Trillions fuel China reform drive ahead of Congress

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BEIJING, Sep 26 (Reuters) A couple of trillion dollars can do wonders for your confidence.

Five years ago China's stock markets were in the middle of a four-year slump that stirred investor anger and was a key reason regulators held off tackling badly needed reforms ahead of the Communist Party Congress in 2002.

That contrasts starkly with the run-up to the 17th Congress opening on October 15, with a strong economy and robust stock market providing a secure backdrop for policy makers to push ahead with a catalogue of economic reforms, many historic in significance.

''I have been surprised at how many reform measures have been implemented this year,'' said Victor Shih, a China specialist at Northwestern University in Evanston, Illinois.

''They are a bit more confident in their policies now.'' It doesn't hurt that Chinese stock markets have created over 1.2 trillion dollars in value this year alone after a strong 2006, and foreign exchange reserves have more than quadrupled to nearly 1.4 trillion dollars in July from under 300 billion dollars at the end of 2002.

''The economy has been very strong with huge fund inflows into the system,'' said Vincent Kwan, Hang Seng Bank's chief economist.

''That has allowed the government in the past year to relax capital controls a great deal,'' he said.

Last month Beijing took the boldest step to date to dismantle barriers to the free flow of capital by announcing a plan to let individuals invest in Hong Kong-listed securities.

The ambitious scheme has run into bureaucratic obstacles and has yet to be formally launched. Still, analysts regard it as a milestone in China's rapid economic and financial development.

MOVING FORWARD In another relaxation, a programme introduced last year to permit qualified institutions to invest offshore on behalf of their clients could be expanded to allow banks to access stock markets in London and New York, state media reported last week.

Beijing is also establishing a 200 billion dollars sovereign wealth fund to try to earn higher returns on its foreign exchange reserves, which are growing at well over 1 billion dollars a day.

The fund is due to open its doors on Friday, newspapers have said.

The period surrounding the 2002 Party Congress was shrouded in uncertainty as a wholesale retirement of older top leaders and the prospect of sweeping ministerial changes froze policy making.

While personnel changes are certain for this Congress as well, there is hope given the strength of the domestic stock market that long-awaited stock index futures could be speedily approved to allow investors a badly needed hedging option.

''The legislative agenda continues to move forward in accordance with the plan that was established at the start of the year,'' said Lester Ross, partner-in-charge with law firm WilmerHale in Beijing.

That agenda includes passage of an anti-monopoly law last month that should foster a more open economy and a level playing field for business.

And a labour contracts law, which takes effect from 2008, will help improve conditions for millions of Chinese workers and could raise costs for bigger employers on the mainland.

Still, China's legislative process is excruciatingly slow and opaque, reflecting the jostling for consensus among various interest groups. A corporate bankruptcy law that went into effect on June 1 took 12 years to wind its way on to the statute books.

MARKET MOVES China is especially wary of pushing too hard on economic reforms for fear of triggering social instability as income gaps widen and the burden of paying for school fees and healthcare grows.

That may explain why the task of recapitalising Agricultural Bank of China, the weakest of the state policy lenders with a bad loan ratio near 23 per cent, is behind schedule.

Restructuring the bank's 25,000 branches could disrupt the already feeble flow of credit to China's sometimes restive rural areas, where raising living standards is a key plank of the drive by Hu Jintao, Party chief and state president, to create a ''harmonious society''.

Hu's emphasis on achieving that goal through ''scientific development'' is expected to be enshrined in the Party constitution at the congress, bolstering his political position.

For markets, though, watching policy movements counts for more than the politics of the Congress.

Earlier this month, China raised interest rates for the fifth time this year to combat inflation, which hit a decade high of 6.5 per cent in the year to August due to soaring food costs.

''China, it seems, has stepped up the pace of interest rate rises as adjusting to market changes becomes more important'' for regulators, said Hang Seng Bank's Kwan.

REUTERS SG BD0911

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