Significance: China's economic policy choice for 2011 will be crucial, not just for short-term growth and price stability, but also in terms of giving a good start to the 12th five-year plan period that begins next year.

Implications: The Chinese central leadership is orienting China's macroeconomic policy towards short-term need for inflation control and longer-term need for structural adjustment, as China is exiting the stimulus cycle and diving into the 12th five-year plan.

Outlook: Key initiatives for the 12th five-year plan are to be started in 2011, mainly including demand-side policies such as income redistribution reforms, an expansion of the social-welfare system, as well as supply-side efforts designed to reduce overcapacity in traditional sectors and divert funds into new strategic sectors and the services sector.

Easy Cycle Ends, Inflation Control a Main Target

The three-day annual Central Economic Work Conference, where top leadership set down China's economic policy framework for the next year, concluded yesterday with the release of a statement summarising the government's policy framework for 2011. As expected, the meeting has called for a switch of the country's macroeconomic policy stance to "proactive fiscal policy and prudent monetary policy", from a policy mix of "proactive fiscal policy and moderately easy monetary policy", which has been adopted since the end of 2008. This signals the official end of the ultra-easy monetary cycle starting since the end of 2008, reflecting policymakers' ever-present concern over consumer price inflation, which also accelerated to a 28-month high of 5.1% year-on-year (y/y) in November, driven by an 11.7% y/y food price surge.

Monetary policy will mainly involve "controlling the valve of liquidity" and diverting more funds to the real economy, particularly the rural sector and small and medium-sized enterprises, according to an official statement released after the meeting. As for the forex policy, the central leadership maintains its perennial ambiguous and equivocal statement of "maintaining the renminbi stability at a reasonable equilibrium level", giving no hint at whether the leadership will allow much greater flexibility of the exchange rate regime. In the meantime, fiscal policy will stay proactive, so as to "stabilise growth, optimise economic structure, readjust income distribution and promote a harmonious society", according to the statement. To sum it up, the new macroeconomic policy mix will be implemented in line with two main priorities for 2011, stabilising the overall price level, and facilitating the structural adjustment of the economy which falls in line with the longer-term goal of the 12th five-year plan. In another word, while fiscal policy will remain in the expansionary mode next year, the focus of government spending is to shift more from capital formation to consumption, with the government expected to spend more on public rental housing, healthcare and other public services as well as income transfers that will boost private consumption power amid higher inflation.

Economic Transformation at Start of 12th Five-Year Plan

What has made the just ended central economic meeting even more unusual is that it was held just ahead of the start of China's 12th five-year plan (2011-15). Indeed, four of the six key tasks outlined by the central leadership for next year pertain to rebalancing and readjustment, a key theme of the 12th five-year plan.

On the adjustment of economic structure and enhancement of economic competitiveness, the central leadership has called for optimisation of investment structure, upgrading traditional sectors, strengthening the service sector and new strategic sectors, and promoting the development of the "green economy". Regional development drives for western China, central China and the north-eastern rustbelt have been reaffirmed, while urbanisation will remain a main thrust.

On the enhancement of public services, which is key to boosting domestic consumer demand, the central leadership has pledged to "make material progresses on a few main things related to social livelihood at the start of the 12th five-year plan period", which will include supporting the development of the pre-school education system as well as high-school and vocational training, making full employment a "priority goal in economic and social development", expanding the social safety net, pushing ahead with healthcare reform, and promoting the development of a "housing security system", which will enable China to build a two-tier housing supply system consisting of welfare housing and commercial residential housing.

On reforms that are much needed for China's economic transformation, the central leadership has also instructed to make breakthroughs in key areas next year. These will include income distribution reforms that are aiming at reversing the widening income gap, the reforms of fiscal, financial and investment systems as well as reforms that will facilitate resource conservation and environmental protection. Specifically, the government is considering new moves on personal income tax, the expansion of the resource tax reform, as well as the expansion of direct financing for businesses, among other things.

On foreign trade and foreign investment, the Chinese central leadership says that China will continue to stabilise and expand the external market, and will speed up the upgrade of processing trade and promote imports—enhancing imports' role in China's efforts to rebalance the economy and readjust the economic structure. As for foreign direct investment (FDI), the government is encouraging FDI in high-end manufacturing, high-tech sectors, modern services, energy conservation and environmental protection as well as FDI in China's central and western provinces, all in line with China's need for structural adjustment and for regional development.

Outlook and Implications

This pivotal annual economic meeting has set down the broad policy framework for next year, and specific macroeconomic policies and targets—such as the annual lending target and money supply growth target—will be announced in follow-up meetings of key government agencies. For next year's macroeconomic and policy targets, it is now widely speculated that China could have a higher inflation target, lower growth target and lower money supply target—which is not just compatible with the short-term economic outlook but also in line with needs of rebalancing and readjustment that are highlighted in the 12th five-year plan.

Short-term priorities for inflation control and growth aside, another even more important policy focus for next year is to begin the key initiatives outlined in the 12th five-year plan, i.e., readjustment and rebalancing. This involves implementation of demand-side policies such as income redistribution reform that is designed to boost the share of household income in aggregate national income, the re-engagement of the government in the provision of public services and social welfare, urbanisation and regional development drives, particularly the western China development initiative. This will also involve the implementation of many supply-side adjustments, i.e., consolidation and upgrade of traditional sectors and expansion of new strategic sectors and services sector, which has been described as a "new industrialisation" drive in the 12th five-year plan.