China’s Reform Is Dead? Long Live Reform
In response to Beijing’s ham-fisted efforts to arrest a freefall in overvalued equity markets, China pessimists are having a field day deriding Xi Jinping’s 2013 dictum that “we must let markets be the decisive factor.” Many are going so far as to assert that reform is dead.
That pronouncement is likely to prove premature. Despite the loss of face – not to mention trillions in market capitalization – President Xi has no choice but to hold the marketization course he laid out 18 months ago, albeit without the benefit of a fast growing stock market to grease the rails. And he needs to rebut the reform obituary writers quickly, because the present lack of direction is adding dramatically to the erosion of confidence in China’s economic prospects.
There is no question that China’s officials encouraged – some tacitly, some directly — a market bubble even once it was obvious from outrageous price-earnings ratios that a correction was inevitable. They applauded index values that were difficult to defend, and pushed them even higher by permitting an unprecedented rise in margin trading. Then, in reaction to the nasty collapse in share prices which naturally followed, they took a series of counter-productive interventions that squandered credibility and made conditions far more dangerous.
The People’s Bank of China, the country’s central bank, loosened liquidity — but not nearly enough to turn the trend. The China Securities Regulatory Commission suspended IPOs and forced brokerages to pledge funds for a buyout fund — but again, not nearly enough to change things. The CSRC also made brokerages promise not to sell shares until the market recovered by 1000 points. Short selling was restricted. Regulators passed along conspiracy theories about hostile speculators and “foreign forces.” An extraordinary fraction of all listed companies is now being permitted to suspend trading, blocking the exits for shareholders.
China needs leadership to clarify what happens next, but thus far there has been little. Though President Xi chairs all the principal economic policy leading groups in China, in three weeks of market meltdown, he has said nothing public on the subject. What’s most surprising is the damage to confidence in Beijing – either to keep cool while market forces played out, or to successfully prop up stocks to ward off a panic. By allowing the government to be seen as lacking control, China’s leaders added to the panic.
China managed to deliver high growth over the past 37 years without healthy capital markets, tempting some in Beijing to think they can do so for another decade. But today capital markets are critical in ways they previously were not. The alternative that worked well for China at an earlier stage of development — government-directed bank credit — is now failing to finance growth. Without healthy capital markets, China’s economic welfare will continue to diminish through 2020 and beyond.
Does this mean that reform in China is therefore dead, and that making market forces decisive is impossible?
What Xi’s catchphrase about “decisive” markets meant was not that marketization was done, or “Read my lips: no more intervention.” Rather, he meant that it had to be accomplished over the medium term or China’s growth would fall short, bringing about political, social and developmental problems. Nothing in the stock market meltdown since mid-June or the series of interventions that followed it changes that reality. To believe that China’s reform ambitions are over is to believe that Beijing has decided it is better to learn to live with GDP growth averaging 0-3% over the remainder of the Xi administration. That would not be a wise decision, and there is no reason to believe President Xi will make that choice.
So what happens now? For those most concerned about the “credibility gap”, the preference is to see President Xi make a strong appearance and take responsibility. Acknowledging the flaws manifest in the handling of stock market reforms to date is a required step toward restored trust. And the factors that can help restore a positive equity market trend going forward need to be identified: many of the culprits scapegoated in the panic of the past weeks – speculative interests, short selling, Chinese and foreign institutional investors that dare to put profit above politics – need to be rehabilitated and embraced as essential elements of a healthy financial ecosystem in the future.
The most important thing needed from Beijing at this juncture is to quarantine the alarm about its stock market missteps from the larger project of economic rebalancing. Center-local fiscal restructuring, foreign exchange and capital account liberalization, and wider trade and direct investment opening in services as well as manufacturing are now on the cusp of progress. Industrial restructuring and state owned enterprise reform are on the agenda, and they depend less on public equity markets than many people believe. Land and labor market reforms need faster implementation. To think that these reforms must come to a halt at the closing gong of the Shanghai Stock Exchange is a mistake.
China has an opportunity to separate its stock market imbroglio from other reform imperatives, including on trade, cross-border financial account liberalization and domestic interest rate liberalization. The reasons to do so have never been more compelling.