China Plenary Ends, Significance Yet to Be Determined

Nearly every one realized that the Third Plenary session of the Chinese Communist Party was important. It ended today and the local markets closed and yet it will take some time for true significance to be appreciated and operationalized.

The initial official coverage seemed to emphasize the upgrading of market forces. Since the early 1990s, the official slogan was that market should play a "basic" role in the allocation of resources. 

Now the Chinese Communist Party says markets will play a "decisive" role. This is the direction that President Xi had been moving; having talked about allowing the "basic role" of the market have "a greater degree and wider scope".  What it really means in practice has yet to be determined, but it does represent an upgrading of the role of markets in what China calls the "socialist market economic system".  

While it would be tempting to see in this President Xi consolidation of power, it may be too early to conclude that.  Recently, Xi's choice for one of two vice chairman of the Central Military Commission was vetoed.  Similarly, an ally who Xi tried to promote to the top researcher for the Communist Party was rejected.    Some reports have emphasized the behind-the-scenes role of former Presidents Jiang Zemin and Hu Jintao. 

Even though the Communist Party still enjoys a monopoly of power in China, it is not a homogeneous entity and what often appears as gradualism may really be a reflection of compromises between different factions and interest groups.    That said, the gradual increase of market mechanisms seems to be a consensual position.  

More controversial will likely be the second point being emphasized in the initial official press coverage, state administrative reforms.  The official press talks about  the deepening of administrative reforms and using innovative administrative methods to make the government more efficient.  While this sounds encouraging, it is not clear what this will mean in practice.   It could be an intensification of the anti-corruption campaign that has earlier this year seen the arrest on corruption charges of the top regulator of state-owned enterprises, a cabinet level minister.  It could be reducing red tape.  It is not clear that is will include liberalizing land ownership and mobility of people. 

Still the noises seem to be in the right direction, with the precise meaning yet to be determined.  However, the more the central committee unites behind gradual economic reform and government reform, the less it appears inclined for political reform.    President Xi has been unable to the close of labor camps (which his father spent seven years in during the Cultural Revolution) and Nobel Peace Prize winner, Lin Xiaobo has been sentenced to an 11-year prison term for advocating democracy.  Reports suggest at least 100 Tibetan monks have set themselves on fire since 2009. 

Before the real meaning significance of the Third Plenary session is clear, US Treasury Secretary Lew will visit Beijing at the end of this week.  In the Asian Wall Street Journal, Lew calls on China to move quicker toward allowing financial markets determine exchange rates.  For its part the PBOC is continuing to allow a gradual appreciation of the RMB in its daily fixings, from which the dollar is allowed to deviate by 1%. 

In recent discussions with China-based asset managers, many were concerned that the RMB was already at fair value and that further appreciation would jeopardize China's competitiveness.  The RMB has gained a little more than 2.25% against the US dollar this year.  This is more than any of the G10 currencies or emerging Asian currencies have risen against the dollar this year.

The rise of the RMB has done little harm to exports, which were up 5.6% above a year ago levels in October, which is substantially faster than world growth.  A gradual rise in the RMB has other useful purposes,  while the downside is limited by the import intensiveness of China's exports and the low value-added work by Chinese labor.  It may help dampen imported (food and energy) inflation.  It encourages Chinese institutions to think about managing risk when investing offshore.  It may also help keep foreign protectionists at bay.   It may also allow China to keep its options open regarding joining the Trans-Pacific Partnership. 

Chinese investors though do not make the mistake that is common among foreign media in calling the yuan's appreciation a record (Bloomberg's lead in a report today reads:  "China raised the yuan's reference rate to within 0.1% of an all-time high...").  They realize that in the 1994, China had a massive devaluation.  The dollar rose from CNY5.80 to about CNY8.75.  

Since 2005, the RMB has strengthened by about a quarter in nominal terms and even more in real terms (given that Chinese inflation is typically above US inflation).  In 2005, some economists argued that the RMB was 40%  under-valued.  Depending on what one uses for inflation in an economy in which the price mechanism is not always clear, it has likely appreciated by something close to that magnitude.  We suspect further gradual appreciation is likely.  At the current pace, the dollar could be near CNY5.80 again in a couple of years.