State council meeting announced tax cuts and Central committee for deepening reforms held its first meeting

Tax cuts – (1) Cut the VAT rate for manufacturing industry to 16% (from 17%), and cut the VAT rate for transportation, construction, basic telecom and agricultural products to 10% (from 11%); (2) Raise the threshold for “small-scale tax payers” to Rmb5 million (of annual sales), from Rmb0.5mn/0.8mn currently. This would allow more business entities to benefit from lower tax rates; (3) Settle input tax refund for qualified business entities in the equipment manufacturing and R&D industries. The government estimated that these three measures in total would reduce tax burden by Rmb400bn (0.5% of GDP) and emphasized that this would benefit domestic and overseas qualified entities equally.

Establish National Financing Guarantee Fund – This fund will support financing of micro to small-sized corporates and the agriculture sector, and also enhance the credit rating system. Based on the government’s estimates, this fund can support loans of around Rmb500bn in the next three years.

The state council meeting also mentioned that organizational reform of the state councilis a key task for this year, and the state council has set up a special coordination group to push for implementation.

In the deepening reform committee meeting, President Xi discussed various issues such as the previous central inspection on environment protection, enhancing financial regulation , tightening non-financial institutions’ investment in financial institutions; further opening up of the expanded free trade zones in Guangdong, Tianjin and Fujian, reforming the compensation structure of the SOEs to better incentivize SOE employees, increasing the Party’s leadership over public hospitals, further reducing red tape and streamlining administrative approvals and more actively participating in international macro economic policy coordination mechanism

We think the tax cut is a positive move. The size of the tax cut is as expected, as it had already been revealed by the PM during the NPC. PM Li indicated the intention to simplify VAT during the NPC, but did not give details at that time. However, the magnitude of the cut is relatively small and is already factored into the official fiscal budget. We expect details of other tax cut measures to be announced in the coming weeks, including the adjustment to (1) personal income tax in terms of higher minimum threshold and exemptions for some education and health expenses and (2) import duties, on cars and other consumer goods.

The details of the asset management rules will likely be announced shortly afterwards. Domestic media commonly predict more flexible treatment in terms of the compliance deadline and valuation standard, which makes sense in light the goal of maintaining financial and economic stability. It is uncommon for this type of rule to reach the agenda of the President directly, which we think highlights the leadership’s focus on this issue.The rule on non-financial companies’ investments in financial companies likely implies tighter controls to prevent the kinds of conglomerates that encompass a large number of sectors and involve a large number of irregular related transactions.

The announcement on SOE compensation did not reveal much detail. It highlighted words such as making employees more creative, proactive, and enthusiasm, which suggests more flexibility than the recent past. Over the past several years, SOE employees often saw lower and more rigid compensation which has not helped their performance or that of the wider economy. This is crucial for the overall efficiency of the economy in light of the broad direction of making SOEs bigger, stronger and more influential. How much can be done remains to be seen. The announcement also stated the need to improve supervision, which indicates the (likely more flexible) new rules will need to be followed more strictly.

The meeting emphasized the importance of continued inspection on environmental issues. As the minister of Environment and Ecology stated, although the level of pollution fell significantly over the winter, it was partially due to favorable weather conditions of strong wind. The pollution level since then has risen and it cannot be assumed that the bulk of the tightening on industrial companies is behind us, in our view.The pace of reform may see some acceleration in the future for two reasons. First, the greater concentration of power can improve implementation if there is enough will and focus from the top leadership. Second, external pressures – both in terms of US tax cuts from a competitive point of view and trade tensions – could provide impetus for reforms. Not all of the reforms will be liked by Western observers, though, as SOE reforms thus far have highlighted — with no clear indication of large scale privatization or downsizing. But the broad direction of lower taxes and greater flexibility seems to be favorable, at least so far.

Its not clear what exactly is behind the international macro economic policy coordination mechanism and to what extent it is related to the trade tensions. The Chinese government has generally shown significant levels of flexibility and willingness to resolve the issues in a non-confrontational way, which helps to keep the risks of a full-scale trade war at a relatively low level.