SUMMARY
- China’s full Third Plenum “Decisions” document contained few surprises relative to expectations or the communique released on Thursday; investor attention will now turn to the end-July Politburo meeting, which is likely to signal a modest increase in stimulus in H2 2024
- The Third Plenum’s policy agenda continues a prioritization of innovation and industrial policy as the key to Beijing’s economic strategy; the lack of attention to broader liberalization and to demand-side policies pose risks for the medium-term growth outlook
- Beijing has outlined important steps on fiscal reform and urbanization, but the pace of implementation is unclear amid tricky questions over resource-sharing; the Plenum document also pledges to increase the attractiveness of capital markets, but the “real economy” and industrial policy goals may trump pleasing investors
China released the full text of the Third Plenum “Decisions” document overnight (an English translation can be found HERE on the Substack of a Chinese journalist). There were few surprises in this document, which elaborates on a shorter communique that was released when the plenum concluded on Thursday (see our recap of the communique HERE).
The underwhelming results of the Third Plenum met our subdued expectations and those of investors. We did not expect the meeting to be a market catalyst, though noted some risk to the upside simply because the bar for Beijing’s reform plans had been set so low (see our preview report HERE). But the unexciting basecase scenario was correct: there were no unexpected signals in the areas that matter most to investors, including China’s macroeconomic framework, signaling on growth versus other tradeoffs, and the regulatory stance towards firms and markets. The broad market reaction to the plenum is thus likely to be neutral; at the very least, we see little reason to expect a positive response.
When it comes to the near-term outlook, investor attention will now turn to the end-July Politburo meeting (exact dates TBD), which will outline Beijing’s stimulus plans for H2 2024:
- As we noted in a quick take on Friday (link HERE), recent messaging implies that the Politburo will signal an incremental increase in stimulus support in H2. The main tool will likely be a faster pace of fiscal spending, which lagged in H1. To be clear, Beijing is not signaling the kind of aggressive stimulus that would be necessary to supercharge weak domestic demand, break out of deflationary pressures, and alter a subdued macro outlook. The goal is to keep the GDP growth target of “around 5%” on track and to avoid downside risks after Q2 GDP missed estimates (see our analysis HERE).
- We do not expect the Politburo to announce near-term changes to property policies. At the Third Plenum press conference on Friday, HAN Wenxiu (an official in the key Party body that coordinates macro policy), cited recent “positive changes” in the property sector since a series of support measures in May. Han was likely referring to a sequential improvement in property sales in tier-one cities and perhaps a slower rate of decline in housing prices. Beijing will likely need to further step up support for the sector later this year, but Han’s positive spin suggests for now that Beijing will assess the effectiveness of its recent measures.
IT’S (STILL) ALL ABOUT TECH AND INDUSTRIAL POLICY
The Decisions document outlines Xi Jinping’s economic agenda for the next five years. Rather than set specific commitments or quantitative targets, it contains high-level pledges across multiple areas of policy. The Plenum’s overall policy framework centers on:
- “Chinese-style modernization,” which stresses China’s unique (non-Western) development path;
- “High-quality development,” which means Xi’s focus on quality of growth over quantity; and
- “New productive forces,” a recent mantra that refers to boosting productivity through innovation, particularly in the manufacturing sector
Beijing also released an official “explanation” of the Plenum by Xi. While largely a summary of the content and the drafting process, it contains some interesting nuances – including Xi observing that the document gives a more prominent place for “national security” compared to the last major Third Plenum in 2013, one year into Xi’s tenure.
The Third Plenum reaffirms that Beijing’s central policy focus is promoting innovation and advanced manufacturing. China’s leadership believes that the current reform direction is correct, but that China must spare no efforts to boost its self-reliance in technology and enhance the security of its industrial supply chains. These goals are as much about geopolitics and the US-China strategic rivalry as they are about economics. The policies to get there include reforms to higher education in STEM, talent development, corporate R&D incentives, the government laboratory system, and pledges to boost funding for key industries and technologies.
Beijing’s strategy for avoiding the “middle income trap” is through increasing innovation capacity and manufacturing productivity, but this may be difficult without broader liberalization. The Third Plenum pays less attention to the deeper reforms to China’s system that are likely necessary to sustainably boost productivity growth – in particular, shifting more resources away from the state sector to more dynamic private firms, and removing other political distortions in the allocation of capital and credit. The Plenum does pledge more legal and political support to the private sector – including the intent to draft a new “private sector law” – but does not imply fundamental changes to the role of the government vs. the market or an effort to scale back the role of state-owned enterprises. The lack of more ambitious liberalization will likely make it more difficult to maintain high rates of growth over the medium term, especially as demographic and debt constraints mount.
Amid Xi’s focus on supply-side reforms to promote advanced manufacturing, policies to promote consumption demand and the service sector continue to get short shrift. The Decisions document says little about accelerating household consumption or development of the service sector, both of which are necessary to reduce China’s reliance on investment and exports as demand drivers. China’s growth pattern since the pandemic has been one in which the supply-side of the economy (manufacturing production and investment) outpaces domestic demand, with consumption of goods especially weak. This imbalance has contributed to deflationary pressure at home and a record manufacturing trade surplus – along with corresponding trade frictions. The Plenum does not outline a clear path out of this dynamic.
While not new, there are two particular categories of industries and technologies earmarked for special attention by Beijing:
- “Strategic industries” include next-generation information technology, artificial intelligence, aviation and aerospace, new energy, new materials, high-end equipment, biomedicine, and quantum technology;
- The document also pledges to bolster “key industrial chains” including integrated circuits, industrial machine tools, medical equipment, instruments, basic software, industrial software, and advanced materials;
In both of these categories, investors should expect intense efforts to promote domestic firms and technologies and reduce dependence on the US and close allies. While this will mean opportunities for some domestic firms, it also runs the risk of excessive/duplicative investment that makes it harder for investors to pick winners and depresses profitability and rates of return – as has been the case with sectors such as solar energy and batteries. The Plenum hints at steps to improve coordination and reduce duplicative investment at the local level, but excess capacity and related issues are likely to seem remain a feature of the system.
MACRO AND STRUCTURAL POLICIES
Fiscal reforms: As expected, the Decisions document outlines reforms to the center-local fiscal relationship but says little about local government debt. The collapse of the real estate sector, which provided a key source of revenue to local governments, has been the final straw for a fiscal system badly in need of reform. The Decisions document pledges both to boost the tax authority of local governments and to move some expenditure responsibilities to the central government, as well as to improve the transfer system by which the central government redistributes funds from rich provinces to poor provinces. The document pledges to create a mechanism to manage local government debt, and to accelerate reform of local government financing vehicles, but without further details. Outlook: These are necessary steps to address a broken center-local fiscal system. The practical impact will depend on just how much control over resources Beijing is willing to devolve to local governments.
Financial reforms: Beijing aims to make capital markets more attractive, but the “real economy” may come first. The Decisions document echoes recent pledges from the State Council and securities regulator to focus on making China’s capital markets more attractive to investors. Those commitments include corporate government and listing reforms that take a page from Japan’s recent playbook. While these technocratic steps are worth watching, deeper governance and structural factors may hold back the dynamism of listed firms, including Beijing’s desire for listed state-owned firms to serve political goals, a priority on funding industries that meet industrial policy needs (but may not be the most profitable), and an overall stance of prioritizing the “real economy” – in particular, the manufacturing sector – over a more expansive role for the financial sector. Outlook: When push comes to shove, capital markets policies may continue to favor issuers and broader policy priorities over high returns for investors.
Housing: The document says relatively little new about the long-term future of the property sector. The language is consistent with the current policy direction of developing affordable housing and a rental market while giving local governments more space to ease policies. Outlook: Beijing’s view of the future of the property sector is still evolving, but the leadership is not positioning it to return as a key growth driver.
Urbanization/demographics: Expect incremental efforts to narrow the rural-urban divide, but fiscal support will be key. The Decisions document pledges faster progress in allowing migrants to cities to obtain residency permits (hukou) and access to social services. It also pledges efforts to raise the fertility rate (such as childbirth subsidies) and to raise the retirement age. Outlook: Faster and more effective urbanization is important for boosting long-term consumption (migrants without social services spend less) and property demand, especially in tier-1 and tier-2 cities. However, the Decisions stops short of specific timelines for hukou reform or a pledge by the center to provide fiscal help. The pace of implementation is thus open to question.
We will have more analysis of the Plenum and the reform agenda as more details and context comes out. We will also be looking out for additional signals ahead of the upcoming end-July Politburo meeting.
