Will Reforms Necessarily Slow Growth in the Short Run?

Will reforms necessarily slow growth in the short run?

Last Friday, China CPC published the Decision on Further Comprehensive Reforms, which draws attentions from investors from both onshore and aboard. Among its 21,496 words, the Decision demonstrate that the government proposes comprehensive reforms such as interest rate liberalization, the acceleration of capital account opening, the IPO registration system, and the relaxation of the one-child policy. These strong reforms are expected to promote China's economic restructuring in the medium-/long-term, improving economic efficiency and supporting the potential growth rate.

However, as investors begin to gain more confidence in the scope and depth of China's reform agenda, some remain worried about the economy's near term growth outlook. Particularly, they are concerned that as China rebalances its demand structure and deals with its inefficient SOE sector, the immediate impact on growth and corporate earnings would be negative, even if these reforms improve China's medium term growth outlook.

While these are valid concerns, I believe a more careful analysis may lead to a different conclusion: reform does challenge vested interests, but it is not a zero-sum game. Rather, China's 35 years of reform have demonstrated that market-oriented reforms have made the pie much bigger. That is, the net impact of reforms on growth and income has been positive, even in the short run.

Let us take a look at the anti-corruption campaign and its impact on consumption. The curtailment on using public funds for official entertaining was expected to have a large negative impact on consumption growth. However, the negative impact on overall consumption was short-lived (sequential growth in retail sales began to rebound from March onward). More interestingly, although a few high-end jewelry shops' and liquor companies' earnings did tank this year, earnings for the broad consumption sector are much better than last year.

How did this happen?

Well, first, for non-discretionary consumption spending such as food, when some people eat less in luxury restaurants using public funds, they still need to eat at home or eat out using their own money.

Second, less outright wasteful/corruption related spending opens up more room for private consumption, either directly through less price pressure in these consumption areas, or indirectly through better income distribution.

As a result, this rotation within consumption inefficient government-related consumption gives way to more mass consumption. It has little negative impact or even positive impact on the overall consumption.

Can the same storyline be played out on investment?

Honestly this rebalance is harder to achieve than the consumption rotation, because the drive for private investment