This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Mark McFarland, Global Chief Economist at Coutts gives his outlook for China.
After a summer of poor data and fears over insolvent banks, China is back on centre stage for good reasons. Optimism has replaced those fears following the creation of the Shanghai Free Trade Zone in late September and expectations of policy initiatives at this year’s plenary session of the Chinese Communist Party. We believe this once-in-a-decade sitting will accelerate China’s transformation into a dynamic consumer society and could offer long-term investment possibilities.
Shanghai’s new free trade zone (SHFTZ) is the first free trade area on China’s mainland to be legally “offshore”, making China a fully functioning member of the Trans-
Pacific Partnership (TPP). This is expected to create in 2015 a free trade area encompassing almost two-fifths of global gross domestic product (GDP).
The government has yet to release full details on the SHFTZ, but we know three things. First, it is likely China will allow the SHFTZ to be governed by international law for trade purposes. Second, a list of 18 sectors – mostly professional services, telecoms, banking and gaming – will enjoy vastly improved market access. This will apply to both Chinese private investors and foreign firms. Third, banking laws within SHFTZ will be liberalised to create China’s first offshore banking market, with a freely exchangeable renminbi.
This initiative is immensely important for China as the World Bank puts China 91st out of 185 countries on its Doing Business Index – just above Zambia and Guatemala. Starting a business is particularly difficult, although regional figures show Shanghai is already well ahead of its national rivals. Making it easier to start businesses is a key part of creating a dynamic service sector.
Other major reforms are expected to allow rural people to buy and sell land for the first time and have proper documentation to secure property rights. We are also expecting reform of the Hukou passport system, which restricts the movement of people from the countryside to cities. These two policies have far-reaching consequences for business development and accelerating the move from capital-intensive growth towards a more balanced economy.
China’s rural population has never been able to collateralise its land holdings and changes should allow for better documentation and land sales that can only mean two things. First, rural areas on the outskirts of urban centres can now be sold for urbanisation and the sellers can enforce their rights to be paid. Second, small business development and reductions in environmental pollution are more achievable through the enforcement of property rights.
Hukou reform, which is expected to affect over 200 million people, will formalise the rights of people from the countryside to live in cities and work for companies that offer them full social security and welfare protection. Rural people living in cities currently do so illegally. They get poor jobs and are often exploited, which has depressed the productivity of large swathes of China’s working population.
The cost and pace of reform are still unclear. The burden of Hukou reform – a higher cost structure per worker – will probably be shared between companies and the central authorities in Beijing. This will add to costs but the longer term benefits of faster productivity growth are clear.
China can afford to make serious structural changes now: its debt levels are low by developed market standards and it is 15 years away from its population peak. Even if Beijing took on all the impaired lending of banks and the legacy debts of local governments, China’s overall public debt burden would only be 45% of GDP (by IMF estimates), compared to an average of 85% for the 27 countries in Europe.
It’s also easy to understate the impact of SHFTZ on business development, commercial property prices and service provision. There’s no doubt that they, and onshore land reforms, have deeply secular implications stretching out decades. As an illustration of what’s possible, the small town of Shenzhen on the edge of Hong Kong was 30 years
ago transformed into a special economic zone to capture the capitalism of Hong Kong in China. Shenzhen’s GDP is now over half that of Shanghai, China’s premier city.
