China’s NPC: Shifting from growth to innovation

China’s top planning session, the National People’s Congress (NPC) kicked off on March 5th, and will set the economic, policy, and reform agenda for the year. This year, on top of the usual communication, the government will also officially unveil specific targets and details of the 14th Five Year Plan. While we await interviews with senior policymakers over the next few days, today’s note will discuss some of the initial takeaways from proposals made public in late 2020 and the government work report.

1. The number that got the most media attention was the GDP target of ‘above 6%’. 

Our take: Given consensus expects around 8% GDP growth, some analysts—and markets— may take the target as a hawkish signal that there is more policy tightening ahead. However, it’s worth bearing in mind that local governments, not financial markets, are the real target audience of the NPC. In a year when growth will likely very comfortably exceed 6%, the real message is for local governments to focus less on near-term growth and more on the reform agenda—as long as GDP growth is still above 6% (which is also loosely tied to the labor market target). 

2. The rest of the 2021 objectives (Table 1) suggest the underlying message is more about continuity, rather than major changes. 

Our take: 2021 is not going to be a year of meaningful policy shifts. Consider that the government reaffirmed its commitment to a ‘neutral’ monetary policy stance, which is now more clearly defined as keeping broad credit growth ‘basically in line’ with nominal GDP growth (we are roughly already in this range, by our estimate). 

Further, the fiscal deficit on the ‘current budget’ (i.e., excluding investment) will fall slightly from around 3.6% of GDP in 2020 to 3.2% in 2021. On top of that, the ‘special’ Central Government Bond (RMB1trn in 2020) will be discontinued. The quota for local government special municipal bonds will be RMB3.65trn in 2021 (vs. RMB3.75 in 2020). But given that not all of the money raised in 2020 was spent, the actual decrease in the fiscal impulse may be quite muted. In addition, fiscal revenue will likely rebound in 2021, which will allow the government to maintain some of the targeted tax cuts for small businesses. 

3. Reforms are in focus.

Our take: It appears that there are four priorities: innovation, consumption, economic ‘opening up’, and the environment. These also dovetail with the 14^th Five Year Plan, but the NPC notably offered some more concrete targets.

• Innovation is now top of the policy agenda. The long list of institutional reforms suggest that policymakers are aware that getting the incentive mechanism right is crucial. On top of allocating more spending for fundamental research, better reward for and protection of intellectual properties is also needed. China has made quite a few policy changes, including regulatory and judicial changes, and the momentum will likely continue in 2021. From an investment perspective, this means innovation-driven companies will likely have a bigger and more secure marketplace in the coming years. Many tech companies are in this category, and over time, innovation tailwinds could outweigh the cost of anti-monopoly regulations.
  
  
• Domestic consumption has also emerged as a more urgent policy priority in recent years. Improving the ‘supply side’, such as building better infrastructure and improving connectivity, helps. But the ‘demand side’ is more important. And the biggest amount of potential demand looks to be in non-core urban areas; for example, China’s nearly 300 million migrant workers and their families are back in rural areas. Unlocking this part of the population’s (very high) precautionary saving requires the government to significantly expand the social safety net. Faster momentum on land reform will also help rural families unlock the value of their assets. All in all, focusing on elevating the domestic consumer is a key secular investment theme for the Chinese market, especially given both demographic and policy tailwinds.
  
  
• High-level ‘opening up’ of the economy is still a priority. The government confirmed that it will continue to open up the economy, particularly to attract foreign direct investment (FDI) in services and manufacturing sectors. The government confirmed they will reduce the number of services sectors on its ‘negative list’, which will expand the sectors eligible for FDI. Many of the announced ‘opening up’ policies are aimed at attracting investment, solidifying China’s critical role in global supply chains and encouraging productivity-enhancing competition. Following the completion of the Regional Comprehensive Economic Partnership (RCEP) and the EU-China agreement, trade deals remain a focus area. Policymakers expressed their wishes to complete the China, Korea, Japan free trade agreement and even expressed a desire to join the CPTPP trade bloc. The direction of travel is clearly for more trade and investment agreements, and policymakers are also studying ways to expand cross-border financial investment (particularly outflow channels).
  
  
• The environment emerges as a key agenda item. The NPC further tightened environmental regulations, and the government will likely announce further policies on reaching carbon neutrality in the coming months. The environment and a broader focus on sustainability are among our top secular investment themes in 2021. Granted, there are a lot of challenges (just look at the continued attraction of traditional fossil fuels), but with incrementally lower costs and stronger political commitments across the world, we believe a focus on sustainability in portfolios can drive long-term growth.

Summing up

Policies are hard to ‘trade’, let alone reforms that have yet to unfold. Further, most of the policies mentioned above are multi-year, or perhaps even multi-decade in nature. This can create a lot of difficulty in sizing the actual ‘impact’ of these policies. That said, we view the NPC as providing wind in the sails of already identified secular growth trends. Innovation (across areas like 5G, tech, and healthcare), elevation of the consumer, and sustainability, will remain key themes for China over the next three to five years (and even longer). Despite the recent market pullback, we believe it’s worth revisiting the equity opportunities in these sectors. We also think China’s core bonds (including Chinese government bonds) and the RMB will be resilient.

All market and economic data as of March 8, 2021 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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