All eyes on China

Politics are very much at play as China's Wen Jiabao tries to push economic reform in the country.

By Jim J. Jubak Mar 4, 2010 3:38PM

Jim JubakWhat looks like a duck, quacks like a duck, but doesn't walk like a duck?


A lame duck, of course.


Watch tomorrow's state of China address and the policies announced by the National People's Congress to see if Chinese Premier Wen Jiabao fits that description.


My bet is that with Wen and President Hu Jintao both scheduled to step down from their posts atop the Communist Party and retire from their government positions in 2013 at the end of their ten-year terms, the jockeying over who will replace them has already begun. And that means that Wen doesn't have the clout he needs to push through the reforms he has repeatedly told the country it needs.


Wen made his most recent argument for reform on Feb. 27 when he said that China's current economic policies are creating increasingly dangerous distortions in China's economy.


A policy that emphasizes investment in manufacturing and growth in exports and that discourages domestic consumption is inflating property and stock prices, and that threatens to produce runaway inflation, he said.


Recent government actions, such as subsidies for rural consumers and requirements that banks keep higher reserves, echo Wen's critique.


But Wen has talked of the need to do much more -- and on this front I think he's likely to be frustrated by opposition from factions inside the Communist Party that profit handsomely from the status quo. The leaders jockeying to replace Wen will be bidding for the support of these factions and will do their best to win that support by blocking any of Wen's reforms that might hurt those groups.


So, for example, Wen and Hu see the need to close inefficient factories and to shut off their access to cheap loans from local governments that keep technically bankrupt businesses in operation. They'd also like to rein in loans to state-owned companies that aren't invested in the business, but are instead used to speculate in property and stocks.


To fix those problems, China needs an effective bankruptcy law, tougher enforcement of environmental and labor laws now on the books, and a thorough overhaul of a tax system that has left local governments dependent on land sales and taxes on industrial production for revenue.


None of those reforms are on the agenda for this year's National People's Congress. And in what looks to me like a shot across the bows of reformers, on the day before Wen's address, China's Ministry of Finance announced plans to sell $29 billion in bonds on behalf of cash-strapped local governments so they can fund infrastructure projects.


Of course, that kind of spending is exactly what Wen has said distorts the economy. And it's exactly this local government cash that has found its way into the pockets of the big state-owned companies that like the current system just as it is, thank you very much.


China's local governments are prohibited by law from taking on debt directly. But this kind of bond offering gives them an officially sanctioned way around the prohibition.


You should be able to judge the current state of the race to replace Wen and Hu by watching to see how much emphasis Wen and the National Congress give to plans to crack down on investment companies set up by local governments to unofficially get around the ban on official local government debt.


And by looking to see if the Congress sets up some kind of schedule for a new national tax system.


My bet is that the National People's Congress won't do anything to rock the boat even slightly this year.


That will be a relief to financial markets and to big Chinese companies that reap the benefits of the current system. You can get easy, one-stop exposure to this part of China's economy in the iShares FTSE/Xinhua China 25 ETF (FXI)


The exchange traded fund, which is on Jim's Watch List, is down about 10% from its early-January 2010 high. You can place an even more concentrated bet on business as usual by buying the pink-sheet traded ADR of a big industrial construction company such as China Railway Construction (CWYCY)


Be aware though that you'll be giving up liquidity by going down that route. Daily volume for the ETF is around ten million shares, but is less than 10,000 for the China Railway ADR.


The only question is “When?” I'm inclined to buy in the days right after Wen's address when markets are still focused on his argument for reform and haven't yet recognized how unlikely any major change will be.


At the time of this writing, Jim Jubak owned shares of FTSE/Xinhua China 25 ETF in his personal portfolio.

0Comments

DATA PROVIDERS

Copyright © 2014 Microsoft. All rights reserved.

Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.

STOCK SCOUTER

StockScouter rates stocks from 1 to 10, with 10 being the best, using a system of advanced mathematics to determine a stock's expected risk and return. Ratings are displayed on a bell curve, meaning there will be fewer ratings of 1 and 10 and far more of 4 through 7.

114
114 rated 1
278
278 rated 2
474
474 rated 3
641
641 rated 4
639
639 rated 5
663
663 rated 6
640
640 rated 7
499
499 rated 8
284
284 rated 9
122
122 rated 10
12345678910

Top Picks

SYMBOLNAMERATING
COPCONOCOPHILLIPS9
TAT&T Inc9
VZVERIZON COMMUNICATIONS9
KOGKODIAK OIL & GAS Corp9
CVXCHEVRON CORPORATION8
More

VIDEO ON MSN MONEY

ABOUT

Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.

Contributors include professional investors and journalists affiliated with MSN Money.

Follow us on Twitter @topstocksmsn.