Exclusive Insight: Zhu Rongji's Fiscal Decentralization Led to Today's Real Estate Bubble
What Wall Street Gets Wrong About Xi Jinping’s New Money Men; How China's new No.2 hastened the end of Xi's zero-COVID policy
Welcome to today's issue of "The China Brief"” In today's edition, we cover the US Commerce Department's export restrictions on 28 Chinese entities, China's central bank's policy tweaks to support the economy, and the upcoming sweeping cabinet reshuffle at China's annual "Two Sessions" meetings. We also highlight China's local governments' incentives to boost car sales, the anxiety on Wall Street and Washington over China's new line-up of top economic policymakers, and Chinese brokerages' pressure to end overseas investing services. Additionally, we discuss China's yuan as a safe-haven asset and its whole nation approach to chip self-sufficiency. Finally, we examine Boeing's 15-plane order from Greater Bay Airlines and China's post-pandemic economic recovery. We also explore how the Chinese Communist Party plans to reinforce its power.
And here’s today’s exclusive insight:
Exclusive Insight: Zhu Rongji's Fiscal Decentralization Led to Today's Real Estate Bubble
This article provides exclusive analysis of how Zhu Rongji's fiscal decentralization policy contributed to the current real estate bubble in China. To understand the risks and issues present today, the first part offers a brief history of China's fiscal system.
China's Fiscal System: A Brief History (1) From the establishment of the People's Republic of China in 1949 until the beginning of the reform and opening-up era in 1978, China had a planned economy, and the central government managed local finances vertically. The revenue and expenditure of local governments were mostly decided by the central government. During this period, China experienced two chaotic periods, the Great Leap Forward and the Cultural Revolution, during which local governments had relatively greater fiscal autonomy due to the central government's loss of control over the economy and local governments. However, after the chaos subsided, fiscal power returned to the central government's control.
(2) After the reform and opening-up in 1978, the central government delegated many fiscal powers to local governments. Local governments had the power to formulate budgets and make expenditure decisions. Each year, local governments only needed to pay a certain amount of fiscal revenue to the central government, and the remaining portion could be used at their discretion. Decentralizing fiscal power had its benefits, such as allowing local governments to keep more surplus, which could be used for local economic development, leading to faster economic growth. This created a self-sustaining and virtuous process.
However, there were also disadvantages. As the economy grew rapidly, the fiscal revenue submitted to the central government did not increase as quickly as the economic growth rate. Meanwhile, the central government's expenditure grew rapidly due to the increasing economic scale, leading to severe financial deficits in the central government and damaging political authority. There were even incidents of the central government borrowing money from local governments.
(3) In 1994, Vice Premier Zhu Rongji led a reform of the fiscal system, known as the "fiscal decentralization," to address the persistent financial deficit of the central government. This reform redefined the distribution of fiscal revenue and expenditure between the central and local governments.
Under the new system, the central government took most of the tax revenue and only bore a small portion of the fiscal expenditures, while local governments had a significant gap between their expenditures and revenues. To fill this gap, local governments had to apply for transfer payments from the central government or sell land, which is owned by local governments in China.
While the fiscal decentralization reform objectively resolved the central government's financial deficit and enhanced its political authority, it also laid the groundwork for today's real estate bubble. Rising housing prices increased demand for buying houses (speculation), leading to increased land prices and local government revenue. This revenue then drove local economic growth and further pushed up housing prices, creating a self-sustaining cycle. Conversely, if housing prices drop, land prices will follow, and local government revenue and economic growth will decline. Local governments obviously prefer the former.
(4) Before 1998, the Chinese people relied on "welfare housing" provided by their employers, typically state-owned enterprises or the government. These houses were built by the employer and distributed to employees as a welfare benefit based on factors such as job rank, seniority, age, and family size.
In 1998, in response to the economic slowdown caused by the 1997 Asian financial crisis, Premier Zhu Rongji cancelled the "welfare housing" program. He hoped that by turning real estate into an industry that could directly boost economic growth, China could quickly emerge from the shadow of the crisis. From that point on, people had to buy their own homes from the market, triggering the self-sustaining cycle of rising housing prices.
(This article is the first part of the "Fundamental Problems with China's Fiscal System" series, authored by Li Weijun, a special analysis expert for The China Brief.)
WSJ: U.S. Export Limits Target 28 Chinese Entities, Citing Alleged Ties to Iranian Military
The U.S. Commerce Department has imposed export restrictions on 28 Chinese entities, citing alleged ties to Iran’s military and national security risks, including arms proliferation and providing surveillance equipment to Myanmar’s sanctioned military. The move is part of a broader effort by the Biden administration to mitigate the growing national security threat from China amid rising diplomatic tensions between the two countries. The listing is designed to prevent U.S. goods from being used by entities that Washington believes are a potential threat to Western interests. The companies added to the Entity List include subsidiaries of Chinese genetics company BGI, cloud-computing company Inspur Group, airfreight company AIF Global Logistics Co., and several electronics firms.
Nikkei: China central bank: Policy tweaks to be 'timely, appropriate.'
China's central bank officials have said that they will adjust monetary policy tools in a timely and appropriate manner and that cutting banks' reserve requirements is still an effective way to support the economy. Policymakers are aiming to support China's economic recovery following last year's COVID-induced slump. The focus of structural monetary policy will be on green finance, tech innovation, infrastructure, and housing. The government is expected to unveil more stimulus during this month's National People's Congress. However, officials say that China will not resort to "flood like" stimulus and will evaluate its structural policy tools to provide long-term support for key sectors.
Nikkei: China set for new Xi-loyalist cabinet at National People's Congress
China's annual "Two Sessions" meetings are expected to see a sweeping cabinet reshuffle as Premier Li Keqiang hands over the cabinet to his successor, who is widely thought to be Li Qiang. A new central bank governor and other top economic positions are also expected to be announced. Fresh stimulus to boost growth and signals about the monetary policy will also be closely watched. China's growth forecast for 2023 and spending plans, including defense and infrastructure, will also be announced. The meetings come as China's economy is rebounding from its weakest growth in decades but faces many challenges, including a weak property market and faltering exports.
Caixin: Chinese local governments roll out incentives for car buyers
Several cities in China are implementing policies to boost vehicle purchases after a decline in car sales in January and February, with sales of fossil fuel cars dropping more than 30% during the period. The government of Guangdong province is encouraging municipal governments to support vehicle trade-ins and promote new energy vehicle (NEV) sales in rural areas. Beijing will renew its incentive policy encouraging residents to replace their fossil fuel cars with NEVs, and the government of Chongqing is offering subsidies of up to CNY3,000 ($433) for NEV trade-ins. While these policies may boost short-term consumption, experts warn that they will also sap long-term demand.
Bloomberg: What Wall Street Gets Wrong About Xi Jinping’s New Money Men
China's upcoming reshuffle of top economic policymakers has sparked anxiety among Wall Street and Washington over fears that the new line-up may take the country towards more state intervention and international isolation. However, a report by Bloomberg suggests that experience, trust from the top, and a pragmatic approach to policymaking may be more important than rigid adherence to the economics textbook and that the new team may be better placed than their predecessors to push through the painful reforms that China now needs. The changing of the guard takes on added significance this year, as the GDP growth target for China's economy will be set at the upcoming National People's Congress in Beijing, and a shake-up of government agencies is expected. While there are still areas for improvement, there are pockets of optimism that the incoming batch of policymakers will continue to take China down an outward-looking and market-driven path.
Reuters: How China's new No.2 hastened the end of Xi's zero-COVID policy
China's new No.2, Li Qiang, hastened the end of President Xi Jinping's zero-COVID policy in December 2022 by pushing for an abrupt reopening of the country, despite plans to gradually reopen towards the end of the year. The chaotic reopening was aimed at containing the economic toll of the zero-COVID campaign and protests that had rattled the leadership. Li is set to be named the country's new premier this month. The protests in November marked a turning point in Xi's handling of COVID management as he started to take a less hands-on approach and allowed Li, his long-time ally, to take charge.
Reuters: At China political meeting, internet bosses are out, chip execs are in
Tencent founder Pony Ma and other members of China's internet industry have been absent from this year's parliamentary sessions. At the same time, delegates from the tech hardware sector will attend for the first time. The new delegates will include representatives from chip firms such as Semiconductor Manufacturing International Corporation and Hua Hong Semiconductor. The move is seen as an indication of Beijing's changing priorities as it looks to bolster its capabilities to counter US export curbs on advanced technology. Meanwhile, in a speech last month, President Xi Jinping called for technological self-reliance.
FT: Chinese brokerages pressured to end overseas investing services
Chinese brokerages that offer overseas investing services to mainland clients are under pressure to stop such services due to regulatory changes that aim to close loopholes exploited by investors to trade in the US and other overseas markets. The new regulation from the China Securities Regulatory Commission comes into force this week and builds on a multiyear initiative to clamp down on such services. The measure broadened a ban in December on registering new clients in mainland China. The brokerages, which often help Chinese tech workers manage employee equity received from outside the country, have until recently allowed mainland clients to open accounts despite not being licensed to provide overseas investment services.
SCMP: China’s yuan to ‘show good investment value’ as the economy recovers, US interest rate gap narrows
China's central bank expects interest rate differentials with the United States to stabilize, and as China's economy recovers, the yuan's role as a safe-haven asset will become more prominent, said Pan Gongsheng, Deputy Governor of the People's Bank of China. According to him, the yuan will attract international investors as an asset as well as a currency for trade, financing, and hedging. He added that there is a "relatively favorable environment and opportunities" for the internationalization of the yuan.
SCMP: Tech war: China doubles down on ‘whole nation’ approach to chip self-sufficiency as US tightens export controls
Vice-Premier Liu He has called for China to maintain a “whole nation” approach to its semiconductor industry, leveraging state and market power for growth. Speaking at a symposium in Beijing, Liu described the semiconductor industry as the “core nexus of modern industrial systems” and said it was vital to “national security and the progress of Chinese style modernization”. He also stressed that the Chinese government would provide “equal national treatment” to foreign experts under a policy to ease China’s chip talent shortage. The comments come amid growing concerns in China about US-led efforts to contain China’s development in chip technologies.
SCMP: Boeing fights off ‘heated competition’ to land 15-plane order from Hong Kong’s Greater Bay Airlines
Hong Kong-based start-up Greater Bay Airlines has placed an order for 15 Boeing 737-9 planes, marking the company's first order with the US manufacturer. The company also signed a letter of intent for five of Boeing's 787 Dreamliners. Boeing CEO Stanley Deal said the firm fought off "heated competition" from Airbus to land the deal with Greater Bay Airlines. The Hong Kong market is dominated by Airbus, with Hong Kong Airlines' fleet comprising 30 of its planes, while Cathay Pacific's budget arm is also made up of Airbus planes.
SCMP: China’s ‘two sessions’ 2023: all eyes on Beijing as lawmakers plot post-pandemic economic recovery
China is expected to set an economic growth target of above 5% for 2023 at the upcoming "two sessions" annual legislature and political advisory body meetings. However, experts have noted that to achieve this goal and restore business confidence, China must overcome challenges such as slowing export demand, rising geopolitical risk, and trouble in the property sector. China's domestic demand is also chronically weak, with observers suggesting private investment must be jump-started, and consumers must indulge in "revenge consumption" to reverse weakening demand. Additionally, Chinese consumers have been tightening their purse strings over the past year, with households adding 17.8tn yuan in bank deposits in 2022.
Foreign Policy: How the Chinese Communist Party Plans to Reinforce Its Power
The Chinese Communist Party (CCP) has concluded its annual plenary session, leaving behind hints of a promised reorganization of CCP and government structures. Chinese President Xi Jinping has called for an “intensified” overhaul to "strengthen the leadership of the Communist Party." Details of the changes are scarce, but there are rumors of an internal affairs committee falling directly under the CCP’s Central Committee, with authority over security and policing services. This committee could reduce the clout of China’s top security agencies and remind them of their ultimate subordination to the CCP. The power reshuffle may also involve an expanded role for Xi's allies. The upcoming reforms could act as a vehicle for another round of purges.
That’s it for today’s The China Brief. If you find our content helpful, please don’t forget to subscribe to our newsletter: