What 2011 holds

The over-arching story from China this year will be the government’s attempt to curb inflation and bring monetary expansion under control while keeping overall growth high to create jobs and give the new Five Year Plan (FYP) a chance of lifting off towards rebalancing.

While rising prices cause obvious complaints, my overall impression after spending the last three months of 2010 in China was of the strength of demand at all levels. Wealthy people paying way over the odds for luxury products or forking out $15 for a cup of coffee in a hotel lounge are only the cream on the much thicker cake of consumerism that has taken hold in Chinese cities, spearheaded by acquisition of property. The crowd in the photograph below is not attending a sports event but filled a stadium in Taizhou City, Zhejiang, to take part in the drawing of lots for local apartments this week. Officials may urge restraint and warn of the danger of young people becoming ‘property slaves’ but as one young man said to us in Beijing "I want to be a property slave so I can make more money."

This thirst for consumption is, of course, what the authorities are counting on to fuel the rebalancing away from dependence on exports and fixed asset investment. Rising wages are there to be spent not added to savings. So how does a government out to pump up consumerism control prices and get people to borrow less? With difficulty at the best of times, but even more so when the leadership shows every sign of preferring a cautious, incremental approach.

Hu, Wen and Li

While Hu Jintao proclaims the enduring correctness of ‘Socialism with Chinese characteristics’, both Wen Jiabao and his putative successor, Li Keqiang, recognise the scale of the challenges China faces as shown in our reports tracking leadership thinking last summer and autumn.

‘Grandpa’ Wen, the human face of the regime, may be aware of the need to act but, as shown by the dismal fate of his August call for political and legal reform, he lacks the political weight to blaze a new trail. A consummate chairman of meetings who takes notes of what everybody says and ends by suggesting a new session in due course, he is not one to engineer a sea change of the kind China needs. Otherwise, he would probably not have survived so long after his association with reformers in 1989. Will Li be any more forceful when he succeeds as Premier in 2013? No sign of it.

Long live the stimulus

The two-year stimulus programme launched in November 2008 is officially over. But its legacy remains strong in infrastructure spending (as in the urban transport plans analysed in our report last week) and in the limits to monetary tightening; the case-by-case nature of selective controls now in vogue leaves plenty of room for officials to show tolerance for favoured local or sectoral interests. Half-a-dozen provinces and big municipalities plan to double their GDP in the Plan period starting this year, double the rate envisaged centrally. Measures to bring down real estate prices have still not proved effective and our recent visits to cities in central and north-east China showed high levels of new construction work.

All this means that 2011 is likely to be a messy year in which direct investors in China should exercise caution and the best opportunities are likely to lie in companies supplying China’s priority growth sectors. As they strive for smooth progress into the transition period of 2012-13, the leaders are going to have to fight a series of economic forest fires while keeping a weather eye open for social stability. Here is what I and my colleagues expect:

Politics:

The driving imperative in 2011 will be to ensure a smooth approach to the leadership change the following year. The main actors are lined up, as set out in our report in July, but their accession to the top jobs will not bring any major policy shifts from the consensus aims expressed in the FYP and in the report earlier in the year by Li Keqiang. The main joker is likely to be to be the high-profile boss of Chongqing, Bo Xilai, who has been accompanying his experimentation in areas such as hukou reform by peppering his speeches with Maoist phrases and encouraging the singing of old revolutionary songs – presumably to underline his family links to the past in contrast to the upstarts now at the helm.

With the future Fifth Generation leadership divided between Xi Jinping’s coastal group, Li’s Youth League group as heirs of Hu Jintao, and free agents epitomised by Bo, the dispersal of authority will continue and make hard decisions that more difficult to take.

Economy:

Growth for 2011 will be around 9 per cent. Wage rises will be the main tool to boost consumption. Structural factors analysed in our report in December will underpin inflation.

There will be a strong focus on urbanization with centrally-approved spending on urban transport as detailed in our note this month. Expansion of affordable housing will be held back by local funding short falls and pricing problems. But there will be adequate funding for approved infrastructure projects which will mean continuing high demand for steel and other materials. The government will also support improvements in logistics.

Administrative measure will be the main weapon against inflation. Monetary tightening in H1/2011 is likely to bring two reserve requirement increases, applied to selected banks, and two interest rate rises. The property market will remain robust; the latest monitoring shows prices up by 30 per cent or more year on year in eight out of 15 main cities in 2010 as a whole. A property tax will be rolled out in Chongqing and Shanghai, but is likely to be aimed mainly at high-end real estate. Local governments dependence on land sales for revenue has grown - government figures show revenue from the source rising by 70 per cent last year.

Chart 1: Property prices in 70 large and medium cities, July 2007 - November 2010 (per cent change)

Social policies

The health programme will run into practical problems for reasons we set out in our report in November. There will be experiments in reform of the hukou residential registration system but liberalisation will be held back by funding issues and by the unwillingness of farmers to give up land leases when food prices are booming.

Foreign relations

Beijing will not give any significant ground in its dealings with governments abroad. It will stick to its currency policy vis-à-vis the dollar, invoking its inflation rate to try to placate foreign critics.

China will make sweet music towards euro-zone countries on the lines of the offers by Wen and Li to consider buying bonds of Mediterranean countries. China has no desire to see a slump in Europe, its biggest trading partner, but it will also be looking for payback on two fronts – a lifting of the EU arms embargo and recognition of its market status.

Closer to home, political relations with Japan will be tetchy. China’s military build-up will alarm its neighbours and face Washington with a continuing strategic dilemma as to how strongly to react. Beijing, meanwhile, will be suspicious of the development of a Washington-Tokyo-Seoul link-up to its east while the US and India join hands to its west. Further afield, China will seek closer relations in Latin America; Brazil is becoming a growing destination for investment as well as a supplier of iron ore, energy and soy.

In this blog, I will be following many of these themes through the coming year. I hope that you will feel inclined to contribute your views so that we can evolve an on-going discussion of where China is heading.