower ranks within ministries.

• Local governments are likely to welcome some aspects of the agenda. Many provinces, for instance, are envious of Shanghai’s new regulation-light Free Trade Zone, even if the details of how it will operate are still unknown.

6. We expect broad principles, not detail, in the document.

The Third Plenum is not the place to discuss details, such as the level of the property tax Beijing will implement, how much money should be set aside for urban residency (hukou) reform or which state enterprises will be privatized over the next five years. Such detail will have been discussed in the preparatory stages, and ministries may already have their plans. The People’s Bank of China, for instance, already has State Council approval for interest rate reform. The key to the plenum is laying out clear principles that inform and provide air cover for the policy detail that follows.

This lack of detail may disappoint those expecting breakthroughs they can sink their teeth into. Instead, we expect one or two catchphrases from the document to be highlighted and widely discussed as guidelines for change. One early reported theme is “comprehensive reform.” Analysts will pore over the document to assess how much the market is prioritized over the state. Once the party leadership has spoken, government leaders will be expected to deliver.

7. Government reform may well be the focus in 2013.

“Give me a lever and the right place to stand, and I can move the world.” So said Archimedes, allegedly. We guess that Premier Li would agree.

Based on discussions in Beijing, we believe much of the strategic discussion among reformers in 2012-13 has focused on how to generate self-propelling reforms -- policy changes that generate momentum for other changes to the growth model.

We believe the lever in this case is government reform. We hope the Third Plenum document will include an extended section on this area that deals with the following issues:

• Streamlining government. China has five levels of government, each with their own budgets

and staff. Experiments to reduce these to three -- central, provincial and county -- have been conducted in some 900 counties over the past few years. Zhejiang Province is leading the way.

Streamlining government reduces needless repetition of functions and saves costs. Beijing may press ahead with slowly reducing the budgetary autonomy of prefecture and township governments in other parts of the country, too. Once these budgets are controlled by other parts of the government, wasteful spending should fall. We note with interest what Shandong province is doing in this regard. From this September, the provincial government will allow counties to retain the bulk of new corporate and individual income tax revenues, the Economic Observer reported. Previously, all taxes were shared among the province, prefecture and townships, based on fixed ratios. The idea is to increase fiscal responsibility at the local level, provide funding to pay for local public services such as education and health care and gradually defund the middle tiers of government. Shandong is now run by Guo Shuqing, who worked with Zhou Xiaochuan and Lou Jiwei on reform in the 1980s.

• Re-orienting government functions. The core of this idea, championed by Vice Premier Wang Yang when he worked in Guangdong Province, is to steer the government away from direct intervention in the economy. Premier Li has reportedly already approved several rounds of cancelling requirements for certain approvals and licenses. Opportunities for corruption naturally decline as these powers are scaled back.

• Providing sustainable sources of local fiscal resources. Ensuring that county governments have the funds they need to provide public services may require raising local taxes -- the main idea behind the much-discussed property tax -- and weaning them off their reliance on land sales. Another idea circulating in Beijing is to centralize some of local government current spending responsibilities. It makes sense for Beijing to assume greater responsibility for primary and secondary school spending, for instance. At the very least, the central government should give extra funds to cities to encourage them to integrate rural migrants into their social welfare systems.

• Creating disciplined budgets that ensure money is well spent. China’s government budgets are generally a bit of a mess. They are usually late, always lacking in detail and often unsupervised. Good ideas being discussed include:

§ More detailed and transparent budgets. “Want to issue a local government bond? Let’s see your financials then.”

§ Medium-term fiscal planning so that local governments are forced to budget for future liabilities

§ Government asset audits. We know even less about local government assets than we know about local government debt.

§ Independent assessments of government spending

• Improving evaluation of local cadres. Something has to change here, in our view. Evaluation has to be shifted from spending to outcomes and from infrastructure to the quality of government services.

• Sorting out local government debt, now and in the future. A formal framework for local government debt is likely to be introduced in the next three years, including debt amounts, repayment sources, guarantees and debt-to-equity ratios. The numbers will be collated and monitored by the Ministry of Finance. In the short run, central government officials have made it clear in public comments that they expect local governments to pay off their own debts rather than

being bailed out. Central controls on access to increased credit facilities for infrastructure vehicles, though not waterproof, appear to be having an effect. This stance is already triggering sales of local state assets.

• Finding ways to allow private-sector participation in infrastructure projects.

Instead of building infrastructure through off-balance-sheet vehicles, thought is also being given to how to encourage private firms to build. This would require clear contracts with local governments, bringing officials’ liabilities into the open.

The core idea behind all these measures is to limit administrative involvement in the economy at the local level, reduce government staffing, limit the ability of local governments to become indebted and push more resources towards social spending. All this should promote further change in the growth model.

8. Enterprise reform is still a sensitive subject, and is unlikely to appear explicitly in the plenum document.

The last plenum to trigger serious state-owned enterprise reform took place in 1993. The meeting signed off on the development of a “modern enterprise system,” a phrase that opened the door for private companies to grow, small state firms to be sold, and large SOEs to incorporate, list and get much bigger. The 1993 plenum was critical to re-establishing economic reform momentum after the crackdown of 1989. Under Deng’s watchful eye, Party Secretary Jiang Zemin presented the “Decision on Issues of Building a Socialist Market Economy.” which called for “the market to be a fundamental factor in the disposition of resources under state control.” This marked a clear break from the planned economy and public ownership.

We do not expect SOE reform to be explicitly discussed in the 2013 Third Plenum document. The subject is too sensitive. We think of SOE reform as a Darwinian process rather than something to be prescribed in a document or tackled head-on.

The idea appears to be change the environment in which SOEs operate so that they either adapt or die. Policies like raising utility prices, cracking down on overcapacity by steering banks away from certain sectors, introducing interest rate reform and opening up sectors like rail and health to private-sector competition all change the relatively comfortable environment in which many SOEs operate.

Squeezing local government investment vehicles will force local governments to sell off state assets. A first wave of sales of hotels, malls and office blocks has begun. We expect the second wave to involve industrial assets. Corruption investigations into a wide range of sectors -- pharmaceuticals, petrochemicals and telecoms, for instance -- may open the door for more serious SOE reform.

The likely outcome and the goal of reformers are that SOE reform will be facilitated, quietly and indirectly, by other reforms. The only problem with evolution is that it usually takes ages and the results cannot be predicted.

9. The party secretary sometimes goes travelling before the plenum to highlight his policy priorities.

Rural land reform was the focus of the last plenum in October 2008. In September of that year, Party Secretary Hu Jintao visited Xiaogang Village in Anhui Province. The village was one of the first to introduce the household responsibility system in the late 1970s, under which farmers, in effect, manage their own fields.

Hu told his hosts that their rights to their farmland would “not change for a long time,” and that the party was now encouraging agricultural land to be rented out. The following month, the plenum passed the “Decision on Some Important Questions in Promoting the Development of Rural Reform,” It encouraged land transfers, commercial farming, integration of collectives, integration of rural and urban areas and the extension of urban hukou to rural migrants. This year, there is much talk of allowing the sale and trading of rural “construction” land – or property held by village collectives on which houses are built. One progressive idea is to allow this land to be sold or rented out to residential developers or industry, with payments going directly to farmers.

Party Secretary Xi seems to like to travel, and we expect him to go on a pre-plenum tour this October. He visited Shenzhen in December 2012, clearly linking himself to Deng Xiaoping’s famous pro-reform southern tour of early 1992. Xi called for “no stop in reform, no stop in opening up.” He said, “We should dare to tackle difficulties and venture along dangerous paths to break through barriers to reform presented by ideological differences and vested interests.”

On his October trip, people will be expecting direction on which particular difficulties will be faced at the upcoming Third Plenum, which paths will be chosen and which vested interests are in his firing line.

10. Reform has already begun.

The 2013 Third Plenum shares at least one similarity with the one in 1978: key reforms have already begun. Anti-corruption efforts introduced earlier this year are having a clear impact, administrative approval powers are being limited, some prices are being liberalized and monetary policy has not been significantly loosened in the face of a prolonged slowdown. We think the Third Plenum will act as a catalyst for these trends and put the party’s stamp of approval on many more.


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