April 17, 2017

Progress and Outlook of China's Supply-Side Structural Reforms

"Supply-side structural reform (SSSR) dominates the economic policymaking landscape in China," according to a white paper published by the Economist Intelligence Unit (EIU). The paper, which is available in both English and Chinese, continues to explain: "In place for more than a year, the policy shapes everything from the government's efforts to reduce excess industrial capacity to initiatives designed to curb high levels of corporate debt, such as debt-for-equity swaps. Evaluating China's ability to overcome its chief economic challenges and sustain its economic growth is impossible without having a proper grasp of SSSR." The EIU's white paper provides the first comprehensive, independent analysis of the program.

The paper explores five components of SSSR: cutting excess industrial capacity, destocking property inventory, corporate deleveraging, lowering corporate costs and improving 'weak links.' Below are the key takeaways for businesses as presented in the paper's "Executive Summary":
  • We expect slower progress on coal and steel industrial capacity cuts, potentially applying downward pressure on commodity prices. Capacity reductions in 2016 involved a significant amount of idle capacity and were concentrated in the private-sector; they have yet to extend meaningfully into productive capacity or the more sensitive state-owned enterprise (SOE) sector. The drive against overcapacity might also be extended to sectors including automobiles, new materials and renewable energy.
  • Efforts to destock property inventory will likely have a fairly marginal impact. Investor unease and slow progress on key reforms make it difficult to stimulate demand across smaller cities. Efforts to restrain supply are complicated by the dependence of local governments on land sales revenue; a property tax is unlikely to come in force before 2020.
  • Some of the deleveraging schemes backed by the authorities, such as debt-for-equity swaps, are problematically structured and may not achieve that much in terms of meaningfully reducing corporate debt. More important will be pushing a productivity reform agenda, especially among SOEs.
  • Companies will benefit from lower effective tax rates, with the government set to ease burdens associated with administrative charges and social security. However, we do not expect a broad cut in the corporate tax rate and the introduction of the Environmental Protection Tax in 2018 will create significant additional costs for industrial firms.
  • Strong government support for innovation under strengthening "weak links" and the Made in China 2025 initiative will provide local firms with resources and capital to help their transition up the manufacturing value-chain, to the likely detriment of foreign players. There are inefficiencies associated with this top-down approach, however, and in terms of innovation, private technology companies will play a bigger role in the transformation than state-owned firms.
Importantly, the paper explains that "SSSR's close association with the Chinese president, Xi Jinping, means it is likely to shape economic policy for many years to come. Companies and investors need to monitor the development of the policy carefully if they are to be alert to both opportunities and risks in the Chinese business landscape."

How do you anticipate SSSR impacting your business?

UPDATE: The EIU held a webinar on Apr. 27, 2017 discussing its whitepaper in greater detail. You can watch a recording of the webinar through this link.

Aaron Rose is an advisor to talented entrepreneurs and co-founder of great companies. He also serves as the editor of Solutions for a Sustainable World.

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