China: Reform Is On The Agenda

China’s leaders set out their policy priorities in March during the annual National People’s Congress, promising further reform while pledging to maintain the current growth rate.

In his annual work report, premier Li Keqiang set the annual GDP growth target at 7.5%. The economy expanded by 7.7% in both 2012 and 2013. Policymakers will face multiple challenges in maintaining the economic momentum, as evidenced by recent data.

In February, China’s official Purchasing Managers’ Index dropped to an eight-month low, and exports fell by 18.1%. The country will also try to reduce its reliance on investment to fuel growth, lowering the annual goal for growth in fixed-asset investment to 17.5%. FAI rose by 19.6% in 2013, accounting for over half of the expansion in GDP.

Reforms for the financial system may also be in store as the country gradually frees up interest rates and encourages greater private-sector participation. In March the China Banking Regulatory Commission announced a banking pilot program allowing ten private companies to set up five private banks in select cities around China.

Among those companies is ecommerce giant Alibaba, which has already launched some online investment products. In fact, it now boasts the fourth-largest global money market fund, Yu’e Bao, which had deposits topping Rmb500 billion ($81 billion) as of early March.

Increased competition coupled with interest rate reform would boost returns for customer deposits. Currently, rigid interest rates depress these returns and encourage savers to seek out riskier investment options. Highlighting these risks, solar equipment maker Shanghai Chaori Solar became the first Chinese company to default on its bonds in March, prompting fears of further defaults in China’s $1.5 trillion corporate bond market.

Policymakers may also face falling foreign investment, as rising costs and other attractive investment destinations steer away multinational companies. According to Bank of America Merrill Lynch, foreign investment into China dropped by 2.9% to $117.6 billion in 2013, while the five original members of Asean saw their FDI grow by 7% to $128.4 billion.

The Chinese government is showing some signs, however, of opening additional sectors to foreign investment. Oil giant Sinopec announced earlier this year that it would seek out new investors to revamp its retail business, and in March a company official said they were open to foreign participation in that revamp. The company announced in March that it would build shale gas capacity at its Fuling site—in the Southwest—to 5 billion cubic meters a year by 2015.