New Experiment in China: Perestroika?

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The immediate focus on China is the possibility of another reduction in the required reserves. China has announced that this weekend (Saturday and Sunday) will be working days and that Mon-Wed next week are official holidays. This, coupled with the continued slide in the Chinese stock market (Shanghai Composite is off nearly 10% since March 14) and the largest injection in the money market in two months today have fanned speculation for some more relaxation of financial conditions.

There is also a larger story unfolding. One of the characteristics of China's developmental strategy has been for it experiment locally before scaling up those that succeed, like special economic zones.

This is similar to what the US did during the New Deal. Roosevelt "nationalized" the successful "experiments" that were implemented on state and local levels. The controversial US national health care seemed modeled on a state "experiment,"

In a development pregnant with potential, yesterday China's State Council (functioning like a cabinet) authorized the city of Wenzhou to "experiment" with financial liberalization. According to reports, private investors will be allowed to buy into local banks, establish loan companies and rural community banks. It may allow residents to make direct investments overseas and explore other ways to liberalize the capital account.

While this is promising, caution is still the better part of valor. Last year, the Wenzhou government issued rules allowing residents to invest overseas, but within weeks the plan was scrapped by SAFE, the State Administration of Foreign Exchange. Both Chinese investors who want to invest in foreign markets (QDII)and foreign investors who want to invest in China (QFII) will be closely monitoring these developments.

This may be one of the last economic reforms driven by Premier Wen. In terms of the balance-of-power between the princelings and Communist Youth League, this is a success for the latter. While the economy is poised to slow, there is also greater uncertainty that the new configuration of government will be as strong advocates of economic reform as the current one.

One question that investors ask is what kind of foreign assets could the residents of Wenzhou be looking to acquire. A way to explore the possibilities is to consider their knowledge set, by looking at Wenzhou's current industries. Wenzhou produces 90% of China's eyeglasses and exported lighters, according to bloomberg. It also exports timber, paper and alunite. Its main industries include electrical machinery, leather products and plastic manufacturing.