This is what China's top leaders will decide at Congress

As Chinese Communist Party Leaders gather for the National People's Congress (NPC) on Friday, they will likely reinforce a key theme highlighted in this week's developments and data: reforms.

The annual meeting is China's biggest political event and primarily serves as a rubberstamp to the annual budget and various government reports. This year, the ten-day review also coincides with the approval of the next Five-Year Plan, the official economic blueprint for 2016-2020.

The biggest takeaway from the NPC traditionally tends to be the Party's annual gross domestic product (GDP) target, expected at 6.5 to 7 percent for 2016 from 7 percent last year.

"Doubtless Western economists will pore over whether the headline rate of growth is 6 or 6.5 percent,' said Mark Tinker, head of Framlington Equities Asia. "But this really is to miss the point, which is one of ongoing reform."

Indeed, the recent weakness in February factory activity data and a downward revision in China's ratings outlook from Moody's have resurfaced the urgency for Beijing to undertake structural reforms to bolster an economy growing at its slowest pace in 25 years and stabilize volatile capital markets.

"Uncertainty about the authorities' capacity to implement reforms to address imbalances in the economy given the scale of reform challenges," was one of Moody's criteria for lowering its outlook on China's Aa3 rating to negative from stable. Ratings could be slashed further if tangible progress isn't made, Moody's warned.

Among the most urgent on Beijing's to-do list at the NPC are 'supply-side' policies, or actions aimed at improving productivity.

These include reducing overcapacity in so-called 'zombie' industries, i.e. those overflowing with inventory, a long-awaited shake-up of state-owned enterprises (SOEs), removing administrative controls, and encouraging innovation, J.P. Morgan explained in a note. Other priority areas are household registration reform, urbanization and social welfare, it added.

Boosting efficiency at SOEs is especially significant given the sector accounted for roughly one-quarter of 2015 industrial revenues, but only yielded one-sixth of industrial profits, according to IHS.

To its credit, Beijing has already taken baby steps to address the matter. According to recent reports, 5-6 million workers in industrial SOEs will be laid off through 2019, on top of another 1.8 million layoffs reportedly planned in coal and steel sectors. No official timeframe was given for the latter, Reuters said.

Still, optimism for the NPC to reveal big-bang measures should be contained.

"There has been much talk in recent weeks [about supply-side measures and plans to deal with loss-making enterprises] but little about how they will translate into action on the ground," Capital Economics stated in a report.

Armed police officers clean handrails at Tiananmen Square ahead of The Fourth Session of the 12th National People's Congress.
ChinaFotoPress | Getty Images
Armed police officers clean handrails at Tiananmen Square ahead of The Fourth Session of the 12th National People's Congress.

Actions to deal with excess capacity and excess debt in key industries are unlikely to be very ambitious, echoed Charles Collyns, managing director and chief economist at the Institute of International Finance.

Rather than closures or write downs, mergers, takeovers and debt-for-debt swaps are anticipated, with excess workers likely to find jobs in the new firms, he explained.

Consequences

The level of government commitment to reforms may be reflected in the state of China's fiscal affairs, another topic high up on the NPC's agenda.

J.P. Morgan is expecting Chinese Premier Li Keqiang to announce a fiscal deficit target of 3 percent of GDP, up from 2.4 percent last year, as Beijing channels funds to support infrastructure and tax changes for companies, especially for small and medium sized enterprises (SMEs).

The People's Bank of China (PBOC) has argued that China can afford to run a deficit of 4 percent of GDP.

"But even a 4 percent budget deficit will represent greater fiscal restraint than the 6-10 percent augmented deficit that China sustained during the six years following the financial crisis," pointed out Capital Economics.

Overall, if the NPC dishes out more detail on reforms and its budget, it could prevent recent currency and equity ructions from reappearing.

"The hope seems to be that the announcement of further initiatives to strengthen confidence in growth and reform will reduce exchange rate pressures and allow calm to be restored," remarked Collyns.

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