China reform checklist: How to tell that this time it's for real?

By Tomasz Janowski TOKYO (Reuters) - The message from Beijing could not be clearer: China needs to shift to a more balanced economy that is socially and environmentally sustainable. That was the conclusion of a key Communist Party meeting a decade ago, yet what followed was more of the same: rapid investment-led expansion, which turned China into the world's no.2 economy, but left it laden with debt, environmental damage and excess capacity. Fast forward to 2013 and China's new leadership is again promising more harmonious development and the question is how to tell whether, this time, it is for real. One encouraging sign suggesting that President Xi Jinping, Premier Li Keqiang and their team mean business is their greater tolerance for slower economic growth while they carry out reforms. After three decades of double-digit rises in GDP each year, the leaders have penciled in 7.5 percent for 2013 - the weakest pace since the late 1990s. "Since the reforms of the late 1970s, leaders have always without exception said that the growth rate is the first priority," said Zhao Xijun, deputy head of the Finance and Securities Institute at Renmin University in Beijing. "The new leaders don't say they don't pay attention to growth, but the new priority is the stability of growth rather than a high growth rate." The new approach was evident earlier this year when investors fretted the economy may be slowing down too much. Rather than adopting the sort of massive economic stimulus of the past, Beijing announced small-scale and targeted measures to support economic activity. Chinese leaders have repeatedly said China needs to wean itself off a reliance on investment and exports, which in parts of the country have led to industrial overcapacity and pollution, and rely more on services and consumption, more akin to the developed economies of the West. To do that means encouraging tens of millions of Chinese to move to cities to live while creating a social safety net and laws, particularly on land ownership, that will give them the confidence to do so. The ultimate test of the new team's appetite for reform will be its actions, but the four-day third plenary session of the Communist Party's leadership starting on Saturday will offer some early clues. Such meetings have served in the past as launch pads for major economic reforms like those unveiled in 1994 that paved the way for China's World Trade Organization membership, though some, such as the one a decade ago, failed to deliver. By nature, the pronouncements are broad and often deliberately cryptic, but China watchers believe the tone and level of detail can reveal where the policy focus will be. "For example, the state owned enterprises' reform will be touched on, but it will probably be in very general language and similar to one used before," said Haibin Zhu, chief China economist with JPMorgan in Hong Kong. "But in some key areas, like fiscal or land reform they will be using more detailed language." In the end, what will matter more is what the authorities do in the next six to 12 months. General expectations are that the follow-up will not be as dramatic as in 1994, but also that it will not be a non-event like a decade ago. The consensus view in Beijing is that the authorities are not ready to take on state-owned giants that dominate sectors such as finance or energy or to let the struggling ones fail. The focus therefore will be on the rest of the agenda: financial, fiscal, land and government administration reforms, pricing of resources, changes to social security and opening protected sectors to private and foreign competition. All are seen contributing in one form or another to China's push towards more private investment, consumption, services and high-value manufacturing, so any progress there would be welcome by investors and economists. "Many of these things hang together and you can't really go the full length on one without another, so any significant step on any of these will be welcome," Markus Rodlauer, deputy head of the International Monetary Fund's Asia Pacific Division in Washington, told Reuters. What few seem to be advocating is for Beijing to break with its gradual, cautious approach. "In a way, a gradual move on all of those (reforms) is what will in the end deliver," Rodlauer, who heads the Fund's China mission, said. "China has been well served by its strategy of gradual, careful reforms and does not need nor should it venture suddenly to implement Big Bang reforms." Of all reforms, a financial overhaul is considered low hanging fruit. Markets and the currency are closely controlled and capital movements in and out of the country are restricted. Driven by the central bank's governor, Zhou Xiaochuan, the gradual move towards market-driven interest and exchange rates and capital flows liberalization is already under way and there is a clear roadmap. In the least, investors expect to see a further broadening of the yuan's trading band next year and the establishment of a deposit insurance scheme - a prelude to a gradual freeing up of deposit rates and full liberalization of interest rates. "If we don't see anything on financial reform in 2014, that will be a very big disappointment," said JPMorgan's Zhu. On the fiscal front, economists and investors will look for steps to share more evenly revenues and expenditure between central and local governments and the expansion of the use of value added tax in the services sector. Local governments now get about half of tax and other revenues, but are responsible for more than 80 percent of public spending. Economists and observers will also look for progress towards a bilateral investment treaty with Washington and a similar pact with the European Union as proof of Beijing's intention to further open up its economy. Some also expect to see land and residence registration reforms tested in some areas, translated into a nationwide policy that would support China's stated goal to boost its urban population. By contrast, a proliferation of pilot schemes, such as the Shanghai Free Trade Zone trumpeted as a laboratory for sweeping financial market reforms, could signal a lack of political consensus to roll out the changes on a national scale. Economists say some caution is understandable given many of the reforms mean handing over controls to market forces and coming months will show how quickly the authorities want to go. But given no one knows how much time China has before its debt pile up, industrial overcapacity, environmental degradation and social tensions prove hard to control, erring too much on the safe side may be risky too. "We don't know how much time Beijing has and we don't know whether the incremental approach they've used in the past is still possible," says Gudrun Wacker, a China policy specialist at German Institute for International and Security Affairs, a Berlin-based think tank. "I believe they will spend the next five years trying to manage the problems and not do anything drastic, but it's like reading from tea leaves." (Tomasz Janowski, Asia Economics Correspondent; Additional reporting by Kevin Yao in Beijing; Editing by Neil Fullick)