Apr 25, 2020 07:24 PM

Caixin Insight: Cracking the Hard Nut of Factor Market Reform

Welcome to the newest issue of the Caixin Insight newsletter, which provides more in-depth and incisive views each week on what’s happening in the world’s second-biggest economy as it gets back on its feet after Covid-19. This issue was compiled on April 22.

There were few surprises, with China’s quarterly GDP data coming in just as bad as expected, and the post-data release Politburo meeting confirming that an unprecedented crisis requires an exceptional response.

“New infrastructure” was finally defined by an NDRC official, and the ball is finally rolling on long-discussed foundational reforms of factor markets including land and labor. Regulators are also continuing to crack down on Covid-19 relief money going where it shouldn’t, but may struggle to manage Chinese companies like Luckin with corporate structures overseas.

Macro update

China released its worst-ever quarterly growth figures on April 17, reporting that

• GDP shrank 6.8% year-on-year, or 9.8% quarter-on-quarter

• fixed-asset investment shrank 16.1% year-on-year, narrowing from a 24.5% drop in the first two months

• infrastructure investment fell 19.7% year-on-year, moderating from a 30.3% slump in the first two months

• value-added industrial output fell 1.1% year-on-year, after sinking 13.5% in the first two months

• retail sales dropped 15.8% year-on-year, easing from a 20.5% decline in the first two months

The last time China reported a drop in GDP was in 1976, before quarterly data began, when the economy contracted 1.6% for the full year. The March data, however, showed some signs of recovery, particularly in terms of retail sales, industrial output and fixed-asset investment.


The pickup in March data is a clear signal that China’s economy is beginning to get back on track, helped by stimulus efforts which are both starting to take effect and accelerating, most recently with an announcement (link in Chinese) on April 20 from the Ministry of Finance that local governments would issue another 1 trillion yuan ($141.2 billion) of special-purpose bonds (SPBs) by the end of May. In a meeting for clients organized last week by Caixin Media and Caixin Global Intelligence, People’s Bank of China Governor Yi Gang said that China’s entire economy, in terms of recovery and resumption of production, has performed better than anticipated.

The central government has repeatedly said it will increase the local government SPB quota, and market expectations have also increased significantly, with some observers expecting issuance to exceed 4 trillion yuan. Their scope has also been significantly expanded, allowing the money to go towards renovation of older residential areas, public health and other municipal facilities, and especially towards new infrastructure, with a higher cap on the ratio of debt to capital spending, up from 20% to 25%.

Factor market reform: A hard nut to crack

China’s Communist Party central committee and State Council issued a set of guiding opinions (link in Chinese) on “setting up a better market-oriented production factor allocation mechanism” on April 9, the first central committee document to address factor markets in a systematic, integrated way.

Factor markets have been on the back-burner for decades, and made a priority at the 19th national party congress in 2017, but little progress has been made. The document’s release at this time illustrates that “desperate times call for desperate measures,” notes Zhong Zhengsheng, head of Caixin subsidiary CEBM Group.

The document calls to “remove institutional barriers that hinder the free flow of factors, expand the role of the market in factor allocation, improve factor markets and promote their construction, and marketize the prices, flows and efficient, fair allocation of factors.”

This is not an easy task, but conducting foundational reforms such as these can give Beijing more bang for its buck on direct fiscal stimulus, which is poised to expand in the months to come.

We don’t have space here to fully unpack the document, which touches on everything from land, labor and capital to technology and data. Many aspects are not new, but bring together key points from disparate documents previously issued by an array of other ministries. The primary highlights, however, are land and labor reform:

- exploring and promoting conversion of different land use types in different industries, and increasing land supply for mixed-industry use

- exploring establishment of a national trade mechanism for construction land and supplementary agricultural land

- exploring and promoting mutual recognition of “hukou” in the Yangtze River Delta, Pearl River Delta and other city clusters

- relax hukou restrictions in all cities excluding several megacities and pilot household registration based on residence

Part of the reason land reform has progressed relatively slowly in comparison to other areas is that it is foundational to China’s economic model — the transition from land-based development towards a new model of innovation-driven growth is the single most challenging aspect of China’s economic transformation, argues preeminent land rights scholar Liu Shouying. The reform also plays into President Xi’s signature rural revitalization initiative, creating a more interactive relationship between cities and the countryside, and taking the pandemic as an opportunity to push through challenging reforms.

The hukou reforms accomplish a similar goal, tearing down restrictions on labor mobility between rural and urban areas, and addressing long standing inequalities in the allocation of public resources, which under the hukou system are mostly tied to one’s place of birth rather than residence. Fully unrolling the system will take years, however, as it entails fine-grained, rolling changes in the division of responsibilities between central and local governments.

Oil futures crash not happening in China

The May WTI crude oil futures contract settled at -$37.63 on April 20, making history and falling below zero for the first time. Traders with long May WTI futures were forced to sell at a negative price to avoid storage costs, which are rising fast.

However, the historical crash is not likely to be replicated in China. Trading rules and storage capacities (and thus prices) are very different than in the U.S. Traders in China are able to store crude for prolonged periods at a flat rate, and face much lower risks of being forced to sell.

Moreover, Chinese trading ports have just enlarged storage dedicated to oil futures trading. On April 21, the Shanghai Futures Exchange approved 1 million cubic meters of new storage in Zhanjiang, home to a major Sinopec refinery, and Dalian, home to one of China’s most important commodities exchanges. The addition brings newly approved Shanghai Futures Exchange storage to 2.05 million cubic meters since the beginning of April.

However, some Chinese investors have been affected nonetheless via crude futures trading tools hosted by Bank of China. These trading tools are very similar to actual crude trading, with traders buying and selling security notes pegged to actual crude futures held by Bank of China. Unfortunately for holders of the notes, Bank of China’s WTI futures position was set to mature on April 20, and thus the bank had to sell at negative prices, resulting in huge losses passed on to investors.

Relief money not for real estate, Shenzhen banks warned

A recent surge in Shenzhen housing prices raised red flags for regulators, who have begun a probe into whether concessionary loans to small and micro businesses amid the Covid-19 pandemic ended up flowing into the property market there.

The loans have much lower financing costs than usual, as low as about 2% compared to 3.9% to 4.5% before subsidies. The Shenzhen branch of the central bank issued an internal notice on April 20 to commercial banks operating in the city, requesting them to check outstanding loans for possible exploitation, and the local bureau of the China Banking and Insurance Regulatory Commission is coordinating to “strengthen management.”

Shenzhen’s housing price rally has been the strongest among tier-1 cities since March. New and resold condo prices rose 0.5% and 1.6% month-on-month in March respectively, three times the national average numbers for big cities, data from the National Bureau of Statistics show. However, the housing market is still tightly regulated and there are no signs of deregulation in the near term, as the April 17 Politburo meeting clearly indicated.

How companies like Luckin dodge regulation

Luckin is not the first overseas listed Chinese company to be plagued by scandals. In 2010, more than 20 Chinese companies delisted from U.S. stock markets, after multiple scandals surrounding Chinese companies listed in the U.S. However, many of the executives at those scandal-ridden companies continue to enjoy successful careers even after their companies delisted.

One reason is jurisdiction: these executives can often dodge their liabilities by staying in China and pay only a small amount for reconciliation. In the case of Luckin, China’s securities regulator harshly criticized the company after its fraud disclosure and pledged to assist U.S. regulators in an investigation. But Chinese regulators’ enforcement powers over Luckin will be limited because it’s registered in the Cayman Islands and traded overseas, analysts said.

The other reasons are more complicated and inherent to cross-border listings. Besides the difference in regulatory frameworks, lack of cooperation and documentation sharing is also a key problem. U.S. regulators often fail to obtain crucial audit working papers needed to press charges, because they are stored in China and there are no existing mechanisms to share them.

The Luckin problem is about more than one company. It also reflects long-standing cracks in China-U.S. coordination of financial supervision that offer room for dodgy business practices. Overseas-listed Chinese companies will always be shadowed by investor skepticism until the issue is resolved, a foreign investment banker told Caixin.

Defining “new infrastructure”

“New infrastructure” has been a hot topic for a little while now but had not been formally defined until April 20, when the director of the National Development and Reform Commission’s (NDRC) innovation and technology department set guidelines for the buzzword at a press conference (link in Chinese). Wu Hao said new infrastructure includes three broad categories:

- infrastructure based on next-gen IT (5G, industrial internet, satellites, data centers, etc.)

- integrated infrastructure (applications of the above, including smart city projects, smart grid, etc.)

- innovation infrastructure (including state-run or publicly beneficial labs, tech parks, R&D centers, etc.)

Wu’s definition differs somewhat from the previous market interpretation which was largely based on a March 2019 CCTV report, as it excludes ultra-high voltage electric grids, intercity high-speed rail, new energy vehicle charging piles, and other high-tech but less “smart” infrastructure. Zhu Baoliang, chief economist of the State Information Center, commented that the market understanding was biased, as these areas had not been described in official language on the term.

However, Wu noted that the connotations of new infrastructure are not immutable, and may expand along with technological development, adding that the NDRC will work to strengthen top-level design and issue further guidelines.


The April 17 Politburo meeting sent two strong signals, both anticipated in our April 15 brief.

First, it clearly acknowledged the severity of the impact of Covid-19, saying the first quarter was “extremely unusual,” with an “unprecedented impact,” and introducing six new “guarantees” on top of the standard “six stability” targets in place since August 2018. The six guarantees are a stark illustration of the depth of the crisis:

- basic operation of government

- basic livelihoods

- employment

- supply chain stability

- market entities

- food and energy security

Second, the meeting clearly called to strengthen stimulus, saying directly that the sense of urgency must be strengthened, and that a greater macro policy effort is needed to offset the impact of the pandemic. Employment is the primary concern, mentioned four times in the readout, and the only item in both the “six stabilities” and “six guarantees.” It is the central focus of the macroeconomic policy response as noted in our meeting on April 17 with Governor Yi, and much of the reason support has been targeted at small and midsize enterprises, which are by far China’s biggest employers.

There was no mention of growth targets, which suggests there is a possibility that they may not be used at least in the short term. The readout concluded that real estate should not be used for speculation, an indication that it will not be used for stimulus, and noting that China should instead lose no time in promoting reform, specifically highlighting market-oriented allocation of production factors as discussed above.

Looking ahead

The National People’s Congress Standing Committee will meet from April 26 to April 29, when it will likely

- approve additional local SPB quotas as procedurally required

- set the timing of this year’s “Two Sessions,” potentially as soon as mid-May



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