Issue 49

3 March 2014

SMU Political-Economic Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PUBLICATION
Keep a lookout for the new makeover SPEX will undergo, coming your way in Issue 50!

This Issue in Brief:

The Tapering of QE: Effects on Emerging Markets
In December 2013, the US Federal Reserve announced its intentions to start scaling back on its bond-buying stimulus programme quantitative easing, or QE for short, starting January 2014. With QE already in its third iteration, a team of writers from SEIC give an overview on the background of QE, and offer some insights as to how the withdrawal of QE may impact emerging markets and the global economy. In collaboration with

Xi Jinping and Chinese Economic Reform

China is facing a serious economic challenge ever since its GDP in 2013 grew the least since 1999. Officials have demonstrated a commitment to reform, but many are sceptical whether or not the proposed reform package will actually be implemented as planned. Will President Xi be able to implement his ambitious reform package to change China for the better or will he postpone the necessary, but dangerously ambitious economic reform and worsen the situation? In two separate articles, Jian Kangyue and Kuang Wencan will provide an analysis as to Chinese economic reform efforts.

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The Tapering of QE: Effects on Emerging Markets

By Alvin Yue, Dinh Thai An, Lee Yin Wei Even after five years have passed, the effects of the 2008 global financial crisis that brought down major financial institutions all over the world still linger on today. The bankruptcy of the investment bank Lehman Brothers during the crisis is an episode that will be remembered for many years to come. The bursting of the housing bubble in 2007, widely seen as the trigger to the global financial crisis, threw the entire US economy into chaos and marked the start of a great recession across the world. Naturally, the Federal Reserve, being the central bank of the United States (US), had to do something to salvage the situation. Their immediate response was to unfreeze the credit crunch by purchasing large amounts of government debt and private assets from banks, so as to inject huge amounts of liquidity into the credit market. Such an action is known as monetary policy, which involves controlling the amount of money circulating in the market in a bid to control the level of economic activity in the country. As liquidity increased then, it became easier for consumers and firms to borrow money from banks for their spending or investments, and this led to a fall in short-term interest rates. However, when short-term interest rates approached zero, it meant that the Federal Reserve could no longer carry on with their conventional monetary policy, and they would have to adopt an unconventional monetary policy instead, better known as Quantitative Easing (QE). Simply put, it involved the purchase of long-term assets with longer maturities than short-term government debt, and doing so would lead to an increase in money supply and a lowering of long-term interest rates. Since December 2008, there have been three stages of QE in the US, each differing in the amount of assets being bought by the Federal Reserve. The overall result of the three QEs was that of the creation of an unintentional QE trap. This meant that to completely back out of QE, there would be dire consequences for economies around the world. The QEs have essentially created a higher demand for US dollars outside of the US than within the nation itself. To use an analogy, QE is now akin to an antibiotic that the ailing world economy is addicted to; one that is used to suppress the symptoms of a fragile economy.

QE1 Expected and Unanticipated

The financial crisis of 2008 led to one of the worlds worst recessions since the Great Depression of 1929. In a bid to tackle this crisis, the Federal Reserve and Treasury Department introduced QE1 in November 2008. It spanned a duration of 17 months during which $100 billion worth of mortgage-backed securities were purchased monthly to bolster the housing market, which was devastated by the subprime crisis. The level of investments was stimulated as a result, and the economy did indeed strengthen as a result of greater liquidity and credit market support. The fact that interest rates were lowered from 6.3% to 5.2% stimulated the US economy, and the Feds aim to create mild inflation was also realized in the creation of more US dollars. This was due to the fact that inflation was seen as proof that demand in the economy was growing, thereby aiding recovery.

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While QE1 did work on the whole, certain problems were starting to surface. For one, with the purchase of bad debts, the Fed now had a significantly high level of toxic assets which could potentially cripple the Fed. Additionally, the problem of hoarding money was beginning to present itself. While there was now more money in the markets, banks had raised loan standards, and were as a result not lending them out as much as the Fed had hoped. It was estimated that if the $1 trillion that the Fed had given the banks was lent out, the economy could have grown by $10 trillion. Yet, banks were using it to write down their remaining subprime mortgage debts and capital ratios.

QE2 Expected and Unanticipated

Nonetheless, the US Fed declared QE1 a success, and launched QE2 which lasted from November 2010 to June 2011. During this period of time, $85 billion worth of US securities and gold would be purchased every month. The plan was to create an inflation rate of 2% by boosting demand. Through reductions in debt servicing costs, as well as an increase in profits remitted from central banks, countries within the Eurozone, the UK and the US benefitted from a $1.6 trillion injection into the economy. As interest rates fell, corporate profits increased by as much as 5% across these countries. There were a few unintended consequences of QE2 which were important to take note of. One of them was the upward pressure on commodity prices around the world. The Feds purchase of gold sparked a massive rally for gold which was increasingly seen as the alternative monetary asset to hold on to. In August 2011, gold prices peaked to $1,786, a 44.7% increase from the $1,238 in August 2010. In addition, markets across the world became more volatile. The currencies of countries belonging to the emerging markets were starting to appreciate; most of the capital flowing out of the US went to emerging markets, whose equities would then surge 24% as a result. The issue with banks hoarding money persisted as well, and did not show any signs of relenting. With the money created sitting idle in banks, US debt issues therefore remained unresolved, and interest was paid instead to foreign reserve banks where most of the money was now held.

The Tapering of QE3, and its Effects on Emerging Markets

With the introduction of the third round of quantitative easing (QE3), which was announced in September 2012, many had started to question the need for a third round of QE. In certain circles, QE3 was nicknamed QE-Infinity, in jest at whether the Fed would ever decide to wind down its unconventional monetary policy in the near future. In December 2013, the Fed finally announced that it would scale back on quantitative easing, starting in 2014. This action sent a signal to investors around the world that the worlds largest economy was now robust enough to grow without any artificial stimulus. As a result, investors around the world would find their way back to the US market, as interest rates in the US would begin to rise with the scaling back of bond purchases. This meant that huge amounts of money, created during the 3 rounds of QE, would be withdrawn from emerging markets and returned to the US. This phenomenon would as a result create instability in financial markets, and slow down the economic activities of developing countries.

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The impacts of tapering would vary from country to country, depending on their economic environments. Firstly, tapering would have a direct impact on Foreign Indirect Investments (FII), which refer to capital invested in stocks and financial assets. From the very short amount of time between June and August 2013, where talk of tapering began to appear on headlines, the FII that flowed out of the stock market in India was estimated at some $3.7 billion, causing the Sensex index to fall by 27% in nearly a month. The same phenomenon was also observed in Turkey. When signs of distress began to surface, investors then started pulling out of the country, pushing the XU100 index to its four month low then. In addition, the outflow of FII also impacted exchange rates, and this was where many problems started to arise. As can be seen from the chart above, since the US Fed began talking about tapering and finally putting it into effect, currencies from emerging markets began to weaken. To some export-oriented countries, a weaker currency could be good news, but to most emerging markets, which rely heavily on foreign capital and have a current account deficit, the depreciated currencies could pose a big problem for their economies. The common feature of many developing countries is that they have to rely heavily on imports, some of which are very important for their economies to function properly. For example, India relies on significant amounts of imported coal and oil as its main sources of energy. Likewise, raw materials and intermediate goods account for 45% of total export levels of Brazil. Therefore, a stable currency is important in keeping domestic prices stable. A weaker currency would mean higher prices for imported goods, which subsequently would lead to higher inflation, thereby slowing down domestic economic activities. To give an example, India was the first country to be affected by inflation due to the tapering announcement, where in August 2013, the value of the rupee fell and inflation increased as a result. Further exacerbating the problem is the pattern of high inflation in India, where in the past five years, Indias Consumers Price Index has climbed nearly 10% annually. For the sake of comparison, the inflation rate of Turkey in 2013 was 7.5%, higher than its target at 5%. However, in India, things may be a bit better than the current situation in Argentina. Unofficially, the inflation rate for 2013 was 28%,
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although the Bank of Argentina reported a lower rate of 10%. Moreover, the CPI index is expected to be raised in 2014. With that, some have started comparing the situation today with that of the 1997 Asian Financial Crisis. However, it should be noted that the circumstances today are vastly different as compared to the past. One reason for the 1997 crisis was that US dollar-denominated debt levels were very high in many emerging markets back then. When investors started to pull out of these local currencies, many parochial companies were in deep trouble with their dollar-denominated debts. The appreciated dollar meant that companies had to pay back more than what they had borrowed due to their own falling currencies. As a result, when they were not able to muster up the required amount of dollars, companies were faced with the prospect of bankruptcy. However, a similar crisis as back then is not likely to happen again. One reason is that much of the debts in emerging markets today are denominated in their local currencies. According to the Financial Times in December 2012, total local currency denominated debts in developing countries rose more than 96% since 2008. Another reason is that many emerging markets today have higher levels of foreign reserves than they did in 1997. One of the more notable countries is China, which has used its trade surplus to purchase US treasury notes for years. As a result, the level of its foreign reserves has burgeoned. The same trend is also observed in Brazil and Russia, where Russia is a major oil exporter and Brazil is a commodity-rich country. That means that these two countries would have steady foreign currency sources to rely on so as to withstand shocks in the system. The above having been said, India, Indonesia, Turkey and Argentina, countries with huge current account deficits and small foreign reserve levels, might be in precarious positions from the effects of tapering. As mentioned earlier on, these countries are usually in need of the US dollar for their imports. Therefore, when tapering takes place, causing investors to put their money back into the US, the local currencies of these weaker countries will depreciate further, resulting in economic losses. This could result in a confidence crisis, where citizens of these countries could lose faith in their own currency, thereby creating the possibility that financial systems would be prevented from working properly. For example, in India, a decade of high inflation and low interest rates led to a large number of Indians to accumulate their wealth in the form of gold. According to The Economist, in India gold is accepted as a method of payment for transactions without the need for any documentation. With the news on tapering, such practises are likely to become more widespread. In March 2013, Indias current account deficit rose to an alarming level of 4.8% of GDP, and half of the gap was caused by gold imports. This forced the Indian government to impose high taxes and quotas on gold imports, so as to curb rising demand and smuggling. Another country negatively affected by the news of tapering is Argentina. After the Argentinean government stopped intervening in the foreign exchange market in January 2014, the peso depreciated 3% to 4% a day, creating widespread uncertainty in the economy. With dwindling foreign reserve levels, the government imposed strict measures on the currency market to stem its outflow. For example, limitations were placed on the number of items Argentineans could buy online. One effect of the currency control measures put in place was that the Argentinean housing market was paralysed as a result, due to the fact that majority of the markets transactions were carried out in US dollars.
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Following the tapering, it is estimated that capital inflows into the emerging markets will fall from 4.6% of their GDP to 4%, thereby reducing the growth levels in these countries. However, should interest rates in the US rise faster, which is unlikely in the short term, these capital inflows may fall by as much as 50%. In conclusion, the tapering of QE3 could have very detrimental effects on emerging markets, as well as the global economy. Since the global financial crisis of 2008, where growth rates in developed markets have been dwindling, emerging markets have since been the engine of growth for the global economy. The fact that developing markets are now faced with more troubles could therefore point towards a deceleration in the recovery and growth of the global economy.

References
1. Selcuk Gokoluk and Taylan Bilgic (2013) Turkey Stocks Slump With Lira as Minister Urges Erdogan to Quit [online] Retrieved from:http://www.bloomberg.com/news/2013-12-25/turkish-lira-jumps-as-graft-probe-claims-two-ministers-jobs.html [Accessed: 27 Feb 2014] 2. Swansy Afonso and Unni Krishnan Gold (2013) Imports by India Slump as Curbs Reduce Demand for Jewelry. Retrieved from: http://www.bloomberg.com/news/2013-10-09/gold-imports-by-india-slump-as-curbs-reduce-demand-for-jewelry [Accessed: 27 Feb 2014] 3. Soros, G., Koike, Y. & Khrushcheva, N. (2014). How fragile are emerging markets? by Kenneth Rogoff. [online] Retrieved from: http://www.prcate.org/comoject-syndimentary/kenneth-rogoff-looks-beneath-the-turmoil-roiling-emerging-economies--equity-and-currency-markets [Accessed: 27 Feb 2014]. 4. Soros, G., Koike, Y. & Khrushcheva, N. (2014). Emerging Markets Submerging Currencies by Michael Heise. [online] Retrieved from: http://www.project-syndicate.org/commentary/michael-heise-shows-why-some---but-not-all---emerging-market-currencies-have-come-under-attackin-recent-weeks [Accessed: 27 Feb 2014] 5. Goni, U. (2014). Peso collapse raises fears Argentina lurching towards decennial crisis. [online] Retrieved from: http://www.theguardian.com/world/2014/jan/24/peso-collapse-argentina-economic-crisis-fernandez-de-kirchner [Accessed: 27 Feb 2014] 6. Lenzner, R. (n.d.). QE2 and the US dollar - in photos: effects of QE - Bernanke's quantitative easing. [online] Retrieved from: http://www.forbes.com/pictures/mdj45edjll/qe2-and-the-us-dollar [Accessed: 27 Feb 2014] 7. Dobbs, R., Lund, S., Koller, T.,Shwayder, A.. (2013, November). QE and ultra-low interest rates: distributional effects and risks. [online] Retrieved from: http://www.mckinsey.com/insights/economic_studies/qe_and_ultra_low_interest_rates_distributional_effects_and_risks [Accessed: 27 Feb 2014] 8. Zerohedge.com. (2013, November, 22). "we will soon learn how strong the qe trap has become" | zero hedge. [online] Retrieved from: http://www.zerohedge.com/news/2013-11-22/we-will-soon-learn-how-strong-qe-trap-has-become [Accessed: 27 Feb 2014] 9. Mcteer, B. (2013, November 13). Rethinking Quantitative Easing. [online] Retrieved from: http://www.forbes.com/sites/bobmcteer/2013/11/13/rethinking-quantitative-easing/ [Accessed: 27 Feb 2014]. 10. Unknown. (2013, November 13). Federal Reserve whistleblower tells America the real reason for quantitative easing. [online] Retrieved from: http://www.infowars.com/federal-reserve-whistleblower-tells-america-the-real-reason-for-quantitative-easing/ [Accessed: 27 Feb 2014] 11. Unknown. (n.d.). QE: a timeline of quantitative easing in the US | opendemocracy. [online] Retrieved from: http://www.opendemocracy.net/openeconomy/ross-heard/qe-timeline-of-quatitative-easing-in-us [Accessed: 27 Feb 2014]. 12. Amadeo, K. (n.d.). Qe1. [online] Retrieved from: http://useconomy.about.com/od/Fed/g/QE1.htm [Accessed: 27 Feb 2014].

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Xi Jinping and Chinese Economic Reform

By Jian Kangyue The recently concluded Third Plenary Session of the 18th Communist Party of China Central Committee is notable because it outlined the economic blueprint for China's future in the next decade. Economists around the globe believe that the comprehensive and ambitious document that addresses Chinas woes, ranging from social issues to economic reforms, are of unparalleled significance not just to China but to the whole world. However, many have raised doubts of whether the reforms are yet another toothless tiger, and question Xi Jinpings ability to implement them.

Conflicted Interests
Within the comprehensive economic reforms lies a few that will conflict each other in implementing them. Xi faces domestic pressures to enhance Chinas economy and keep it at 7 percent. Yet, he is also pushing for reforms that will compromise short-term growth to balance against social concerns and the global economic landscape. Major reforms like deficiencies in the banking industry and restructuring of obsolete industries are obstacles that Xi needs to weigh carefully against. Moreover, reforms aiming to level the playing field between state-owned and private firms have seen a direct clash of interests in the past years. Governors are likely to continue to support the state-owned enterprises as they are still widely seen as the cornerstone of Chinas domestic economy. At the same time, they know the importance of attracting foreign investments to boost its already slowing economy. As long as there continues to be no discussions on genuine and concrete reforms, the implementation of these reforms will face strong internal resistance from its people and governors alike.

Factional Politics
Including the CCP Central Committee, China has a 405-member strong Politburo. The sheer magnitude of the government amplifies the deviation of the differential ideals of how the proposed economic reforms can be achieved. With further varying demographics within these states and the considerable autonomy to set policies within the states, governors are expected to set policies that vary widely. There are also conflicting interests between top officials and governors. In the past, governors are promoted based on telling economic signs such as GDP per capita within each state. However, the Standing Committee is starting to urge governors to focus on sectorial restructuring instead of short-term growth. Yet, these goals do not have straightforward economic indicators to measure its success. Coupled with internal pressures, it will still be in the interests of the governor to upkeep the GDP per capita to secure promotions and bonuses. Consequentially, these different ideals and misalignment of interests will put China a few step backwards in wanting to implement any kind of reforms that can potentially affect their short-term growth.

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Soured International Relations

It is no secret that Chinas relations with neighbouring countries have worsened with recent diplomatic rows. China recently drafted plans for an Air Defense Identification Zone (ADIZ) in the South China Sea amidst global condemnation. The United States has also gone to the extent to publicly warn China against establishing the ADIZ, and has sent US Secretary of State John Kerry to raise concerns over China's insistent territorial claims in the South China Sea. Experts around the world predict that China will be preoccupied with responding to a barrage of regional disputes and U.S. pressures, on top of having to keep up with North Korea occasional belligerence. This will distract Xi from focusing on the implementation of the Third Plenary Session reforms, and may even lead to more serious problems like territorial disputes involving military aggression that will have unthinkable consequences. Conflicting interests, factional politics and soured international relations all point towards an unsurmountable obstacle for Xi to implement the ambitious reforms that he has painstakingly administered. Besides, there are still a wide range of controversial issues that threaten to pull China back from a smooth implementation of the comprehensive reforms. However, even as these issues continue to hamper Xis efforts to garner a united support for change, there are still many who hold faith in Xi to implement these reforms.

Xis Popularity & Credibility

Xis proponents believe that his hard-line political stance will see him to a successful implementation of these policies. Some even go as far as to say that Xi will leave a legacy that is similar to that of Mao Zedong. Indeed, Xi Jinpings popularity and credibility has already exceed many of his predecessors. In June 2013, Xi launched a year-long mass line campaign, which mandates officials to attend sessions and engage in grassroots activities so as to better serve the needs of the public. Officials and governors will go through programmes to reflect upon their actions, correct their wrongdoings and encourage them to forge closer bonds with the people. A larger part of Xis popularity and credibility stems from his determination to weed out corruption. If anything, his continual pursuit for vindicating senior officials is starting to form a precedent deterrence to potential corrupts. As if the high-profile case surrounding Zhou Yong Kangs case is not enough, Jiang Zemins recent abrupt exit has also raised speculations that he is the ultimate tiger that Xi is going after for. Concurrently, Beijing has also started briefing officials about Zhou Yong Kangs case. If Xi can continue to show progress in Zhous case and proof that even the most powerful will get convicted of corruption, he will send a resounding message to China that corruption, under his new leadership, will not be tolerated. This, to some extent, will determine the direction of reform and provide intangible ease and support from the people of China to implement economic reforms.

Conclusion
As the Third Plenum Meeting announces the comprehensively sweeping reforms, the Chinese people have every reason to be hopeful. Prickly issues that plagued China's top leaders for years due to a lack of consensus or political will, have been pushed through by Xi. This indicates his growing influence in setting the direction for the Chinese government. Xi is also expected to play a leading role in the Leading Group on Comprehensive Deepening of Economic Reform and the National Security Commission.
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However, considering the sheer complexity of the Plenum, the scale of Chinas population and its myriad of political and economic problems, it is not difficult for one to understand that the implementation of the Plenum will not be an easy task. Whether China is fundamentally ready in their complex political system and social issues remains to be seen. In the coming years, the world will watch with bated breath on Xis handling of sensitive issues closely. Can he implement the comprehensive reforms and policies successfully? Only time will tell.

References
1.Bao, C. (2013, November 11). SOE reforms to be launched after plenum. China Daily. http://www.chinadaily.com.cn/china/2013cpctps/2013-11/11/content_17094060.htm 2.Bill, F. (2013, October 11). China's Third Plenum: What The 'Smart Money' Thinks. Forbes. http://www.forbes.com/sites/billfischer/2013/11/10/chinas-3rd-plenum-what-the-smart-money-thinks/ 3.Jaime, A.F. (2013, November 21). China's reforms: Enlarging but not discarding the cage. CNN. Retrieved from http://edition.cnn.com/2013/11/20/world/asia/china-reform-jaime-florcruz/ 4.Jeremy, P. (2013, December 26). On Chairman Maos Birthday, a Conflicting Legacy for Xi Jinping. The Wall Street Journal. Retrieved from http://blogs.wsj.com/chinarealtime/2013/12/26/a-subdued-birthday-celebration-for-chairman-mao/ 5.Liu, Q. (2013, November 29). How the Third Plenum will change people's lives. China.org.cn. http://www.china.org.cn/china/third_plenary_session/2013-11/29/content_30746484.htm 6.Lucy, H. (2014, January 31). Chinas Xi Jinping highlights fresh air in year of the horse. Financ ial Times. Retrieved from http://www.ft.com/intl/cms/s/0/67ac4000-8a55-11e3-ba54-00144feab7de.html?siteedition=intl#axzz2tKBbygl5 7.Moran, Z. (2013, November 1). Chinas Third Plenary Session Of 18th CPC Central Committee: 8 Things To Know About Chinas Party Congress And Its Reform Agenda. International Business Times. http://www.ibtimes.com/chinas-third-plenarysession-18th-cpc-central-committee-8-things-know-about-chinas-party-congress 8.Paul, C. & Judy, H. (2013, November 2). China President Xi confident about healthy economic growth. Reuters. http://www.reuters.com/article/2013/11/02/us-china-president-idUSBRE9A103V20131102 9.Ryan, J. (2012, December 10). U.S. intelligence: china economy to surpass u.s. by 2030. ABC News. Retrieved from http://abcnews.go.com/blogs/politics/2012/12/u-s-intelligence-china-economy-to-surpass-u-s-by-2030/ 10.Unknown. (2013, November 2). Xi: China confident of sustainable economic growth. China.org.cn. http://www.china.org.cn/china/2013-11/02/content_30482091.htm 11.Unknown. (2013, November 23). From SOE to GLC. The Economist. http://www.economist.com/news/finance-andeconomics/21590562-chinas-rulers-look-singapore-tips-portfolio-management-soe-glc 12.Wayne, Ma. (2013, November 12). Third Plenum: The Analysts Take. T he Wall Street Journal. http://blogs.wsj.com/chinarealtime/2013/11/12/third-plenum-the-analysts-take/ 13.Yang, Y. (2014, January 5). Chinese official presides over meeting on "mass-line" campaign. Xinhuanet. http://news.xinhuanet.com/english/photo/2014-01/05/c_133019982.htm 14.Yiwei, Z. & Aixin, Li. (2014, Feburary 14). Kerry to discuss new ADIZ. Global Times. Retrieved from http://www.globaltimes.cn/content/842433.shtml#.Uv5qmvmSyRN 15.Yuanyuan, H. (2013, May 16). JP Morgan cuts China's GDP growth forecast. China Daily. http://www.chinadaily.com.cn/china/2013-05/16/content_16502443.htm

Yuwen, D. (2014, Janaury 14). When will Xi Jinping bag a tiger?. The University of Nottingham. http://blogs.nottingham.ac.uk/chinapolicyinstitute/2014/01/14/when-will-xi-jinping-bag-a-tiger/

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Xi Jinping and Chinese Economic Reform

By Kuang Wencan In China, the Third Plenary Meeting of its top leaders is often regarded as a landmark event. Although such a meeting only produces vague guidelines rather than concrete policies, it does have the potential to reset the countrys long-term growth trajectory, and from time to time, lead to fundamental economic reforms. For example, the 1978 third plenary meeting, during which Deng Xiaoping famously rejected Maos Two Whatevers principle and announced his open door policy, has allowed China to enter into a phase of rapid growth, lifting the living standards of hundreds of millions of people. In recent years, as China approaches the Lewis turning point, fear of an economic slowdown has pervaded the globe. Many scholars have been calling for a Reform 2.01 so as to ensure the long-term sustainability of Chinas growth. Amidst high expectation for reform, the Third Plenary Session of the Xi Jinping-led central committee took place in Beijing last November. Honoring his promises for unprecedented economic and social reforms 2, Xi announced a 60-point reform package, setting forth his vision of the rejuvenation of the Chinese nation. Impressive as Xis reform program looks on paper, many economists are pessimistic about its actual implementation. As the famous economist Roubini3 put it in the Davos World Economic Forum, Talk is cheap ... we have to see action and so far we have not seen a lot of action." Will Xis reform program be actually implemented? This paper attempts to answer the question by analyzing factors that are likely to drive or stall Xis reform.

Aggravated Social and Economic Problems Necessitate an Urgent Reform

Perhaps the most powerful impetus for Xis economic reform stems from the fact that china s economic and social condition have already deteriorated to such an extent that procrastination is no longer an option. In the past few years, the Communist Party has witnessed an increasing number of mass incidents (large-scale protests), and on many occasions, even the uprising of entire villages, such as the case of wukan village4. Many scholars in China have attributed this rising social tension to an economic phenomenon called guojinmintui, which refers to the economic trend where the state enterprises advance while private sector retreats and where the fruits of economic growth were mainly reaped by the state while the private sectors and individual citizens were cut out of the benefits. This phenomenon is especially visible during the financial crisis.
To avoid an economic hard landing, the then Wen Jiabao-led State Council announced a 4 trillion stimulus package in the fourth quarter of 2008, and ordered the state banks to start making loans to businesses so as to save solvent firms from bankruptcies and sustain the countrys GDP growth. However, while all companies are created equal, some of them are more equal than others and many deserving private companies were not granted any of those stimulus. 10

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For instance, while the state-owned China Eastern Airlines was bailed out by a 7 billion5 Yuan capital injection form the State-owned Assets Supervision and Administration Commission (SASAC), the more solvent and privately owned East Star Airlines was denied access to state bank loans and was forced into bankruptcy liquidation. As a result of guojinmintui, the wealth gap between the public and private sectors continues to diverge and rampant corruption scandals, such as the Bo Xilai case, continues to disgrace the leadership, forcing the communist party into its worst legitimacy crisis since the 1989 Tiananmen Square incident. Now to reverse that trend, the Xi-Li administration has to enact the reform policies that they recently announced. As Chinas GDP growth starts to slow, the last window of opportunity to reform is closing, and after a lost decade of no reform6 the people are getting increasingly impatient, the Xi-Li administration, unlike their predecessors, can no longer afford to muddle through; their reform has to be properly implemented and the Chinese leadership knows that.

Vested Interested and Xis Reform

While the legitimacy crisis of party can certainly motivate Chinas top leaders to enact potentially painful reforms so as to avoid the possible demise of their authoritarian regime, the motivation that the crisis provides has its limits. This is especially so if we take into consideration the likely opposition from the vested interest groups7. Chinas decades of double-digit growth has improved the living standards of the public, but it has also created large groups of constituents who have benefitted immensely from the current economic system. These groups, including the aforementioned SOEs, provincial governments as well as real estate developers, will surely resists all policy changes that might threaten to undercut their perks and privileges. In fact, the power of these vested interest are so deeply entrenched in the current economic system that scholars in China have attributed the failure of many recent pilot reform programs8 on them. It is against this backdrop that many China watchers have argued that a complete implementation of Xis reform program is unrealistic. Many leaders of these interest groups hold important posts in the party congress, as they push back on economic reform, the Xi-Li administration might have to make compromises and water down their reform plans so as to maintain the internal unity and stability of the party.

Centralized Power and Leadership Unity can Comprehensively Deepen Reform

While resistance from vested interests are real, and reforms are certainly made more difficult because of that, it is not impossible for the leadership to overcome such resistance. During Dengs time, China had a fully central-planned economy. The interest of SOEs and central-planning agencies, which were subject to Dengs reform back then, were no less deeply entrenched as compared to that of the vested interest today, but Deng Xiaoping, nevertheless managed let some to grow rich first and implemented his painful reform plans by playing the provinces against the center.

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If we benchmark Dengs reform to that of Xi, it is reasonable to say that its not impossible for todays leadership to overcome political opposition, as long as Xi has the same kind of political power and support that Deng had back in Chinas first reform era. Of course, time has changed, todays communist party has to operate based on collective leadership, and theres no single outsized leader in China today who can steer the direction of the nation however he wants. But then again, Xi Jinping is by far the most powerful and transformative leader since Deng10. The possibility of him engendering a genuine and meaningful economic reform should not be understated. This is especially the case considering the following two points. Firstly, theres clear sense of urgency and a collective understanding of the need to reform in the party. In the months leading up the third plenum, Li Keqiang, the head of state council, pledged "Wrist-Cutting" resolution11 to reform the economy, while other members of the PSC have also publicly endorsed the idea of economic rebalancing, showing strong support for Xis reform agenda and great signs of unity in the party leadership. Beyond that, provincial governments, envying the light regulation in the Shanghai FTZ and the potential reform dividends, have also expressed great enthusiasm in setting up free trade zones in their own provinces.12 All these support would help improve the outlook of the actual implementation of Xis policies. Secondly, Xi has amassed more power in his first year than his predecessor did in a decade. Coming from privileged family, Xi has more political capital than his predecessor to reform the economy. Within just one year, Xis anti corruption campaign has already investigated and arrested so many tigers (high-level party bureaucrats) that were previously thought to be untouchable, including the former Minster of Railways, Liu Zhijun13, and the security czar, Zhou Yongkang14. Not only that, Xis political power was further strengthen ed after he was appointed the head of both the central leading group for comprehensive reforms15 and the National Security Council16 (NSC). As an APCO report17 argued, with the help of NSA, oppositions to Xis reform can be easily eliminated; all xi has to do is to place them under the rubric of security, and the vested interest will get out of the way. With such power centralization, its likely that Xi will be able to replicate Dengs success and fundamentally reform Chinas economy.

Event Risk and Conclusion

No reform is immune to event risks, especially given that Chinas loosely regulated shadow banking system has just dodged a bullet just a few weeks ago18. Should the widely anticipated hard landing ever occur, its still a question whether the Xi-Li Administration will continue to deleverage the economy and rein in Chinas local debt, given that they have kept emphasizing the importance of sustaining Chinas GDP growth rate. Will Xi Jinping eventually revert to the governments old habit of delaying reform and ramping up infrastructure investment to support growth? Only time can tell. But for now, based on the limited information we have, such scenario isnt likely to happen and given the aforementioned arguments its reasonable to be optimistic about the actual implementation of Xis proposed reform plans.

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Reference
1. 2. Reform in China: the party's new blueprint. (2013). http://www.economist.com/blogs/analects/2013/11/reform-china Retrieved from The Economist:

China Signals Unprecedented Policy Changes on Agenda at Plenum. (2013). Retrieved from Bloomberg News: http://www.bloomberg.com/news/2013-10-27/china-signals-unprecedented-policy-changes-on-agenda-atplenum.html Fear of China hard landing stalks Davos. (2014). Retrieved http://www.capitalfm.co.ke/news/2014/01/fear-of-china-hard-landing-stalks-davos/ from Capital News:

3. 4. 5. 6. 7. 8. 9.

What Wukan Really Meant. (2012). Retrieved from The Diplomat: http://thediplomat.com/2012/01/what-wukanreally-meant/ China Eastern gets RMB 2 bln capital injection from SASAC. (2009). Retrieved from China Knowledge: http://www.chinaknowledge.com/Newswires/News_Detail.aspx?type=1&NewsID=23512 Weiying, Z. (2013). China must seize rare chance for reform. Retrieved from Financial Times: http://www.ft.com/intl/cms/s/0/f0c375d0-8596-11e2-bed4-00144feabdc0.html?siteedition=intl#axzz2tOusn3Fd Are Chinese Leaders Ready to Take on Vested Interests? (2013). Retrieved from The Wall Street Journal: http://blogs.wsj.com/chinarealtime/2013/11/11/are-chinese-leaders-ready-to-take-on-vested-interests/ Matthew P. Goodman, M. P. (2013). Shanghai FTZ: Harbinger or Red Herring? Center for Strategic and International Studies. Shirk, S. (2013). Can Chinas leaders harness support for change? Retrieved from East Asia Forum: http://www.eastasiaforum.org/2013/10/23/can-chinas-leaders-harness-support-for-change/

10. Keck, Z. (2013). Xi Jinping: Chinas Most Powerful Leader Since Deng and Mao? Retrieved from The Diplomat: http://thediplomat.com/2013/08/xi-jinping-chinas-most-powerful-leader-since-deng-and-mao/ 11. Premier Li Keqiang Pledges "Wrist-Cutting" Resolution in Promoting Reforms. (2013). Retrieved from Caijing.com.cn: http://english.caijing.com.cn/2013-09-11/113288286.html 12. Ningzhu, Z. (2014). China approves 12 more free trade http://news.xinhuanet.com/english/china/2014-01/22/c_133066293.htm zones. Retrieved from Xinhua:

13. Liu Zhijun, China's ex-railway minister, sentenced to death for corruption. (2013). Retrieved from The Guardian: http://www.theguardian.com/world/2013/jul/08/liu-zhijun-sentenced-death-corruption 14. China corruption: aide to ex-security chief Zhou Yongkang investigated. (2013). Retrieved from The Guardian: http://www.theguardian.com/world/2013/dec/30/china-corruption-aide-zhou-yongkang-investigation 15. Bodeen, C. (2014). China's President Xi Jinping Named Head Of New Security Body. Retrieved from The World Post: http://www.huffingtonpost.com/2014/01/24/xi-jinping-head-of-security_n_4658336.html 16. President Xi to head leading group for overall reform. http://news.xinhuanet.com/english/china/2013-12/30/c_133007127.htm 17. APCO. (2013). An Analysis of China's Third Plenum. APCO World Wide. 18. Lopez, L. (2014). The Chinese Shadow Banking System Just Dodged A Bullet. Retrieved from Business Insider: http://www.businessinsider.sg/china-shadow-banks-2014-1/#.UwDWEhoW2F8 (2014). Retrieved from Xinhua:

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SEIC Correspondents for Issue 49:

Wong Shi Jun Aaron (Vice President, SPEX)
Undergraduate Lee Kong Chian School of Business Singapore Management University aaron.wong.2012@business.smu.edu.sg

Zhou Li (Creative Director)

Undergraduate School of Economics Singapore Management University li.zhou.2012@economics.smu.edu.sg

Alvin Yue Weng Fatt (Writer)

Undergraduate School of Economics Singapore Management University alvin.yue.2012@economics.smu.edu.sg

Dinh Thai An (Writer)

Undergraduate School of Economics Singapore Management University thaian.dinh.2013@economics.smu.edu.sg

Lee Yin Wei (Writer)

Undergraduate School of Economics Singapore Management University yinwei.lee.2012@economics.smu.edu.sg

Jian Kangyue (Writer)

Undergraduate School of Economics Singapore Management University kangyuejian.2012@economics.smu.edu.sg

Kuang Wencan (Writer/President)

Undergraduate School of Economics Singapore Management University wencan.kuang.2012@economics.smu.edu.sg