The Two-Chinas Revolution

The pace of China’s financial reforms put in place since the 3rd Plenum in mid-November has confounded those who said at the time that nothing exciting would emerge from the meetings. In fact, Beijing has been pouring out new measures at a dizzying rate that looks likely to match the 1987 Big Bang that liberalized London’s financial markets.

Beijing has just concluded the first-ever National Urbanization Work Conference, setting out six rules that are designed to put the market in the driver’s seat as opposed to government’s overriding role.

Taken with other measures over the past two months, in relative terms, the reforms could be even bigger than The City’s, given that some of them introduce historic investor protections that have never been in place in China’s financial markets or for control of property. These are changes that are taking place across a wide range of Chinese society including land reform, electronic commerce and reform of the inefficient State-Owned Enterprise behemoths that dominate the industrial landscape.

In effect, these changes are almost creating two Chinas – an old one that prevailed for decades that is giving away to a new, truly market-oriented one. All of this is in marked contrast to the decade of relative stasis under the government of former President Hu Jintao and Premier Wen Jiabao.

And well there needs to be. According to the Chinese Academy of Social Sciences, the number of annual protests has grown steadily since the early 1990s, from approximately 8,700 “mass group incidents” in 1993 to more than 90,000 today. Some social scientists say the numbers are far greater. Mass incidents are defined broadly as "planned or impromptu gatherings that form because of internal contradictions," and can include public speeches or demonstrations, physical clashes, public airings of grievances, and other group behaviors that are seen as disrupting social stability.”

In addition, there has been massive capital flight. Over the decade starting in 2002, according to the non-governmental organization Global Financial Integrity in its report released last week, Illicit Financial Flows from Developing Countries: 2002-2011, a staggering US$1.08 trillion was illegally spirited out of China over those 10 years.

A major part of it was through trade mispricing in Hong Kong, where Chinese authorities cracked down dramatically earlier this year. Trade mispricing refers to trade between related parties at prices meant to deceive tax authorities or hide capital flight. For instance, it was estimated in a 2009 study for the Department of Economics at Oslo University that 2009 trade with Norway, using China’s statistics, was only US$2.67 billion. However, using Norway’s statistics, the same trade was valued at US$5.349 billion.

It is important to note that any system, including the best, faces the dangers of insider trading and manipulation – witness the arrests in the United States over the past year of some of the country’s biggest hedge fund managers.

But since President Xi Jinping and Prime Minister Li Keqiang took over the government, it has been showing its teeth by a vast cleanup of corruption unlike anything seen since the days of Prime Minister Zhu Rongji from 1993 to 1998.

Hundreds of party officials have been arrested or disciplined, and two of the biggest ministries – railways and oil and gas – have seen their top leaders cashiered. The wholesale catering trade and high-end liquor sales, particularly of Maotai, the de rigueur toast at lavish banquets, have both taken dramatic hits. The market appears to be taking notice of the government’s campaign against extravagance. And, although no names have been given, this massive home, for sale in Australia, is thought to have belonged to one of those arrested, and now must be liquidated.



Whether reform can continue without systemic change is up in the air. President Xi has emphatically defended the Communist Party’s stewardship of the government and the economy, making it clear there will be no political reform. This is a country where societal corruption is endemic and has been depressingly and convincingly demonstrated in everything from the building of roads and bridges to the production of infant formula and passing off rat meat as pork and well beyond.

Financial Reform

In 2014, Beijing is expected to accelerate financial reforms to bring its capital markets up to par with the international playing fields. In terms of access to capital, banks still hold the key. But that is changing very fast.

Direct financing – through the equities and bond markets – now stands at about 15 percent of the capital raised in the financial markets, up from just 5 percent a decade ago. There is only one way to go, and that is up, as government leaders have identified the bond market in particular as the antidote to the borrowing splurge by local governments that has created at least US$1 trillion of debt by local government financing vehicles (LGFVs).

The government is in the middle of an audit to find out this magnitude of the debt and then must find ways to clean it up. Beijing so far has been extremely reluctant to shoulder any of it. It still has been unable to get a handle on the shadow banking sector, where man of these debts have originated.

The rapid growth in China’s equities markets has not been without its side effects. Insider trading and stock market manipulation have been rife and investor behavior has been overwhelmingly speculative. In 2011 and 2012, every initial public offering was oversubscribed and nearly half were oversubscribed by more than 100 times, leading the securities regulator CSRC to suspend all IPOs in November 2012 to rejigger the listing rules and disclosure requirements.

Now, more than a year later, the CSRC has declared 2014 to be the year of financial reform to implement the new rules. The equities markets are moving toward a disclosure-based system like most developed western markets and Hong Kong in line with Premier Li Keqiang’s “small government, big market” philosophy.

That means a busy year for China’s IPO market, which is readying to make up for the 2013 suspension. In 2012, there were 154 IPOs, raising just over RMB 100 billion (US$15 billion), which was considered very soft. Today, with 763 companies in the IPO pipeline, 83 candidates are in the final stage of listing approval, and 50 are likely to receive green light in January. Technology, media, high-end manufacturing, life sciences and healthcare take up the bulk of what is coming up.

In the banking sector, private companies are establishing new small and medium banks that hopefully will be nimbler and more innovative to compete with the state-owned, old guard “big four,” Bank of China, China Construction Bank, the Industrial and Commercial Bank and the Agricultural Bank. In addition, China’s highly successful internet companies are being given the opportunity to take a crack at internet finance through government-granted banking licenses.

In terms of financial deregulation, China’s new free trade zone forms a pilot project that promises breakthrough experiments including easier cross-border investment flows, qualified foreign investor access and a so-far untested amount of capital account convertibility.

Land Reform

To fully grasp the concept of land reform, it is imperative to realize China is undergoing creative destruction – the destruction of one China and the creation of another. In accordance with the moving of a vast tide of rural residents to the cities, which began 30 years ago with Deng Xiaoping’s opening of the Pearl River Delta to international investment, for the first time the government is experimenting with giving local people more say over control of the land they live on or farm.

This should play a role in slowing the abuses by local officials who have in the past simply appropriated farmers’ lands, generating troubling friction that has led to riots in newly urbanizing areas.

It will seek to avoid the development of widely publicized “ghost cities’” as well as the further expansion of its mega cities such as Shanghai and Beijing as well as increasing living spaces, especially for residential use.

This will require a revolutionary reform of the tax system. Local governments pay 85 percent of all expenditures but collect only 52 percent of fiscal revenues, primarily through selling land – thus the thousands of protests that take place in the countryside as local officials seize land. It is also this lack of funds that led to the gigantic LGFV crisis mentioned above, as local government officials turned to off-budged financing vehicles to finance development

In the urbanization conference, China formalized a series of key tasks including gradually reforming the infamous houkou system to allow the millions of workers who have migrated from the rural areas to have residency rights, giving them the right to vocational training, medical attention, schooling and other amenities.

City residential permits for towns and small cities will be fully liberalized. Currently, the ratio of the migrant population – 23 percent of the urban population – to public services is 45.2 percent and their standard of living is 51 percent of their urban counterparts.

Authorities in larger cities will gradually allow qualified rural migrants to become city residents, although Beijing is expected to keep strict controls on the populations of the so-called mega-cities in an effort to forestall the chaos that has overwhelmed other Asian cities such as Bangkok, Mumbai, Manila and Jakarta, where rural residents have swarmed into urban areas in search of jobs and other opportunities.

The urbanization committee also set land supply rules, with intensive use of existing land encouraged, and the quantity and quality of arable land will be maintained. The government will seek to reduce land supply for industrial purposes while increasing residential living space.

In an effort to provide adequate funding for local governments, Beijing is working to establish a multi-sourced, sustainable funding system to identify main tax revenue sources. The central government says it will link the scale of fiscal transfer payments to local governments, establish a local debt issuance management system and encourage private investment in construction and operation of urban infrastructure.

Fourth, Beijing says it will seek to “optimize” the locations of cities and towns outside the major capitals. In fact, the government plans to expand 20 major inland capital cities to house 7 million people each to serve the needs of more than 800 million people to make them the growth focal points in their respective areas

Fifth, in an apparent acknowledgement of the problems that have dogged the current satellite cities, the committee said it will “improve urban construction levels by realistic positioning and scientific planning” while trying to preserve countryside landscapes.

Sixth, local governments will be required to propose realistic urbanization plans and cultivate specialists in city management.


China is already the world’s dominant supplier in terms of telecommunications equipment, and its massive 600 million netizen community has kept on bringing surprises, with the latest big thing in the online-shopping space. E-commerce has surged in recent months, with online sales growing over 40 percent annually in the third quarter before more than doubling in November on a huge sector wide promotion campaign called “Singles Day.”

China will overtake the US this year as the world's largest e-commerce market. A China Daily survey found online purchases have become the first choice among shoppers in Tier-1 cities. The consultancy AT Kearney’s 2013 Global Retail E-Commerce Index estimates that the country’s US$64 billion online retail market is expected to grow to US$271 billion over the next five years, vaulting it to the top of the list for the world’s 30 most promising online markets. Japan and the United States are expected to fall to second and third place respectively.

With a developing “Next Generation” categorization, China’s e-commerce market has “been able to shortcut the traditional online retail maturity curve as online retail grows at the same time that physical retail becomes more organized,” according to the report. Although there are still significant logistical challenges, the report predicts that “infrastructure improvements, increased Internet access for rural regions, rising wealth, and consumers’ growing predisposition to spend” will all lead to the market’s continued boom.


The main factors enticing Chinese online shoppers to buy have been pricing, promotions, and the broad assortments of goods.

“Although the market is clearly booming, the listed logistical issues still have a major impact on luxury retail, where expectations of quality are high,” according to Jing Daily. “However, improvements in infrastructure and the rapid rise of incomes in a massive number of lower-tier cities with fewer brick-and-mortar retail stores is likely to boost luxury e-commerce sales in the years to come.”

(Steve Wang is Research Director and Chief China Economist for REORIENT Securities Ltd. of Hong Kong and a frequent contributor to Asia Sentinel)