The central government issued the full text of the Communist Party of China (CPC) Central Committee’s decision on major issues concerning comprehensively deepening reforms on November 15th, providing a roadmap for China’s further development, according to the Xinhuanet – the mouthpiece of China’s central government.
The CPC will set up a sub-committee to ensure the reform progresses smoothly, as it is sometimes difficult for certain or several departments to push forward such a complicated project. The key features of the policy statement are to emphasize market forces in the economy, scale back government direction and enhance property rights.
The CPC decided to expand farmers’ land rights, ease the decades-long one-child policy, and encourage private capital to set up small to medium sized banks. The household registration system, namely “Hukou”, that impedes free migration between rural regions and urban regions, will be scrapped in towns and small cities.
The CPC forewarned that it intends to more closely control the finances of deeply indebted regional governments. Local governments will be able to sell bonds to fund construction projects and officials will be rated on criteria including borrowing levels. Tighter control over local finances and new funding channels may limit the risk of a debt crisis (which an audit report on the debt scale at 36 municipalities by the National Audit Office in early June 2013 cautioned of).
Local governments are currently responsible for about 80% of spending while receiving 40% of the nation’s tax revenue. The larger migrant population following a loosening of the “Hukou System” is likely to place an even heavier burden on city and town governments, given concomitant social services costs. The fiscal and tax reforms are expected to broaden local governments’ sources of income, aiding a reduction in local fiscal risk.
We believe the policy statement to have several implications:
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Rely more on market dynamics to determine resource allocation (positive): Recognizing the discrepancy between housing supply and demand, the government aims to address the issue via sustainable organic growth of the housing market rather than stiff and ineffective pricing restrictions. The government-sponsored “economic housing scheme” is expected to fulfil housing needs of low-income households, while the residential housing market should target more affluent buyers. We believe further enforcement of pricing control is unlikely from 2014 onwards. However, the implementation of housing market mechanism may take time and current restrictions (especially in T1 cities) may remain effective over the next 12 months. Likewise, the government is not very likely to relax existing restrictions on second home financing, as these are targeting speculative property investments.
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Push forward legislation of property tax (neutral): the property tax will be introduced to more cities, although the collecting range and scale are expected to be insignificant in the near term. In the long run, property tax is expected to supplement local governments’ income, following a reduction in income from land sites sales.
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Ease of one-child policy and relaxation of “Hukou” may result in higher housing demand (positive): The government will loosen the population policy by allowing couples to have two children if one of the couples is an only child. This policy is intended to increase household size and therefore higher housing demand from both first time home buyers and upgraders. We are more sceptical about the prospective success of this policy given the trend of falling birth rates driven by evolving lifestyles and concerns over the cost of children. Relaxation of “Hukou” is intended to facilitate migration of the rural population and accelerate the urbanization process. The government estimates that urbanization may increase to 60% by 2030, with prospectively 200 mn more city dwellers in the next 17 years. This naturally translates into increased housing requirements and demand for better infrastructure. We believe both the property market and the cement industry will benefit from the increasing population in urban areas.
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Loosen control over interest rates and encourage banks backed by private capital (positive): Large developers and cement producers should have better access to bank financing at lower costs. The government intends to relax the control of interest rates and remove the cap on saving rates by the end of 2015. It also encourages private capital to set up banks, giving rise to intensified competition in the banking sector. However, this move may undermine banks’ profitability, as they: [1] reduce lending rates to compete for loans, [2] raise deposit rates to compete for deposits; and [3] lower lending standards, resulting in higher bad debt. We are also concerned that any partial deregulation of the financial system may feed into an asset bubble as new lenders compete for loans.
Overall, we believe the reform, if implemented as pronounced, may benefit large developers such as Country Garden, Shimao Property and Longfor, cement producers such as China Shanshui and West China Cement as well as industrials companies such as China Automation and China Lesso. Smaller developers (Agile Property and KWG Property, for instance) may lose market share in T1 and key T2 cities due to a more competitive landscape. Lastly, we believe the new policies will have limited impact on the utility companies under our coverage.