1、Retooling ReformIs Chinas housing market building up a bubble rivaling that of Japans in the late 80s， or the USs before 2007？ Will Chinas debts implode and foreign exchange reserves hemorrhage？ Will there be more massive job losses because of efforts to take on overcapacity？ These are the hypotheti
2、cals that Chinese and international observers and investors cant stop discussing， and exactly the ones that Chinas policymakers are trying to avoid. A “good reserve of policy instruments”in Chinas “toolkit” will tackle internal and external risks in order to achieve Chinas growth target this year， C
3、hinese Premier Li Keqiang said at a press conference on March 16. He spoke shortly after the conclusion of this years Two Sessions， the annual meetings of Chinas top legislative body， the National Peoples Congress （NPC） ， as well as the countrys political advisory body， the Chinese Peoples Political
4、 Consultative Conference. During the two-week NPC session， ministers of Lis cabinet pledged to stabilize the housing market， relieve debts and overcapacity， and encourage innovation and entrepreneurship to secure the pace and quality of growth both this year and over the next five. The goal is to bu
5、ild a “moderately prosperous society”by 2020， an ambition set out in the governments 13th Five-year Plan （2016-2020） ， which was approved by the NPC during the Two Sessions. It appears that the implementation of market-driven reform has recently been nudged higher up the central governments agenda t
6、han ever before. This reform will test the resolution and skill of its designers. The biggest challenge its architects face is that the market does not necessarily do as it is told. Pressure Points With US$1 million， you can buy 46 square meters of real estate in prime locations in Shanghai， or 58 i
7、n Beijing， respectively ranked eighth and 10th on a list of world cities with the highest property prices in 2015， according to a March 2 report published by real estate firms Knight Frank Residential and Douglas Elliman. Those 2015 figures are already significantly outdated because housing prices i
8、n Chinas biggest cities have rocketed since the beginning of the year. A new， more worrying phenomenon is that various methods of financial finagling have helped underfinanced households in those cities to circumvent the minimum down payment requirement. As NPC delegate and mayor of southwestern Chi
9、nas Chongqing municipality Huang Qifan warned during the meetings， zero down payment mortgages and soaring property prices were exactly the recipe that produced the US subprime mortgage crisis that hit in 2007. Meanwhile， less developed provinces and smaller cities， where 70 percent of Chinas 739 mi
10、llion square meters of unsold real estate inventory is located， had to hand out subsidies to attract buyers. Despite this， the countrys National Bureau of Statistics released data showing that in January and February， housing prices in these areas lagged even further behind those in big， booming cit
11、ies. The gap has been widening since property investment in China slowed down significantly in 2014 and saw nearly no growth in 2015. Taxes and fees for developed land were once local governments main cash cows. Since 2009， many local governments have borrowed huge sums of money from banks via the o
12、bscure operations of financing platforms， deluded by the fantasy of an everlasting property boom. An investigation by the NPC found accounts of contingent debts were somewhat murky. Methods of debt accumulation， as well as its breakneck pace， have become one of the two most worrying predicaments kee
13、ping analysts and Chinas policymakers up at night. The other is Chinas corporate debts. The countrys corporate debt-to-GDP ratio is staggeringly higher than those of the US， the UK and the average among G20 states. Much of this borrowed money was spent on inefficient production， causing overcapacity
14、. As a part of the renewed efforts to deal with this phenomenon， about 1.8 million workers in the steel and coal industries， mainly in State-owned enterprises （SOEs） heavy with debt， will lose their jobs in 2016. This process will possibly involve writing off bad loans on banks balance sheets due to
15、 the shutdown of factories and increased public spending on relocating laid-off workers in order to avoid social unrest. Behind this debt buildup and the bank loans that supported the property boom is Chinas huge supply of money that it has kept on the market for the past few years. China will relax
16、 its monetary policy further in 2016 to prop up growth. However， Chinas foreign exchange reserves， the main source of Chinas money supply， have fallen by US$790 billion as of February， having peaked in June 2014. There is concern that if this drop was caused by selling foreign exchange reserves to e
17、ase the yuans sharp depreciation in the context of a recent capital exodus， as widely speculated by the market， the remaining reserves could rapidly be drained. Separately， none of these issues is a major problem. Nor would they become a major problem in the future as long as the economy keeps growi
18、ng robustly. However， they are all linked in one way or another， and together they put Chinas fiscal and financial strength under a huge amount of stress. White Knights Specific solutions to each of these problems were announced at the Two Sessions. In regards to the out-of-control housing market， C
19、hinas central bank vowed to crack down on the illegal lending practice of funding down payments through real estate and online peer-to-peer platforms. Stricter restrictions on purchasing property and land supply have been announced to help big cities stabilize their housing prices both now and in th
20、e future. At a press conference during the NPC session， Chen Zhenggao， minister of housing and urban-rural development， expressed his“emotional” commitment to getting migrant workers settled in smaller cities where he sees housing markets with great potential. In the past two years， instead of renov
21、ating slums， the government has assisted some poorer residents to buy new apartments from developers through lowered prices or government subsidies. This arrangement will be further promoted this year to improve the condition of the property market and reduce unsold real estate inventory， both of wh
22、ich are goals listed in Li Keqiangs government work report that was released during the Two Sessions. By the end of Q3 2015 Many analysts recently found that Chinas total debt-to-GDP ratio， well below the average of advanced economies， is not as high as previously feared， thanks to the robust financ
23、ial position of Chinas households and the central government. While the countrys households are expected to save the hous- ing market， the central government is ready to dig deeper into its own pockets to clear up the mess of local government debts and overcapacity. The 2016 budget plan， approved du
24、ring the NPC session， has raised the public deficit to a record high of 3 percent of GDP ， an international red line. Lou Jiwei， Chinas finance minister， explained at a press conference during the NPC session that the additional deficit would be used to address some of the countrys thorniest issues.
25、 About US$15.4 billion or more will be spent in 2016 and 2017 to provide for SOE workers laid off in the new campaign to remove industrial overcapacity. This is to dispel local governments core concerns about the social unrest that typically accompanies mass unemployment. For years their resistance
26、towards stopping financial support to so-called“zombie” SOEs has been regarded as one of the major obstacles to solving overcapacity. Another process racking up a large tab is closing the fiscal revenue gap left by reduced taxes. Easing operational costs is one of the five tasks outlined in the 13th
27、 Five-year Plan. Besides more tax rebates to small businesses and lower corporate contributions to social insurance， a sweeping tax reform involving local taxes will spread to all service sectors， including the property sector， starting May 1. This reform has already been in a trial phase for two ye
28、ars. As a result， total corporate taxes will be slashed， with local governments the most affected， according to Minister Lou Jiwei. Joerg Wuttke， president of the European Union Chamber of Commerce in China（EUCCC） ， said the tax reform and budgeted spending directed toward laid-off SOE workers stood
29、 out to him in particular. The EUCCC has been following Chinas overcapacity efforts closely since 2009. As Wuttke explained to NewsChina， though European companies do not have a strong presence in those sectors， they regard lingering overcapacity as “damaging” to both Chinas economy and the credibil
30、ity of the Chinese government， and this affects their confidence in the Chinese market. He describes the tax reform as a “nanny States” warning to its children that in the future they will not be allowed to keep so much money on hand and do whatever they want， like supporting local zombie enterprise
31、s. Meanwhile， local governments are allowed to issue bonds regulated by the new budget law， local tax systems will be improved to finance local public services and money is ready to ease unemployment pains in SOEs. Wuttke said these are encouraging signs. Naturally Naughty The problems themselves ha
32、ve shown how difficult it is for even very targeted policies to achieve their intended results. For example， in early 2016， while all the restrictions in bigcity housing markets remained in effect， policymakers introduced lower mortgage rates and taxes specifically designed to boost the markets of s
33、maller cities. Contrary to design， those markets plodded forward， while real estate prices in megacities continued to run amok. Heavy debts were mainly built up by local governments and SOEs taking advantage of the big stimulus package introduced in 2008 and 2009 that was meant to cope with the sudd
34、en shock of the global financial crisis. Joint campaigns were co-launched by ministries several times over the past 10 years to get rid of outmoded overcapacity and install better facilities. The most recent previous campaign began in 2009. Yet despite these efforts， overcapacity grew. For instance，
35、 the countrys crude steel output， the biggest overcapacity culprit， increased by an annual average of 6 percent from 2010 to 2015， according to the Brussels-based World Steel Association. At the same time， China still needed to import high quantities of high-end steel products. One of the possible e
36、xplanations behind why these policies are not bringing about their intended effects is that it is often the nature of the market to think differently than policymakers. This is true everywhere. The recent relaxed monetary policy in Japan and Europe that was meant to encourage corporate borrowing has
37、 not been successful， as banks are reluctant to offer loans at such low interest rates because that would squeeze their profits. As another example， China changed the way it set the official benchmark for its foreign exchange parity price in mid-August last year in order to give the market a bigger
38、say， yet investors interpreted it as a sign that Chinas economy was in worse shape than anticipated and the government was ready to depreciate its currency to boost exports. Some of these unexpected results are the markets knee-jerk responses to certain policy tools. Big cities with more jobs and be
39、tter public services attached to residents hukou， or permanent residence permits， are naturally much more attractive to property buyers， driving those cities frenzied housing prices. Favorable policies in the name of support- ing innovation have incentivized investors to produce more solar panels th
40、an the market demanded. Increased communication with the market by Chinas central bank since February and the US Federal Reserves decision not to raise interest rates have helped slow down the outflow of capital from China. Wuttke said the countrys reliance on highend steel imports was a result of q
41、uality Chinese steelworks being run out of business by zombie enterprises that ended up wasting financial resources and racing each other to the bottom. Thus， it is crucial to always think about market forces when choosing which tools should be used. Proposed SOE reform shows why this is so important. In this round of SOE reform， more of these enterprises are being pushed towards mergers and acquisitions instead of bankruptcy. While the Two Sessions
