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CHINA ENTERING A NEW POLITICAL ECONOMY CYCLE The World According to Xi Jinping Thought Citi GPS: Global Perspectives & Solutions December 2017 Citi is one of the world’s largest financial institutions, operating in all major established and emerging markets. Across these world markets, our employees conduct an ongoing multi-disciplinary global conversation – accessing information, analyzing data, developing insights, and formulating advice for our clients. As our premier thought-leadership product, Citi GPS is designed to help our clients navigate the global economy’s most demanding challenges, identify future themes and trends, and help our clients profit in a fast-changing and interconnected world. Citi GPS accesses the best elements of our global conversation and harvests the thought leadership of a wide range of senior professionals across our firm. This is not a research report and does not constitute advice on investments or a solicitation to buy or sell any financial instrument. For more information on Citi GPS, please visit our website at www.citi.com/citigps.
Citi GPS: Global Perspectives & Solutions December 2017 Li-Gang Liu Johanna Chua Chief Economist for China Head of Asia Pacific Economic and Market Analysis +852-2501-2718 | ligang.liu@citi.com +852-2501-2357 | johanna.chua@citi.com Oscar Choi David Lubin Head of China Equity Research Head of Emerging Market Economics +852-2501-2737 | oscar.choi@citi.com +44-20-7986-3302 | david.p.lubin@citi.com Xiaowen Jin Jin-Wook Kim Asian Economics Team Asian Economics Team +852-2501-2766 | xiaowen.jin@citi.com +852-2501-2775 | jinwook.kim@citi.com Tracy Xian Liao Michel Nies Commodities Strategist Emerging Markets Economics Team +852-2501-2799 | tracy.liao@citi.com +44-20-7986-3303 | michel.nies@citi.com Jerry Peng, CFA Xiangrong Yu China Research Team Senior China Economist +852-2501-2462 | jerry.peng@citi.com +852-2501-2754 | xiangrong.yu@citi.com
December 2017 Citi GPS: Global Perspectives & Solutions 3 CHINA ENTERING A NEW POLITICAL ECONOMY CYCLE The World According to Xi Jinping Thought th Kathleen Boyle, CFA With China’s 19 Party Congress now behind us, the primary takeaway is that Global Head & Managing Editor, Citi GPS President Xi Jinping has cemented his role as the most powerful leader in China since President Mao Zedong. This will pave the way for him to extend his term beyond 2022 and put more weight on the economic policies and priorities that he advocates. Given that the ‘China dependence’ of many countries has risen considerably as China has become the largest contributor to global growth (at 40% vs. the U.S. at 16% in 2016), it is important to take a deeper look into the economic policies and initiatives unveiled at the Party Congress. In the report that follows, we outline what was said, examine the implications for Chinese growth based on the policies announced, and also examine the effect of these policies on the rest of the world. Although specific GDP growth targets weren’t mentioned at the Party Congress, the Communist Party of China has repeatedly affirmed its commitment to doubling China’s 2010 GDP and per capita income by 2020, which we estimate would require annual growth of at least 6.3%, which we view as feasible. Economic stability and risk control will continue to be a high priority for China to avoid a hard- landing scenario and maintain a minimum level of acceptable growth no matter the rhetoric. Given the consolidation of political power, we expect more breakthroughs, in industrial upgrading (e.g., Made in China 2025), rural land reforms, second-round urbanization (e.g., the Xiong’an new district, the Yangtze River economic belt, and the Great Bay area), financial reforms and further opening up (e.g., the Belt Road Initiative) as well as environmental protection. We see the accelerated implementation of the ‘Made in China 2025’ initiative leading to China being best-positioned competitively in the communication equipment, advanced railway equipment, aerospace equipment, new energy vehicles and shipbuilding sectors. If the Chinese government is committed to providing significant state resources, even less well-positioned sectors could make rapid inroads. This could create greater competitiveness challenges in other countries who are already significant players in these targeted industries, and hurting countries with a high percentage of their GDP in these targeted industries, particularly countries in Central & Eastern Europe, countries with a large percentage of vehicle production (e.g., Mexico and Germany) and certain Asian countries (i.e., Singapore, Korea, and Thailand). The emphasis on accelerating financial reforms should lead growth in China’s financial markets to the size of U.S. markets by 2025 — a tripling in the size of the bond market to $37.5 trillion, stock market capitalization rising to $31 trillion and banking assets of $68 trillion. In addition, the implementation of the rural vitalization strategy should unlock $20.6 trillion in rural farm wealth. Finally, the new emphasis on environmental issues and top leadership’s determination to solve prominent environmental problems will have an effect on commodities and those countries that export commodities to China. However, combined with the new industrial manufacturing emphasis, there are countries that are both potential winners and losers. © 2017 Citigroup
China’s Reform Policies Implications Have Global Spillover SIX PRIMARY THEMES FROM THE 19TH PARTY CONGRESS 1 2 3 4 5 6 Accelerating Revitalizing Coordinating Reforming Belt and Road Accelerating Industrial the Rural Regional State-Owned Initiative and Financial Upgrading and Sector Development Enterprises and Opening Up Reforms Innovation-Driven and Accelerating Restructuring Development Second-Round SASACs Urbanization SECTORS LIKELY TO RECEIVE THE MOST ATTENTION AND SUPPORT Techno ergy log En ufa Man cturin w Biotech and ed y Bi Ne c g o an ulture Tech Me w Materials Adv hnology ric n Ag Ne dical Tec iq on rn ue Mode i at s Inform © 2017 Citigroup
THE WORLD’S DEPENDENCE ON CHINA HAS INCREASED China contributed 1 percentage point to global GDP growth, more than 40% of the total China’s share of goods exported has risen substantially and is now over 20% in 5 countries Taiwan 2014 - 2016 37% Australia 2000 - 2002 32% Chile Korea 26% 25% Peru 21% 19% 12% 6% 6% 7% CHINA’S NEW FOCUS ON ADVANCED MANUFACTURING WILL CREATE CHALLENGES IN CENTRAL AND EASTERN EUROPEAN AND ASIAN COUNTRIES WHO ARE ALREADY SIGNIFICANT PLAYERS IN INDUSTRIES TARGETED BY CHINA Region/Country Affected (% of GDP in targeted industries) Central and Asia Eastern Europe SK SG 40% 37% CZ HU 27% 27% BG TW 22% 22% MY KR 15% 14%
6 Citi GPS: Global Perspectives & Solutions December 2017 Contents China Entering a New Political Economy Cycle 7 “New Era” and Policy Priorities — Growth Still Matters 12 Key Economic Themes 13 Financial Markets Opening Quickens 28 Shifting Towards a New Sequencing Strategy 28 Bond Market Opening Is Instrumental in Accelerating Financial Market Development 28 A More Modest Path for Equity Market Liberalization 29 How Large Could China’s Financial Markets Be in 2025? 30 Implications for Capital Inflows 30 What This Means for the Rest of the World 32 China-Specific Reform Policies that Impact ROW Primary via an Impact on China’s Growth 32 Mapping China-Specific Reforms to the Rest of the World 33 China Reform Policies that Impact ROW that goes beyond its impact on China’s Growth 35 On Global China Dependence 40 Commodities – Low Spare Capacity and High Price Volatility Could be the ‘New Normal’ 44 Chinese Commodities Demand Should Stay Supported and Supply-Side Reforms Might Generate Higher Price Volatility 44 The "War on Pollution" Looms Large 45 Exports of Semi-Processed Manufacturing Goods are Set to Fall 48 China Equities: What Caught Our Eyes 49 New Bottom Lines 49 Innovation and Industrial Upgrade 49 Rural Area and Cities 50 © 2017 Citigroup
December 2017 Citi GPS: Global Perspectives & Solutions 7 China Entering a New Political Economy Cycle Li-Gang Liu The once-in-five-years pivotal event for China – the 19th Party Congress – is now Chief Economist for China past us and the primary takeaway is that President Xi Jinping has cemented his role as the most powerful leader in China since President Mao Zedong. This will pave Xiangrong Yu the way for him to extend his term beyond 2022 and throw his weight behind the Senior China Economist economic policies and priorities that he advocates. In this report, we dissect the th political appointments and public statements surrounding the 19 Party Congress to Xiaowen Jin assess what the event means economically and politically for China and the rest of Asian Economics Team the world. China’s Greater Centralization of Power Under President Xi President Xi has now secured his status as China’s most powerful leader since President Mao. The most important indication of his increased power is the appointment of five new like-minded members of the Politburo Standing Committee (PSC), none of whom are in their 50s, which would suggest there are no apparent heirs to President Xi, assuming the age-limit rules are upheld (which is likely given the time-honored age-limit rule known as quishang baxia, or “in at 67, out at 68”, was honored with the announcement of the new Central Committee members during the Party Congress). The new Politburo Standing Committee members — Li Zhanshu (67, rank 3), Wang Yang (62, rank 4), Wang Huning (62, rank 5), Zhao Leji (60, rank 6) and Han Zheng (63, rank 7) — were all selected from the group of 25 Politburo members announced at the 18th Party Congress. This opens the door for President Xi to stay on beyond 2022 after completing his upcoming 5-year term. Figure 1. Politburo Standing Committee — Members of the 19th Party Congress Name Xi Jinping Li Keqiang Li Zhanshu Wang Yang Wang Huning Zhao Leji Han Zheng Rank 1 2 3 4 5 6 7 Birth Date 15-Jun-53 1-Jul-55 30-Aug-50 12-Mar-55 6-Oct-55 8-Mar-57 1-Apr-54 President, Premier of the Chairman of the Chairman of the First-ranking Secretary of the First Vive Premier Chairman of the State Council Standing National Secretary of the Central of the State PRC Central Committee of the Committee of the Central Secretariat Commission for Council Official Military NPC Chinese People's of the CPC, Discipline Title Commission Political President of the Inspection Consultative CPC Central Party Conference School Secretary of the Vice Premier of the Director of the Secretary of the Party Secretary of Previous CCP Central State Council Policy Research CCP Central Shanghai Position Secretariat, Chief Office of the CCP Secretariat, Head before of the General Central Committee of the CCP Joining Office of the Organization the PSC Communist Party Department of China Photo Note: Official titles highlighted in red are Citi’s predictions, as the official announcement will not be released until next year’s NPC meeting. Source: Baidu, Wiki and Citi Research © 2017 Citigroup
8 Citi GPS: Global Perspectives & Solutions December 2017 While an age-limit rule for leaders has been honored by the current Party Congress, the term-limit rule for the governing Communist Party of China (CPC) top leadership transition may be under revision during the next five years. This term-limit was written into China’s Constitution and allows for one government to have two five- year terms. Although there is no explicit term requirement for the General Secretary of the Party under the Party Constitution, the term-limit from China’s Constitution regarding the General Secretary’s tenure has been followed in the last twenty years. Given the PSC appointments that were announced, we think there are two possibilities that could unfold. This first option is for President Xi to remain as Party General Secretary while the office of State President and Premier will be handed to a new successor in the 20th Party Congress. The second option is to revise the term-limit rule in the Chinese Constitution so that President Xi could continue to remain as the top leader of China. As a result, the legislative agenda of the National People’s Congress (NPC) in the coming years will help us assess whether this possibility is real. Five like-minded new PSC members have been selected, which has further Figure 2. Party’s Leadership Echelon consolidated President Xi’s power. In terms of the roles in the PSC, Zhao Leji was (19th Party Congress) elected as the Secretary of the Central Commission for Discipline Inspection, Structure of Chinese Number replacing Wang Qishan’s role, while the rest of the state-level positions will be Communist Party announced at next year’s National People’s Congress. According to the precedents Total party membership 88,758,000 National Party Congress 2287 from the announced ranking and position allocation in the 18th Party Congress, we Alternative Central Committee 172 believe that: Central Committee 204 Politburo 25 Li Zhanshu will replace Zhang Dejiang, taking the position of Chairman of the Politburo Standing Committee 7 National People’s Congress, General Secretary 1 Source: Wikipedia, Citi Research Wang Yang will replace Yu Zhengsheng’s role as Chairman of the Chinese People's Political Consultative Conference, Wang Huning will take over Party Propaganda, replacing Liu Yunshan, and take over the President of the CPC Central Party School, and Han Zheng will be the First Vice Premier of the State Council, replacing Zhang Gaoli and assisting Premier Li’s work. Among the new members, Li Zhanshu, Zhao Leji, and Wang Huning worked closely with Mr. Xi in his first term. Li Zhanshu is currently the Chief of the General Office of the Central Committee of the CPC and Zhao Leji used to be the Head of Organization Department in the CPC. Wang Huning is currently the Director of the Policy Research Office of the CPC Central Committee, and though he has no provincial executive experience, he helped Mr. Xi come up with both the Chinese Dream Theme and Xi Jinping Thought initiatives. Mr. Han has also worked with Mr. Xi in Shanghai and ensured his successful elevation to the top job in the Party. Wang Yang’s able handling of Sino-U.S. relations earned him a slot in the top leadership circle. Even without the chairman system being introduced, there is no doubt Mr. Xi’s power has fully consolidated. © 2017 Citigroup
December 2017 Citi GPS: Global Perspectives & Solutions 9 Figure 3. Other 18 Members in the New Politburo Name Current Position Ding Xuexiang* Deputy Head of the General Office of the CPC Wang Chen* Vice Chairman of the Standing Committee of the National People Congress Liu He* Chief of the Leading Group for Financial and Economic Affairs Office Xu Qiliang Vice Chairman of the Central Military Commission Sun Chunlan Head of the CPC United Front Work Department Li Xi* Party Secretary of Liaoning Li Qiang* Party Secretary of Jiangsu Li Hongzhong* Party Secretary of Tianjin State Councilor of the People's Republic of China, Director of the Foreign Affairs Leading Yang Jiechi* Group Office Minister of Supervision, Deputy Secretary of the Central Commission for Discipline Yang Xiaodu* Inspection Zhang Youxia* Director of Equipment Development Department Chen Xi* Executive Deputy Head of the Organization Department of the CPC Chen Quanguo* Party Secretary of Xinjiang Chen Min'er* Party Secretary of Chongqing Hu Chunhua Party Secretary of Guangdong Guo Shengkun* Minister of Public Security, State Councilor of the People's Republic of China Huang Kunming* Executive Deputy Head of the Central Propaganda Department Cai Qi* Party Secretary of Beijing Note: Name with * demotes they are a new member. Source: Wiki, Citi Research The amendment to enshrine Xi Jinping Another important milestone for Mr. Xi’s greater power consolidation is the Thought ensures that Mr Xi will be regarded amendment of the Party Constitution to enshrine “Xi Jinping Thought on Socialism as the country’s highest leader with Chinese Characteristics for a New Era” (Xi Jinping Thought). The CPC regards “Mao Zedong Thought”, “Deng Xiaoping Theory”, Mr. Jiang Zemin’s “Three Representatives,” and Mr. Hu Jintao’s “Scientific Development Theory” as its guiding philosophies, of which only two carry the names of their creators (See: What to Expect from Party Constitution Revision?). Since ‘thought’ ranks above ‘theory’ in the Chinese context, adding Mr. Xi’s thought and his name essentially elevated his stature in the Party to a level higher than Mr. Deng’s and comparable to Mr. Mao’s. The ideological change ensures that Mr. Xi will be regarded as the country’s highest leader even after he has stepped down from office. Figure 4. What Does ‘Xi Jinping Thought’ Stand For? Overarching Goal To realize socialist modernization and national rejuvenation Principal Between unbalanced and inadequate development and the people’s ever-growing needs Contradiction for a better life Overall Plan The five-sphere integrated plan (五位一体) Overall Strategy The four-pronged comprehensive strategy (四个全面) Basic Policy Ensuring party leadership over all works (14 Points) Committing to a people-centric approach Continuing to comprehensively deepen reform Adopting a new vision for development Seeing that the people run the country Ensuring every dimension of governance is law-based Upholding core socialist values Ensuring and improving living standards through development Ensuring harmony between human and nature Pursing a holistic approach to national security Upholding absolute Party leadership over the people’s forces Upholding the principle of “one country, two systems” and promoting national reunification Promoting the building of a community with a shared future for mankind Exercising full and rigorous governance over the Party Source: Citi Research © 2017 Citigroup
10 Citi GPS: Global Perspectives & Solutions December 2017 The amendment also institutionalized Mr. The NPC included the commitment to supply-side industrial reforms and giving play Xi’s industrial reforms, his fight against to the “decisive role” of market forces in resource allocation into the revised corruption, and his infrastructure initiatives Constitution. The revision also included “following the principle of achieving shared growth through discussion and collaboration, and pursuing the Belt and Road Initiative." It ensured that the CPC must "make comprehensive efforts" to ensure that "the fight against corruption goes on." On the political side, the NPC wrote Mr. Xi’s military thinking and the CPC’s "absolute" leadership over the armed forces into the revised Constitution. Also included was that the CPC must firmly exercise self- supervision and practice strict self-governance in every respect. These revisions formalized the policy initiatives and should facilitate their implementation over the medium term. The expected revival of the Chairman There were expectations that the 19th Party Congress might revive the post of system did not happen this time Chairman as the head of the PSC. In accordance with the Party Constitution, the General Secretary is only the convener of the Politburo and PSC meetings but status and voting power is the same as all other Committee members, and the PSC’s decisions are made by consensus. While in the Chairman System, the Chairman is the leader of the PSC and can veto the decision of all. Since such a change to the CPC’s top organizational structure would require a revision to its Constitution, which in turn would need an approval by the NPC, this now becomes one thing to watch out for in the next NPC in 2022. Even without the Chairman title, Mr. Xi’s status as China’s most powerful leader since Mr. Mao has already been fully secured. With the full consolidation of Mr Xi’s position, With the full consolidation of Mr. Xi’s position, the top leadership will be much more political incentives and rules will now be unified and effective compared to Mr XI’s first term. Political incentives and rules will more straightforward and we expect more now be more straightforward for government officials and policy makers. This breakthroughs in policy should allow the CPC to carry out the reforms which were revealed in Mr. Xi’s Political Report (PR), while facing less resistance. We expect more breakthroughs, as outlined in the PR, in industrial upgrading (e.g., “Made in China 2025”), rural land reform, second-round urbanization (e.g., the Xiong’an new district, the Yangtze River economic belt, and the Great Bay area), financial reforms and further opening up (e.g., the One Belt One Road initiative) as well as environmental protection. However, the consolidation of top leadership will be a double-edged sword — it could also mean a greater risk of reduced “checks and balances” and of policy errors that could exacerbate imbalances in the future. © 2017 Citigroup
December 2017 Citi GPS: Global Perspectives & Solutions 11 Figure 5. Key Takeaways from Mr. Xi’s Political Report Grand Centenary To secure a decisive victory in building a moderately prosperous society in all aspects; To realize the Chinese dream of national Themes Goals rejuvenation China at new historic juncture from standing up and getting rich to becoming strong and embracing the brilliant prospects of national "New Era" rejuvenation "New Principal Between unbalanced and inadequate development and the people’s ever-growing needs for a better life Four “News” Contradiction" "New Thought" Thought on socialism with Chinese characteristics for a new era (14-point basic policy) Now-2020: Build a moderately prosperous society in all aspects; 2020-2035: Basically realize socialist modernization; 2035-2050: "New Roadmap" Develop China into a great modern socialist country that is prosperous, strong, democratic, harmonious and beautiful Overall From rapid growth to high-quality development; Transforming growth model, improving economic structure and fostering new Assessment growth drivers Advanced manufacturing: Build China into a manufacturer of quality and develop advanced manufacturing; Promote integration of the internet, big data and artificial intelligence with the real economy; Foster medium-high end consumption, the sharing economy, modern supply chains and human capital services Rural vitalization strategy: Extend current rural land leasing contracts by another 30 years upon expiration; Deepen "three rights separation" reform; Protect the property rights of farmers and collectives; Develop modern agriculture, Strengthen nat’l food security Coordinated regional development: Create networks of cities and towns based on city clusters, especially the Beijing-Tianjin-Hebei Economic region and the Yangtze River economic belt as well as the big bay area linking Hong Kong, Macau and greater Pearl Delta provinces; Development Policy Highlights Develop forward-looking plans and adopt high standards for building the Xiong’an new district Financial reforms: Make finance better serve the real economy; Strengthen the macro control framework with "dual-pillars" of monetary policy and macro prudential assessment (MPA); Hold the bottom line of avoiding systemic risks SOE reform: Support state capital in becoming stronger, doing better, and growing bigger; Further reform SOEs, develop mixed- ownership entities, and cultivate globally competitive enterprises; Implement a negative-list system for market entry and treat SOEs and POEs equally BRI and opening-up: Pursue the Belt and Road Initiative (BRI) as a priority; Grant more powers to pilot free trade zones and explore the opening of free trade ports; Give equal emphasis to "bringing in" and "going global" to make new ground in opening China further Win the battle against poverty: Lift all rural residents living below the current poverty line out of poverty by 2020; Implement Poverty targeted poverty reduction and alleviation measures; Make heads of Party committees and governments at each level assume the Reduction overall responsibility for poverty alleviation Social Maintain the stance that “houses are for living in, not for speculating with”; Speed up the establishment of a healthy residence Housing Policy Development system with multiple sources of supply and more balanced weighting between property renting and purchasing Education First Make senior secondary education universally available; Improve preschool education, special needs education, and online education Put an end to the practices of hospitals funding their operations with profits from overpriced drugs and improve the system for "Healthy China" medicine supply; Support the development of private hospitals and health-related industries "Beautiful Guiding principle: "Green mountains with blue waters are mountains of gold and silver" China" Ecological Development Establish regulatory agencies to manage state-owned natural resources and monitor natural ecosystems; Solve prominent Major Tasks environmental problems such as air, water, and soil pollutions; Promote green development via eco-friendly governments, families, schools, communities, and transport services Secure a sweeping victory in the fight against corruption; Institute a system of disciplinary inspection at the city and county level; Anti-Corruption Improve Party and state oversight systems by establishing supervisory commissions at the national, provincial, city, and county levels; Formulate a national supervision law Political Development Party Uphold the Party's absolute leadership over the military forces; Basically complete the modernization of national defense and forces Leadership by 2035 and make the armed forces world-class forces by the mid-21st century Rule of law Set up a central leading group for advancing law-based governance in all areas Source: 19th Party Congress Political Report, Citi Research © 2017 Citigroup
12 Citi GPS: Global Perspectives & Solutions December 2017 “New Era” and Policy Priorities — Growth Still Matters The next five years will be a critical time period for China. The political report (PR) Figure 6. Our Forecast for Annual GDP unveiled what the top leadership considered the priorities for China in the medium Growth at 6.8% for 2017E Has Been Locked to long term. As we expected, the PR’s grand themes were the pledges to “secure a In decisive victory in building a moderately prosperous (xiao kang) society in all %YoY aspects” and to realize the Chinese dream of national rejuvenation. The PR defined 8.0 the next five years as critical for delivering the “first centenary goal” of building a Forecast 7.5 moderately prosperous society and laying the foundation for the “second centenary 1 7.0 goal” of developing China into a “great modern socialist country.” Recognizing 6.5 China’s progress in economic development, the PR declared the start of a “new 6.0 era,” positioning China at the new historic juncture from “standing up and getting 5.5 rich to becoming strong and embracing the brilliant prospects of national rejuvenation.” Mr. Xi further outlined a three-step plan to achieve the goals: (1) build 5.0 2012 2014 2016 2018 2020 a moderately prosperous society in all aspects before 2020; (2) basically realize GDP Growth Growth Target socialist modernization between 2020 and 2035; and (3) develop China into a great modern socialist country that is prosperous, strong, democratic, harmonious, and Source: CEIC, Citi Research estimate beautiful between 2035 and 2050. The word “beautiful” was added to the official description of the strategic goals, reflecting the new emphasis on eco-friendly development. Despite the PR’s propaganda-style language, we agree that the next five years are indeed critical for whether or not China can stride over the middle- income trap and join the club of high-income economies. China needs growth — better growth, In this new era, the PR changed the “principal contradiction” facing China from the sustainable growth one between “the people’s ever-growing material and cultural needs and backward social production” outlined in 1981, to the one between “unbalanced and inadequate development and the people’s ever-growing needs for a better life.” This means the top leadership has come to believe that the major constraint for China is no longer the capacity of production, but instead the structure and quality of production. Indeed, some sectors are facing overcapacity problems, while the new economy is still emerging. However, in the transition from factor- and investment-driven to innovation- and consumption-led growth, China can’t still afford to ignore the speed of growth. We believe growth target will remain around As a high-level strategic report, the PR did not specify any GDP growth targets (we 6.3% until 2020 – next 5 years is critical think that will be left to the March NPC meeting) but, in line with the centenary goals, the CPC has repeatedly affirmed its commitment to doubling China’s 2010 GDP and per capita income by 2020, which we estimate would require annual growth of at least 6.3% (see Figure 7). It also reiterated its plan to lift all of its poor (43.35 million people as of 2016) out of poverty, known as the “2020 poverty relief target”, which in itself is correlated to realized growth rates (Figure 8). Without major crises, we think it unlikely that the CPC will miss these measurable targets as hitting these targets is key to the CPC’s credibility and authority, and past leaders, from Mr. Deng Xiaoping to Mr. Hu Jintao, all achieved such targets. In this context, economic stability and risk control will continue to be a high priority for the CPC — a hard- landing scenario will be avoided, and there should be a minimum level of acceptable growth no matter the rhetoric. 1 The CPC and the People’s Republic of China will celebrate their centenaries in 2021 and 2049, respectively. © 2017 Citigroup
December 2017 Citi GPS: Global Perspectives & Solutions 13 Figure 7. An Average Growth Rate of Only 6.3% Is Needed in the Next 3 Figure 8. China’s Rural Poverty Declines Faster in High Growth Period Years to Achieve the Goal of Doubling Real GDP from the 2010 Levels RMB tn 2010-2017 CAGR: 7.5% 2017-2020 CAGR: 6.3% 0 1985-1990 Decline in Rural Population in 90 82.6 China GDP (2010 price) Poverty (in millions) 80 Double 68.7 -50 70 64.3 real 60.3 60 56.4 GDP 52.6 1980-1985 1990-1995 48.8 from -100 50 45.2 1995-2000 41.3 2010 40 2010-2015 2005-2010 30 -150 20 2000-2005 10 -200 0 7 9 11 13 2010 2012 2014 2016 2018F 2020F CAGR over 5yr period Note: Assumes 6.8% GDP growth for 2017 Source: CECI, Citi Research Source: Xinhua News, Citi Research Key Economic Themes Theme #1: Accelerating Industrial Upgrading and Innovation-Driven Development While recognizing China as a major manufacturing country, the Political Report also Figure 9. The Weight of Secondary Industry pledged to strengthen China’s role in the global production chain, improve To China’s Total GDP Is Still Sizable manufacturing quality, deepen the integration of the Internet, big data, artificial % Share of China's Nominal GDP intelligence (AI), and their application in the industrial sector, elevate medium- to 60 25 high-end value chains, and support the upgrading and optimization of traditional 20 industries. Meanwhile, the report stated that innovation should be the leading force 50 for development as well as the support to China’s modern economic system. China 15 should aim at reaching the technological frontiers, strengthening fundamental 40 10 research, and achieving breakthroughs in research and innovation. 30 5 1992 1996 2000 2004 2008 2012 2016 We believe the “Made in China 2025” initiative, already adopted as a strategy for Secondary Industry industrial upgrading, will see accelerated implementation. Over-capacity and the Tertiary Industry deterioration of external demand have led to manufacturing sector growth rapidly Primary Industry(rhs) slowing from 12.7% in 2010 to 6.1% in 2016 (Figure 10). While growth has Source: CEIC, Citi Research rebounded somewhat in 2017, it is unlikely to accelerate again. In the Information & Communication Technology (ICT) sector, China appears to have fallen behind its neighboring economies, which have seen much faster export growth (Figure 11). This has led to a stronger sense of urgency. In May 2015, the “Made in China 2025” plan was announced, which promoted 10 focal manufacturing sectors to be globally competitive by 2025 (Figure 12 & Figure 13) and treated innovation as the top priority. Some progress toward this initiative appears to have been made. During the 19th Party Congress’ group interview, Mr. Miao, the Minister of Industry and Information Technology, stated that the top-level design of “Made in China 2025” has been basically completed — five key projects including the establishment of a national manufacturing innovation center, intelligent manufacturing, strengthening the industrial base, green manufacturing, and high-end equipment innovation have 2 made some inroads. 2 http://www.gov.cn/zhuanti/2017-10/19/content_5233151.htm © 2017 Citigroup
14 Citi GPS: Global Perspectives & Solutions December 2017 China’s R&D spending as a share of GDP While it is still much lower than most developed economies, such as the U.S., grew four-fold in the past 30 years to 2.16% Germany, and Japan (Figure 14), China’s R&D spending as a share of GDP grew th in 2016 and is forecast to rise to 2.5% by four-fold in the past 20 years to 2.1% in 2016. In the 13 Five Year Plan, the 2020 government targeted this ratio to increase to 2.5% by 2020 and given its emphasis in the 19th Party Congress, we think it is highly achievable. Given the sizeable weight in nominal GDP (Figure 15), climbing the manufacturing value-chain could be pivotal in preventing secondary industry growth from slowing further and leading to lower GDP growth. One barometer to monitor if R&D spending is translating to tangible applications is to look at patent applications. Recent data of applications under the Patent Cooperation Treaty (PCT), which covers patent protection simultaneously across a large number of countries, shows a very sharp increase in Chinese patent applications, with 20% of those patents in 2013-2016 coming from just two companies — ZTE Corp and Huawei Technologies. Figure 10. Growth in Momentum of the Manufacturing Industry has Figure 11. Tech Exports from China have Lagged Behind Neighboring Trended Down Economies % Overall Real GDP Growth 2015-100 Tech Exports, Seas Adj 25 160 VN TW Manufacturing/Secondary Industry Real KR SG GDP Growth CN Series6 20 140 120 15 100 10 80 5 60 1992 1996 2000 2004 2008 2012 2016 Feb-15 Aug-15 Feb-16 Aug-16 Feb-17 Aug-17 Source: Citi Research Source: CEIC, Citi Research Figure 12. Made in China 2025 Intended to Increase the Manufacturing Sector’s Global Competitiveness China's Strategic Manufacturing Sectors' Global Competitiveness Scorecard Macro Scores (mkt size, growth, country ranking) 14 Best Positioned Communication 12 Equipment Advanced Railway Equipment C.N.C Machine Aerospace 10 Integrated Circuit Tools Equipment New Energy Vehicles Shipbuilding 8 Enterprises Industrial Software Robot Medical Devices Power Equipment Biotech 6 4 Agricultural Machinery Worst Positioned 2 4 6 8 10 12 14 Micro Scores (R&D, net margin, net gearing) Source: Citi Research © 2017 Citigroup
December 2017 Citi GPS: Global Perspectives & Solutions 15 Figure 13. Evaluation Matrix/Targets for Manufacturing Industries in 2020 and 2025 Evaluation Matrix for Manufacturing Industries in 2020 and 2025 Type Indicator 2013 2015 2020E 2025E R&D spend as % of core business revenue for above-scale manufacturing 0.88 0.95 1.26 1.68 Innovation Ability industries (%) Number of effective patents per 100 million revenue from core business (1) 0.36 0.44 0.70 1.10 (2) Quality Competitiveness Index for manufacturing industries 83.1 83.5 84.5 85.5 Increase by 2% Increase by 4% Qualitative Growth of value added by manufacturing industries - - based on 2015 based on 2015 Efficiency Around 7.5 Around 6.5 Growth of entire labor productivity for manufacturing industries (%) - - (CAGR for 13th (CAGR for 14th five-year plan) five-year plan) Combination of Penetration rate of Broad Band(3) (%) 37 50 70 82 Industrialization Penetration rate of digitalized R&D instrument(4) (%) 52 58 72 84 and Informatization Utilization rate of numerical control for critical activities(5) (%) 27 33 50 64 Decrease by Decrease by Decrease in energy consumption per unit of industrial value added for - - 18% based on 34% based on above-scale manufacturing industries 2015 2015 Decrease by Decrease by Development in Decrease in carbon emissions per unit of industrial value added - - 22% based on 40% based on Environmental 2015 2015 Protection Decrease by Decrease by Decrease in water consumption per unit of industrial value added - - 23% based on 41% based on 2015 2015 Comprehensive utilization rate of solid industrial waste (%) 62 65 73 79 Note: (1) Number of effective patents per 100 million revenue from core business = Number of effective patents by above-scale manufacturing corporates / Total core business revenues by above-scale manufacturing corporates; (2) Quality Competitiveness Index for manufacturing industries is the aggregative indicator of economic technology that reflects the overall quality level of our country's manufacturing industries; (3) Penetration rate of Broad Band here refers to the penetration rate of fixed-line Broad Band (Penetration rate of fixed-line Broad Band = Number of households using fixed-line Broad Band / Total number of households; (4) Penetration rate of digitalized R&D instrument = Number of above-scale corporates adopting digitalized R&D instrument / Total number of above-scale corporates; (5) Utilization rate of numerical control for critical activities is the average utilization rate of numerical control for critical activities from above-scale industrialized corporates. Source: www.gov.cn, Citi Research Figure 14. China’s R&D as % of GDP is Targeted to Reach 2.5% by 2020 Figure 15. China is Seeing a Rapid Rise in Share of Patent Applications Filed Under the Patent Cooperation Treaty (PCT) 45% Global Share of PCT Patent Application 4.5% 40% 4.0% 3.5% 35% 3.0% 30% 2.5% 2.5% 25% 2.0% 20% 1.5% 15% 1.0% 10% 0.5% 5% 0.0% 0% 1996 1999 2002 2005 2008 2011 2014 2017E 2020E 2000 2002 2004 2006 2008 2010 2012 2014 2016 U.S. U.K. Germany Japan Korea China U.S. EU-28 JP CN KR EM Asia ex CN/KR Source: Haver, Citi Research Source: OECD, World Intellectual Property Organization (WIPO), Citi Research © 2017 Citigroup
16 Citi GPS: Global Perspectives & Solutions December 2017 Theme #2: Revitalizing the Rural Sector Rural development is an important part of The Political Report pledged to implement a “rural vitalization strategy” — a term the solution to Mr. Xi’s vow to eliminate first used in the CPC’s official documents. Rural development is an important part of absolute poverty in China by 2020 the solution to poverty, with Mr. Xi vowing to eliminate the absolute poverty in China by 2020. Because of this, rural development should not be an empty policy, and we expect substantive progress to be made in (1) rural land reform; (2) rural infrastructure investment; (3) modern agriculture development; and (4) food production support in the next few years. In our view, rural land reform is at the heart of rural vitalization. Indeed, rural land reform is entering a critical new phase. The government launched Figure 16. Rural Land Consists Mainly of a national pilot scheme of rural land reform in 33 counties in 2015. The Land Farmland and Construction Land Administration Law is currently under revision and the government just extended the Rural Land ongoing pilot program to the end of 2018 in order to encourage further experiments, with the results likely to be institutionalized by the amendments. China’s land system has a dual structure, with urban land being owned by the state and Farmland Construction Land Unutilized Land marketable while rural land is owned by collectives and largely non-transferable (Figure 16). The PR said that the CPC will improve the current three-layer system of Housing Plots rural land rights, with ownership belonging to the collectivities, contractual rights Commercial Collective given to farmers, and management rights being transferrable. In particular, the PR Construction assured that rural land contracting practices will remain stable and unchanged on a - Non-Commercial Collective Construction long-term basis, and it extended the current round of leasing contracts by another 30 years upon expiration. These changes should give more (contractual) rights to farmers and make them transferrable. Source: Citi Research The confirmation and separation of these rights — the so called “three rights Figure 17. “Three Rights Separation” at heart separation” — are a prerequisite for their effective pricing and orderly transfer. The of New Rural Land Reform ongoing rural land reform has “three arrows” (Figure 17): Reducing rural land expropriation: Collectively-owned rural land cannot enter Housing the market unless it has been expropriated by the government and converted into Plot System Reform urban land. The reform will reduce the scope of land expropriation by local Define and government so as to protect farmers’ land use rights and economic interests. Separate Marketization Rights to Land Marketization of rural commercial construction land: It will allow rural of Commercial Land Expropriation Construction of Reform commercial construction land to be traded in a unified urban-rural market, Land enjoying the same rights and prices as state-owned urban land. It will also Source: Citi Research reduce the local government monopoly on rural land transfer. Reform of the housing plot system: Rural households can use their housing plots for residences but largely cannot derive market value from them. The reform will promote the collateralization, guarantee, and transfer of housing plots to increase farmer’s asset revenues. It will also support and encourage the voluntary transfers of housing plots for compensation by rural migrant workers. The reform will unlock total rural land wealth As we show in Figure 18, our construction of the “shadow prices” points to of RMB135.9 trillion or $20.6 trillion remarkable rural land wealth owned by farmers at RMB135.9 trillion ($20.6 trillion). 3 Dividing this number by the registered rural population (with Hukou ) of 872.5 million, the rural land wealth works out to about RMB155,717 or $23,594 per capita, which is 12.6 times the rural disposable income per capita. Of course, it is important to note that land wealth is a stock concept and whether such a wealth effect can be unleashed will depend on the government’s land policy. 3 The Hukou system is a government system of household registration. © 2017 Citigroup
December 2017 Citi GPS: Global Perspectives & Solutions 17 Land reform will have profound implications for the rural sector and the broad economy. We expect it to: Increase rural household wealth and consumption: The disposable income of urban residents has been persistently around three times that of rural residents. A larger share of urban disposable income comes from properties versus rural disposable income — up 7.5 percentage points higher in 2016. By unlocking the rural land value, the reform will increase farmers’ wealth and property income and hence foster consumption growth and upgrading. For investment, it should benefit sectors like autos, consumer discretionary, consumer electronics, education, and real estate. Advance urbanization and sustaining economic growth: The reform will unleash migrant workers’ ties to land. With the establishment of a market-based exit mechanism, migrant workers will be able to cash in their land wealth and settle down in cities. Of course, this will have to progress in tandem with Hukou reforms. Improve agricultural productivity and promote corporate farming: Compared with developed and some developing countries, China’s agricultural sector is lower in labor productivity and mechanized production, because of its decentralized land system. The confirmation of farmers’ land use rights with certificates will make them feel more secure to transfer out their rights for returns. The reform will thus open the door to corporate farming. In our view, China’s modern agriculture is an area of great potential for investment. Restore local fiscal discipline and social stability: The 1994 fiscal reform recentralized fiscal power to the central government, while leaving local governments to shoulder increasing fiscal burdens. To offset these burdens, local officials have turned to land sales by seizing rural land from farmers and selling it to property developers for large gains. As a result, rampant land expropriation has been a major driver behind social unrest. The reform will reduce local government’s expropriation of rural land, which will be conducive to greater social stability. Returning the land use rights to farmers is also an essential step to restore local fiscal discipline. Figure 18. Estimating Land Wealth of Rural Household Area Price Wealth Bn Sq m Mn Mu* RMB/Sq m RMB/Mu RMB Bn US$ Bn Rural Construction Land 187 280 421 280,842 78,636 11,915 Housing Plot 113 170 524 349,306 59,382 8,997 Commercial Construction Land 33 50 524 349,306 17,465 2,646 Non-Commercial Construction Land 40 60 45 29,808 1,788 271 Farmland 1,280 1,920 45 29,808 57,232 8,671 Total 135,868 20,586 *A mu is unit of land measure in China – there are 0.0015 mu in 1 square meter. Source: Citi Research © 2017 Citigroup
18 Citi GPS: Global Perspectives & Solutions December 2017 Theme #3: Coordinating Regional Development and Accelerating Second Round Urbanization China will continue to promote city clusters The Political Report stated that China will continue to promote city clusters, and accelerate the urbanization of its especially the Beijing-Tianjin-Hebei area and the Yangtze River economic zone as agriculture population well as the Greater Bay Area linking Hong Kong, Macau, and greater Pearl Delta provinces, and accelerate the urbanization of its agricultural population. The PR pledged high-level planning and high-standard construction of the Xiong’an new district in order to showcase a comprehensive, cross-province, and new urbanization model for others to follow. Developing clustering metropolitan areas is The second round of urbanization started in 2014 when the new urbanization plan the key emphasis in this new phase of (2014–2020) was laid out in China’s Third Plenum. Its aim is to lift the urbanization 4 urbanization ratio to 60 percent in 2020 (versus the 45 percent identified by Hukou registration). Developing clustering metropolitan areas is the key emphasis of the next round of urbanization in China. Five metropolises are mentioned in new urbanization plan (2014–2020), namely, the Jing (Beijing)-Jin (Tianjin)-Ji (Hebei) area, the Pearl River Delta area, the Yangtze River Delta area, the greater Chongqing & Chengdu area, and Middle Reaches of Yangtze River Economic Zone (Figure 20). The implications for China’s medium-term infrastructure investment will remain fairly elevated. The Xiong’an new district, announced in April of 2017, will be a good example for Figure 19. Xiong’an’s Status is Identical to regional comprehensive urbanization (Figure 19). The new district covers three Shenzhen and Shanghai Pudong New Area counties in Hebei Province (Xiong Xian, Rong Cheng & An Xin) near Baiyangdian Xiong'an Shenzhen Pu Dong Lake, with an initial construction area of 100 km sq, but expanding to 200 km sq in Area Initial:100 km sq, 1991.64 km sq 1210 km sq the medium term. The new city, dubbed as the sub-hub for China’s capital city, is medium term:200km sq, 160 km south of Beijing, and it will be used to host non-essential functions of the long term: 2000km sq capital city with an aim to relieve Beijing’s population pressure, traffic congestion, Population 1.01 mn 11.38 mn 5.47mn pollution, water shortage, and environmental degradation. In return, we believe Hebei province will be more willing to give up its small- and medium-sized heavily 5 GDP ~RMB 21.4 bn RMB 1.95 trn RMB 8.732 trn polluting steel and chemical industries on the prospect of around RMB $1 trillion ($151 billion) of investment being spent in Xiong’an over the next five years. In Establishment Time 2017 1979 1992 addition, more central government fiscal revenues could be spent there once some state-owned enterprises (SOEs), non-essential ministries, and education and research institutions are moved into Xiong’an from Beijing. After six months of Source: Media Reports, Citi Research preparation, 48 enterprises have been approved to set up subsidiaries in the 6 Xiong’an new district, and planning construction has entered into the final stage, in accordance with the head of the National Development and Reform Commission 7 (NDRC). Though Dr. Ma, Chief Economist from the People’s Bank of China (PBoC), has stated the required investment for Xiong’an New Green City will be around RMB1 trillion in 5 years, merely ~1.2% of China’s 2016 GDP, the implications for Beijing property and the regional urbanization process is important (see: Xiong’an: A New District - How Big an Impact on the Economy?). 4 It is a three part One-Million Population Strategy: (1) shifting 100 million people from agricultural-based to registered urban Hukou; (2) rebuilding rundown city areas and villages inside cities where 100 million people reside; and (3) urbanizing central-west provinces in which 100 million people reside. According to the plan, by 2020 all cities with a population of 200,000 will be connected through regular railways and national highways, cities with a population of 500,000 will be linked through high-speed trains, and the aviation network will cover 90 percent of the total population. 5 http://www.jiemian.com/article/1562924.html 6 http://news.sina.com.cn/c/nd/2017-10-12/doc-ifymrqmq4797895.shtml 7 http://news.xinhuanet.com/politics/19cpcnc/2017-10/21/c_129724307.htm © 2017 Citigroup
December 2017 Citi GPS: Global Perspectives & Solutions 19 The Greater Bay Area will help develop the Meanwhile, a new urban agglomeration, namely the Guangdong-Hong Kong-Macau greater Pearl Delta economy and promote a Greater Bay Area which was proposed by Premier Li in this year’s government further opening up in services, particularly working report, intends to utilize Hong Kong and Macau’s advantage to develop the financial services greater Pearl Delta economy and promote a further opening up in services — financial services in particular. The long waited Hong Kong-Zhuhai-Macau Bridge (expected to be completed by the end of 2017) and the high-speed train network extension to Hong Kong could provide infrastructure support for urban agglomerations development. With 0.6% of China’s land area and 4.9% of the population, the Greater Bay Area generates 12% of China’s GDP, and is China’s most affluent and densely populated region (Figure 23). Given its strong industrial base and advanced technology and services sectors, the Greater Bay Area has the potential to rival the global peers such as the New York Metropolitan and Tokyo Metropolitan areas (see: GD-HK-Macau Greater Bay Area: The Engine of China’s Rise). Regarding the Yangtze River economic zone, the development plan released in May 2016 outlined the main tasks, such as transportation network construction, 8 industrial upgrades, and ecological environment protection. This economic zone, which covers 11 provinces and municipalities, three city clusters, and accounted for over 40% of the national population and GDP, will be the key for regional development coordination, new urbanization, and industrial transformation (Figure 21). Urbanization could accelerate the migration Urbanization is of great importance to boost the economic growth in the future, of surplus labor from rural to urban areas as especially when the demographic bonus has started to fade, and trade and well as boost consumption investment–led growth has slowed. On the supply front, urbanization could help the migration of surplus labor from rural to urban areas and help ease the pressure of slowing urban labor growth. On the demand front, the rapid urbanization process will also boost consumption and facilitate the economic rebalance to consumption- led growth. As a result, the new round of urbanization could likely benefit the consumer sector. The government is targeting an urbanization China has 102 cities with a population of at least one million people, and 63 cities ration of 65% by 2025, up from 56% at end- with a population of 5 million and above. The current urbanization ratio remains low 2016 at around 56% by end 2016, and the government would like to see this ratio increase to 60% by 2020 and 65% by 2025 (Figure 22). We think this urbanization target is fully achievable. Barring the infrastructure development, the soft reform to push up the rural population migration is also crucial. The Hukou reform and policies to facilitate migrant workers to have equal access to urban residence, health care, and public education are expected to make more progress, which will also create more demand for urban public infrastructure such as schools, hospitals, and others. Over 80 million agricultural workers have In 2014, guidance was issued on pushing forward Hukou reform and some progress become urban residents in the past five has already been achieved: 28.9 million people received a resident permit in 2016, years sharing the equivalent rights as local residents for life and work, after the 9 announcement of the new residence permit rule on January 1, 2016. Moreover, in accordance with the PR, over 80 million agricultural workers have become urban residents in the past five years. We believe the Hukou reform will be crucial for urbanization and will be accelerated in the next five years. 8 http://www.ndrc.gov.cn/fzgggz/dqjj/qygh/201610/t20161011_822279.html 9 http://news.xinhuanet.com/politics/2017-02/11/c_1120448026.htm © 2017 Citigroup
20 Citi GPS: Global Perspectives & Solutions December 2017 Figure 20. Five Metropolises Are Mentioned in New Urbanization Plan Figure 21. Yangtze River Economic Zone Covers 11 Provinces & (2014-2020) Municipalities and Accounted for Over 40% of National GDP Source: Citi Research Source: Citi Research Figure 22. Urbanization Ratio and Weight of Population in Urban Figure 23. Guangdong-Hong Kong-Macau Greater Bay Area is Critical Agglomerations for Both Urbanization and Opening Up % 60 Most Affluent & Dense Region Theme 1. Infrastructure / Property 50 Population inflows and urbanization Theme 2. Lifestyle Consumption 40 Industries' Mutual Supplement Theme 3. R&D Manufacturing 30 GDP: US$1.4tn Population: 68mn 20 Land area: 56,083 sq km 10 Population density: 1,213 ppl / sq km 0 1990 1995 2000 2005 2010 2015 Urbanization Ratio % of Population in Urban Agglomerations of More Than 1 Million Source: World Bank, Citi Research Source: Citi Research © 2017 Citigroup
December 2017 Citi GPS: Global Perspectives & Solutions 21 Theme #4: Reforming SOEs and Restructuring SASACs In the Political Report, Mr. Xi stated that China will improve both state-owned Figure 24. Reported Central Controlled SOEs 10 enterprises (SOEs) and the stated-owned asset management system (SASACs ). Pilot It will accelerate the improvement of the stated-owned economy, maintain and Central Government Controlled SOEs Pilot List increase the value of stated-owned assets, make SOEs stronger, better and larger, First Batch of Central SOE Pilots and prevent any losses of stated-owned assets. China will also deepen the SOE China Unicom [First flagship case launched] reform and develop a mixed-ownership economy to cultivate globally competitive China Eastern Airline Southern Power Grid enterprises. China Nuclear E&C Group Harbin Electric Compared with the 18th Party Congress statement on SOEs, the new report spells China State Shipbuilding out some concrete and deliverable key initiatives to push SOE reform ahead. Two Reported Second Batch of Central SOE Pilots important initiatives have been ongoing since the first half of 2016: First, it is to China Three Gorges Corporation engage in further ownership reform. It is hoped that the State can diversify SOE CRRC Air China Cargo ownership to achieve two pressing objectives: (1) lowering SOE debt; and (2) Travel Sky Technology Limited improving corporate governance, incentive structure, and efficiency. Second, it is China Nuclear Fuel Corporation expected the management organization of the SOEs will also experience significant Hunan Aerospace Limited changes. The future SASACs at both central government and provincial levels could China Salt have different but more effective roles in managing and safeguarding state assets. China Gold Capital Investment Subsidiary of COFCO Since the second half of 2016, various State Council documents have been issued Source: Media Reports, Citi Research and clearer directions are emerging. First, firm characteristics and sector locations will decide the ways of SOE future restructuring and reform. For viable firms, further partial privatization by deleveraging state shares appears to be the focus in the next few years. The flagship case of mixed-ownership reform of China Unicom is a case to the point (see: China Unicom Announced Mixed Ownership Plan, SOE Reform to Accelerate). That the 19th Party Congress reiterated mixed-ownership reform for SOEs suggests fast implementation will take place. This will have important implications for the equity market, especially those listed firms targeted in the next round of announcements for mixed-ownership reform (Figure 24). Second, for those firms in over-capacity sectors, strategic restructuring and structural adjustment are the suitable solution. The State Council already announced guidelines last July (see: State Council Announces New Guidelines to Restructure Central Government- Owned SOEs), and the restructuring of over-capacity firms has already achieved some tangible results: Since the 18th Party Congress, the SASAC at the central government level completed the restructuring of 18 pairs and 34 SOEs’, and the number of centrally-owned SOEs was reduced to 98 from 117. The third issue around reform that should be addressed is zombie firms and their exit from the market, however, the disposal of zombie firms and improvement on bankruptcy law is not mentioned. The reform of SASAC at both the central and provincial government level will be another focus in the coming years. It is reported that the authorities intend to make substantial adjustments on SASAC structure and its personnel. In May 2017, the State Council announced that the SASAC should regain its role as a government regulator in charge of SOE affairs, and it has also given the management role previously held back to the SOEs. The SASAC will perform the role of an investor, and should not interfere in daily corporate operations and execution of the management function. This document clarifies the relationship and the division of labor among regulators, investors, and managers of SOEs. Specifically, the document lists 43 regulation items that will be simplified. 10 SASAC is the State-owned Assets Supervision and Administration Commission of the State Council. © 2017 Citigroup
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