Xi Jinping gets serious about reform

China will accelerate supply-side structural reforms, as two consecutive People's Daily articles this week have made crystal clear.

Monday, an interview with an "authoritative source" widely believed to be Xi Jinping's top economic adviser Liu He enshrined an "L-shaped" trajectory for the Chinese economy and lambasted the notion that debt-fueled stimulus can continue as before.

Then on Tuesday, a speech by Xi Jinping to leading provincial officials from January was published, in which supply-side structural reform was emphasized.

Taken together, these are powerful affirmations that the trillion-dollar stimulus of Q1 should be understood as provisional demand support for much-needed supply-side restructuring - not a return to China's old ways of propping up GDP.

Given that Xi has further consolidated central party control of the provincial party hierarchies and ultimately determines how much credit flows through the economy via the central bank (headed by ally Zhou Xiaochuan), this should mean the end of monetary stimulus and only limited fiscal stimulus for the remainder of 2016.

As the first article indicates, the provinces have unveiled their supply-side structural reform blueprints, meaning they're now on the hook to deliver on reducing overcapacity and rein in debt. Further:

Officials in Hebei Province, a major steel production base with China's worst air pollution, will face immediate removal from their posts if new steel mills are built or closed factories reopen.

It remains to be seen whether this new enforcement will truly have teeth, but the purge of Hebei provincial party officials last month (including the party secretary) has doubtless removed a major obstacle. And the tailing off of the industrial recovery in late April, including in the steel sector, may be an early fruit of a sustained downsizing effort - even as it's touted by Gordon Chang as evidence that China's finally going to crash.

The danger now is that growth will tail off more sharply than expected in coming months: Beijing may well have to choose between missing its GDP target range of 6.5-7 percent and staying faithful to supply-side reforms, as weaker provinces' growth contributions remain abysmal or worsen further. Those still hopeful of China's prospects should cross their fingers that Xi will have the guts to tell the world, if it comes to it, that low-6 percent or even high-5 percent year-on-year growth is tolerable for a few quarters.

In fact, with annualized Q1 growth having clocked at barely 4.5 percent (vs. year-on-year 6.7 percent), it could be as simple as acknowledging what's already happened. Such honesty and humility would serve Beijing far more than cosmetic target-hitting - doubly so as the world realizes China's much better off with just 5-6 percent growth that's high quality than with nearly 7 percent growth that's more traditionally driven.