Xi's Handwriting Betrays Paradox at the Core of China Policy

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  • China's leader ordered government to protect small investors
  • Focus on policy challenges increases amid annual NPC meeting

Inside China's Economic Blueprint

The order came down from the highest levels of China’s government, in a handwritten message from President Xi Jinping to officials charged with fixing the country’s crashing stock market: Make sure to protect the interests of small and mid-level investors.

Xi’s command -- scribbled across a report on probes into short sellers and other "malicious" traders -- was shared at a July meeting between regulators and law enforcement officials, according to a person with knowledge of the matter, who asked not to be named because the meeting was private. In the ensuing months, policy makers would escalate an unprecedented campaign to prop up shares and punish speculators accused of exacerbating the rout.

It’s safe to say that the results aren’t what Xi envisioned. Not only have Chinese stocks lost $728 billion since July, but the government’s handling of the crash has undermined its credibility among both international money managers and the individual investors it sought to protect. The intervention shows how Xi’s brand of populism clashes with his pledge to create a market-based economy, risking more policy misfires as he tackles challenges from reforming state-owned enterprises to allowing the yuan to trade more freely.

"If they can’t get stocks right, how are they going to get the trickier puzzle of SOE reform right?" said Michael Every, the head of financial markets research at Rabobank Group in Hong Kong, who correctly predicted the tumble in Chinese equities. "The government’s attempts have been a total failure, leading to a huge drop in confidence among investors."

Questions over the ruling Communist Party’s policies have taken on renewed urgency this week as leaders huddle for the National People’s Congress, an annual parliamentary session where lawmakers will sign off on China’s five-year economic plan. Nine months after the stock-market rout began, the aftershocks are still a focus of NPC delegates gathered in Beijing.

The market rout is “destroying the middle class,” Fan Yun, a businesswoman from Shanghai, said during a meeting of her municipality’s NPC delegation on Sunday, an unusually outspoken assessment of government policies. "The 10 years of stock-market development since 2007 is a decade of tears.”

Investing Masses

The second half of 2015 was especially painful. The average Chinese investor who entered the stock market in May -- when new account openings surged to record highs -- suffered losses of 27 percent through December, according to figures compiled by Hithink RoyalFlush Information Network Co., one of the nation’s biggest providers of financial data. 

Corwin Huang, a 26-year-old financial professional in Beijing, is among those disillusioned by policy makers’ response to the selloff, particularly that of the China Securities Regulatory Commission.

“I used to appreciate the CSRC’s efforts to support the market," said Huang, who liquidated his stock holdings in late January after recording a 50 percent loss. "Eventually, I decided I was wrong. I overvalued the government’s capabilities."

It’s easy to see why protecting China’s small investors was such a priority for Xi, who has also spearheaded a crackdown on official corruption and pledged to lift 50 million people from poverty by the end of the decade.

For one, stock investors are a huge constituency: About 90 million individuals had registered as investors by the height of the boom in June, more than the 88 million-strong Communist Party. Keeping the wealth of China’s middle class intact also furthered an official goal of creating a consumer-led economy, while the government’s credibility was on the line after senior officials joined state-run media in promoting equities before prices collapsed.

Circuit Breaker

There are signs that regulators have learned from mistakes. They scrapped a controversial market circuit breaker just four days after it was introduced in January, a rare admission of policy error after the mechanism was blamed for exacerbating investor panic. Last month, the government dismissed CSRC Chairman Xiao Gang, who had overseen both the stock-market bubble and bust.

Authorities are “still learning by doing,” said Wai Ho Leong, a Singapore-based senior regional economist at Barclays Plc, who cited recent remarks by Premier Li Keqiang and central bank Governor Zhou Xiaochuan as signs of an effort to improve communication with the market. "They will get it right in the end."

Old Habits

Still, policy makers seem to be prioritizing a rising market over long-term reform. The government’s plan to reduce intervention in initial public offerings, which had fueled fears of an oversupply of new shares, is unlikely to be implemented this year, a person familiar with the situation said this week. State-backed funds stepped in to support the stock market on Friday, according to two people with direct knowledge of the situation, in an effort to boost investor sentiment during the NPC. The Shanghai Composite Index rose 0.1 percent on Tuesday amid speculation of state buying.

Instead of meddling with market prices, China’s leadership should focus their efforts on educating individual investors and ensuring that market information is accurate and openly available, said Zhu Ning, deputy dean of Shanghai Jiao Tong University’s Shanghai Advanced Institute of Finance.

"The CSRC took an unnecessary and improper role of guaranteeing the equity market will rise," Zhu said. "In the long run, instead of facilitating growth of the stock market and investors, this role actually limits and hurts the market."

QuickTake: China’s Managed Markets

Xi, who gave himself control over China’s financial policies and long-term economic planning, will need to win back the confidence of local and foreign investors if he wants to steer the world’s second-largest economy through its deepest slowdown in a quarter century.

Plans presented at the NPC call for closing dirty and inefficient mills and mines, filling millions of vacant homes and letting capital flow more freely across China’s borders without a major yuan devaluation. The Communist Party wants to do it all while avoiding a surge in unemployment that could threaten social stability and damage its claim as the nation’s best option for economic prosperity.

Fang Tao, a 28-year-old employee at a sportswear company in Shanghai, has yet to be convinced China’s leaders can pull it off.

"It’s like the government is using our real money to try out their immature reform," said Fang, who lost 30 percent of his investment in stocks last year.

Full Coverage: China National People's Congress 2016