China’s Market Meddling

(Bloomberg) -- China’s Communist Party leaders say they’re learning to love free markets – to a point. With an economy weighed down by overcapacity and surging debt, the government is overhauling a financial system that was built to fuel high-speed growth. Its stated goal: Give markets a “decisive” role in setting prices and interest rates. The unstated challenge: Avoid exacerbating the economic slowdown, triggering panic in global markets or weakening the party’s grip on power. China’s epic stock market boom and bust in 2015 revealed a leadership frantically shifting course. Leaders stepped in again to contain steep declines in 2018, albeit less aggressively. The fiddling reveals a conflict between the desire to embrace elements of capitalism and an instinct to shelve reforms and assert control when things go awry.

The Situation

Government moves to stem routs in shares, commodities and the currency have included banning sales by major stakeholders, restricting short-selling and pushing state-owned bodies to purchase equities. It also has allocated billions of yuan to reduce fallout risks from companies that pledged shares as collateral for loans. In the 2015 meltdown, the Shanghai Composite Index tumbled more than 40 percent in just over two months; Nearly half the market was suspended, triggering rebukes from stock-index compiler MSCI Inc. China devalued the yuan later that year and promised to rely more on supply and demand to determine its daily fixing to the U.S dollar. Most interest rates now are determined by the market, though the central bank steps in during volatile periods. China’s progress was acknowledged when the International Monetary Fund added the yuan as a reserve currency from 2016, and MSCI added mainland China to its benchmark stock indexes in 2017. A liquidity crunch for private companies — a side-effect of a government campaign to tackle risks in the financial system — and concern over share-pledging triggered another sell-off in 2018. Sentiment had already been hurt by a trade war with the U.S., currency weakness and the slowing economy. Though much less visible than before, China’s “national team” of state investors was enlisted again, while banks were told to increase lending. Yet the government is still making market-friendly noises. It published rules for cross-listing stocks between Shanghai and London and made it easier for foreigners to trade China’s bonds. 

The Background

Mao Zedong derided “capitalist roaders” in the 1960s. Today there are more stock investors — 90 million — than Communist Party members, most with less than a high-school education. Policymakers pledged in 2013 to widen the use of markets in allocating resources. They also want to rein in a credit boom and a shadow, unregulated finance system. The debt buildup has evoked comparisons with Japan before its real estate and stock market bubble burst in the late 1980s. China isn’t the only country to intervene during market meltdowns and central banks have often sought to provide extra funding in times of turbulence. Some European countries temporarily banned short-selling in 2011 and 2012 during the region’s debt crisis. Japan tried to stem a stock market slide in 1992 by buying stocks.

The Argument

The IMF and China’s major trading partners argue that the country needs to loosen the guiding hand of the state and better integrate with the global financial system. The U.S., which has long accused China of keeping the yuan weak to boost exports, says it must do more to speed reforms, including better-protecting intellectual property — a key reason U.S. President Donald Trump cited for launching a trade war. China’s market interventions have hurt its credibility and fueled volatility by sending conflicting signals. There’s concern about the moral hazard of a hybrid system where investors assume the government will intervene in times of trouble. It also raises questions about China’s commitment to moving to a system where money is priced according to risk and allocated via market forces rather than channeled at the government’s bidding. Experience shows that mishandling the process could spur turmoil. 

The Reference Shelf

• 2018 has been a year of adversity – and big losses – for equity investors in China.
• QuickTakes on China’s monetary toolkit, its economic data mysteries, its debt bomb and currency liberalization.
• Another QuickTake on China’s “ national team” of state investors.
• The Guardian explored China’s contradictions regarding capitalism in a 2015 article about the stock markets.
• The IMF summarizes China’s economic outlook in six charts.

To contact the editor responsible for this QuickTake: Paul Geitner at pgeitner2@bloomberg.net

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