Alicia García Herrero (Natixis) | The market is closely watching the long-awaited Third Plenum in China, which will be hosted from July 15 to July 18 in 2024. Historically, this event has been pivotal in signaling key policy shifts and economic reforms in China. This time around, market participants and China watchers have a very specific question: will measures be announced for the Chinese economy to revive after years of underwhelming performance?
Our prediction to the question is that any measures to be announced on China’s key economic problems (from the real estate stagnancy to the restricted financial situation of local governments) will be moderate and gradual, like Chinese medicine, as opposed to a shock therapy. It remains to be seen whether gradual measures will be enough to cure the Chinese economy from its challenges. This is particularly the case since the recent emphasis on the “New Production Forces” by Xi Jinping himself, will be continued. The unintended consequence is that deflationary pressure becomes protracted, unless strong measures to support demand are enacted, which seems unlikely. In the spirit of gradualism in policy decisions, the government is also expected to provide some moderate rebates for low- and middle-income households to sustain consumption but this is unlikely to change consumption trends.
More structural measures including mitigating population aging, but introducing a welfare state is unlikely to be announced. As far as investment is concerned, which is at a record low except for manufacturing, a further appeal to opening-up to foreign competition may be included. The question is, though, how the implementation of such an opening-up will be.
The Third Plenum also needs to address the deterioration of the fiscal situation, particularly that of local governments struggling with declining land sales revenue. Given the lack of alternative revenue, one could expect an announcement at the Third Plenum increasing the tax allocation to local governments, possibly consumption tax. In addition to the revenue, managing government spending will also be key. The government will need to carefully balance the increase in pension and medical costs with the shrinking working-age population, such as through measures like postponing the retirement age, and implementing stricter controls on the government administrative cost.
The difficulty in simultaneously achieving both economic and fiscal targets is a key reason behind our expectation of a Third Plenum dominated by gradualism. The future growth model requires a shift to high-skilled manufacturing with stronger local government finance but we are not there yet. This is why only fine-tuning policies are to be expected.
All in all, the Third Plenum will address the key issues concerning the market, but the measures announced will look more like Chinese medicine than a shock therapy.
