The Meaning of China’s Stock Market Intervention
The spectacle of the stock market meltdown in China has led many analysts and investors to see an upside to the downturn. The slump is “the most serious crisis” facing President Xi Jinping “since he came to power,” China commentator Willy Lam told an audience of academics in Vancouver on July 10. “It will require a lot to restore people’s confidence in the regime.” Volatility might force the state to clean up the unregulated loans fueling stock purchases and to intervene less in equity markets and the broader economy. The drop might even foster massive discontent with the Communist Party and support for real political reform. That’s because in China, unlike other major nations where large institutions dominate the markets, retail investors—90 million or so individuals, most of them belonging to the urban elite—do most of the investing.
In reality, the stock market plunge is likely to have the opposite effect. Xi’s government is too closely linked, in many citizens’ minds, to a guarantee that stocks are a safe and profitable bet. “When a market malfunctions, the government should not let market sentiment turn from bad to worse. It should use powerful measures to strengthen market confidence,” said a July 20 commentary in the People’s Daily, the official newspaper of the Communist Party. To forestall public discontent, the regime is likely to become more interventionist in the market and possibly in the broader economy as well. It has made $483 billion available to the China Securities Finance Corp. to prop up the stock markets. While that might restore calm and foster short-term stability, it won’t benefit China or the world economy in the long run.
There’s no doubt that some Chinese investors—especially novices who hadn’t previously witnessed a selloff—feel betrayed by Beijing’s assurances of prosperity. China’s financial microblogs, where ordinary investors chat and which had focused previously on market tips, are now full of broadsides against the government. One furious investor posted an essay that soon became a viral sensation. Ruing that the crash had wiped out the savings of many members of the middle class, he said, “For us the ‘Chinese dream’ is just a dream.”
At the same time, most critics on the microblogs haven’t called for faster economic or political liberalization. Instead, they demand the government do more to “save” the exchanges, even if that gives the central government greater powers. The pace of the selloff seems to have convinced Beijing, too, that it should intervene more in the markets, not less.
The government has launched several plans to reform its exchanges, but these have been dwarfed by its efforts to stop the decline in stock prices. Apart from pouring state money into the market, it is also believed to have been behind announcements by China’s brokers association of a new target—4,500—for the Shanghai Stock Exchange Composite Index. (It peaked above 5,000 in mid-June before plunging to 3,500 in early July; it’s recovered to about 4,000.) Beijing halted initial public offerings, recruited state banks to funnel at least $200 billion to brokerages to help buy shares, and used official speeches and commentary to assure citizens the market will stabilize. According to a leaked document posted by China Digital Times, the government also instructed state media to reduce coverage of the market.
Chinese analysts say these interventions are the first of many efforts to control the markets more closely. Junheng Li, an analyst with JL Warren Capital, wrote that in the wake of the plunge, “a free functioning and independent capital market [is] inconsistent with the control that the Communist Party is striving for.” Many Chinese economists expect that if these interventions don’t get the market rising again, the regime will dedicate even more funds, primarily from state banks and organizations, to what are essentially share buybacks. That would give Beijing greater control of both the equity markets and companies on the exchanges, because the government can decide which companies will benefit from its investment.
In addition, Xi’s administration might well impose drastic, long-term curbs on traders that it believes have repeatedly sold short, a violation of market norms. Announcing plans to reduce the practice in early July, the government said it would take action against “malicious short selling” but left vague which types of shorting would count as “malicious,” giving it even more latitude to shut down traders.
Some analysts have noted that China’s slumping stock market hasn’t yet caused a significant slowdown in economic growth and that Beijing’s handling of equities might have minimal impact on the government’s management of China’s macroeconomics. But the response to the crisis sets a tone for the broader economy. Xi had promoted financial reforms, including changes in the equity market, as part of the overall agenda of economic liberalization. Market forces would be allowed to play a “decisive” role in determining the direction of the economy, Chinese leaders announced in a major communiqué in November 2013, after a meeting of the party’s Central Committee.
That promise is undermined by massive intervention in equity markets. “As the stock market was plunging over the past few weeks, the government moved away from market-based reforms” it previously vowed, noted David Dollar, the U.S. Department of the Treasury’s economic and financial emissary to China from 2009 to 2013 and now a senior fellow at the Brookings Institution. It’s also sending a signal to opponents of liberalization, including leaders of state enterprises and the conservative wing of the party, that the government’s commitment to decentralizing the economy may be wavering. Conservatives and leaders of state enterprises will use these signals to press their case that reforms of state banks and the broader economy should be slowed—that state enterprises, powerful symbols of Chinese prestige, shouldn’t be broken up and privatized in case they’re needed to help bail out the stock markets again or to “save” other parts of the economy.
Already, state enterprises have become skilled at making their case that economic reforms are injecting too much instability and potentially giving foreigners power over markets. During and after the 18th Party Congress in 2012, several executives from government-owned enterprises lobbied the incoming Xi administration heavily and succeeded in keeping it from taking steps to reduce the power of state companies in many industries, according to Chinese academics and businesspeople.
The intervention in the stock markets may stall efforts to further open Chinese exchanges to the world, making reform of the financial system harder. Beijing will almost surely slow plans to allow foreign companies to hold IPOs in China or to have foreign financial companies play a bigger role in trading shares on Chinese exchanges. These changes would have promoted transparency and probably reduced the state’s power over the exchanges.
Some Western companies are growing wary because of the market interventions. BlackRock, which already trades shares on Chinese exchanges, warned that if the government continues to bolster markets, “there are going to be fewer global participants” in China’s exchanges.
A weakening of Xi’s reform plans would be dangerous for China and for the world. Xi and Premier Li Keqiang have rightly noted that China’s growth was too dependent on increases in money supply, debt, and investment driven by the state—an unstable base for sustainable expansion. Already, the country’s total debt-to-gross domestic product ratio is one of the highest among large economies.
Allowing China’s vibrant private industries more room to flourish and making equity markets and the real economy fairer and cleaner would create a sturdier foundation for growth. According to a study by the McKinsey Global Institute, Chinese companies have become highly innovative in areas such as telecommunications with the relative liberalization of the past decade. The country will never become a leader in innovation unless the state allows markets to work even more freely.
Indeed, without reforms that empower the private sector, it will be challenging for China to maintain the high growth rates that have become critical to spurring its global expansion. Eventually, relying on state interventions could lead to a crash in China’s real economy—one that would be a global calamity, not just a disaster for Chinese stock traders.
Kurlantzick is a senior fellow for Southeast Asia at the Council on Foreign Relations.