China's President Xi Jinping signaled a tolerance for slower expansion to avoid environmental degradation as policy makers outlined plans for the private sector to take a bigger role in boosting growth.

The country won't sacrifice the environment to ensure short-term growth, Xi said during a study session of the Communist Party's top leadership on Friday. His comments followed a statement issued on the same day that the State Council, which is chaired by Premier Li Keqiang, approved measures including tax reform to revamp the economy.

Xi and Li, who took over respectively as president and premier in March, are laying the groundwork to cut the government's role in the economy, open state-dominated industries to private investment and revamp the household registration system that's hampering urbanization. Some changes are already being trialed, while others will be decided at a meeting of the Communist Party's leadership later this year.

"Reforms are more pressing now; growth is running out of space, there's more pressure on the labor markets and local governments have too much debt," said Jean-Pierre Cabestan, head of the department of government and international studies at Hong Kong Baptist University who has studied Chinese politics for three decades. "They need to boost the economy but they can't do it with another stimulus or some form of quantitative easing."

Since taking office, Li has pledged to cut government interference in the economy, give market forces more power and boost the role of private companies.

Biggest Dividend

In his first press conference as premier on March 17, Li described reform as the "biggest dividend for China" and said that cutting the government's power was a "self-imposed revolution." The changes would "be very painful and even feel like cutting one's wrist," he said.

In its Friday statement, the State Council approved a series of measures put forward by the National Development and Reform Commission. They include boosting social welfare, taxing products that are resource-intensive and heavily polluting and expanding levies on natural resources.

Chinese stocks listed in the U.S. fell the most in three months that day on concern that economic growth is slowing and that measures to open markets to private companies and rein in state-led investment will hurt earnings. The Bloomberg China-US Equity Index dropped 0.7 percent, taking its decline for the week to 3.5 percent.

Policy Shifts

Seven working groups are drafting proposals for reform in the financial sector, the fiscal system, land tenure, prices, the bureaucracy, income distribution and household registration, according to a Barclays Plc report dated May 13. These will be presented to the third plenum of the Communist Party's Central Committee later this year, analysts led by Huang Yiping, the bank’s Hong Kong-based chief economist for Emerging Asia, wrote.

Big shifts in economic policy must be ratified by the Central Committee, a group of some 200 people picked every five years by a party congress and from whose ranks come the top civilian and military officials in China. The third full meeting of the current Central Committee – known as the third plenum – is set to be held later this year although the date hasn't been announced.

It was at such a third plenum in late 1978 that Deng Xiaoping and his allies inaugurated a series of economic reforms that began to open up China to foreign investment and loosen state controls over the economy.

'Extremely Complex'

"Many people have the perception that the upcoming third plenum could be important because of what happened more than 30 years ago," said Lu Ting, chief China economist at Bank of America Corp. in Hong Kong. "But for the really important reforms such as hukou and land reform, it's unlikely the government will be very aggressive because they are extremely complex and difficult reforms."

Xi's pledge to protect the environment follows growing public discontent that industrial expansion is creating pollution and threatening food safety. Pollution has replaced land disputes as the main cause of social unrest, Chen Jiping, a former leading member of the Communist Party’s Committee of Political and Legislative Affairs, said in March.

Demonstrations against industrial plants have taken place in Shanghai and Kunming, the capital of southern Yunnan province, this month. State-owned China National Petroleum Corp., the country’s biggest oil producer, pledged to take measures to ensure a chemical factory it wants to build near Chengdu, the capital of Sichuan province, won’t harm the environment amid growing opposition to its proposal.

Difficult Implementation

"Environmental issues are much higher on the agenda with the current leadership," said Ma Jun, a Beijing-based environmentalist and founder of the Institute of Public and Environmental Affairs. Xi's comments "are very positive and more serious this time, although the implementation will be very difficult."

As part of efforts to curb pollution, the Ministry of Environmental Protection said this month it suspended approval for coal-fired power projects in the regions of Inner Mongolia, Henan and Guizhou. It also ordered 15 companies, including state-owned Hebei Iron & Steel Group, to pay fees for sulfur-dioxide emissions, according to a statement on its website.

"The government is showing a much bigger tolerance for slower growth because they understand that China's potential growth rate is slowing and that concerns about the environment are rising," said Bank of America's Lu. "One of the reasons we cut our growth forecast is because protests over environmental issues are leading to the cancellation or delay of a lot of investment projects."

Lu lowered his 2013 estimate for economic expansion to 7.6 percent from 8 percent on May 14, the second reduction this year.

The median estimate of 51 analysts in a Bloomberg News survey this month was for economic growth of 7.8 percent this year. That's down from an 8 percent median projection of 52 economists in an April poll and would match the pace of expansion in 2012 that was the weakest in 13 years.