Xi's reform agenda gets two little-noted boosts

Stratfor reports that top officials in Hebei province are being purged as part of the anti-corruption campaign, noting that this is most likely a political purge to eliminate resistance to industrial downsizing, which will disproportionately impact the province.

Accounting for nearly a quarter of total Chinese steel output, Hebei in fact would be the second-biggest steel producer in the world - ahead of Japan - if counted as a separate country. Its heavy industry's quality and productivity remain embarrassingly poor, with many factories still using several decades-old equipment and methodologies. The result: Beijing's notorious pollution, a whole decade after a big initiative was announced to close obsolete plants ringing the capital municipality.

The purge, if it succeeds in placing loyal henchmen of Xi Jinping in charge of Hebei, would be a boost to his frustratingly slow reform agenda. It indicates that chronic stalling and foot-dragging on overcapacity cuts by local officials and SOEs have been traced all the way up to the provincial administration, whose grace period to get with the program prescribed by the central government has now expired.

We see here a classic example of just what the anti-corruption campaign was meant to accomplish: it was never about eradicating graft by punishing it evenly, but wielding the threat of discipline to get a wayward bureaucracy back in line with the center.

The change in Hebei is especially significant because it facilitates Beijing's ambitious scheme for "J3", or "Jing-Jin-Ji", a new mass metroplex area encompassing Beijing (Jing), Tianjin (Jin), and Hebei province (Ji) that some have dubbed as the world's biggest megacity (with 130 million inhabitants, more than the entire population of Japan).

Xi Jinping has gotten another little-noted boost lately in the form of rising stress in the corporate bond market. This is a crucial sign that at least some market discipline is being introduced into the financial system as more Chinese firms swap their bank loans for debt securities, and increases the central government's leverage over recalcitrant SOEs which continue to resist restructuring. A similar approach is likely in the young but already significant municipal bond market, which would enable Zhongnanhai to rein in noncompliant local governments.

Ironically, the very fastidiousness and fickleness of foreign investors in particular is especially useful here, and explains why Beijing recently opened up its bond market to outsiders. In time, once state companies and local administrations are exposed to international capital flows, their market and fiscal risks, respectively, will be priced more accurately. In the long term, this is the only effective way to govern them. Even if the central government continues some protectionist support to shield its favored entities from the full brunt of global financial forces to maintain ultimate control of markets, the foreign participation will send powerful independent price signals that domestic market players will also heed, and even Beijing's golden geese won't want the stigma of "poor rich kids."

At the moment, China's recovery is as much another mini-boom of speculation and policy front-running as it is anything more fundamental, so unfortunately we're headed for trouble again before long. But it's encouraging that Beijing appears to understand that just because it's bought some more time, doesn't mean it can delay confronting deeper systemic challenges.