The question this year for investors in China is whether the government will continue moving toward a free-market economy—or keep grabbing the wheel.

Author: Tom Leander

DOUBLE WHAMMY

China has been on a wild ride since mid-2015, when the government responded to the August market meltdown with a sudden devaluation of the renminbi. The move drew global criticism—Goldman Sachs chief executive Lloyd Blankfein dubbed it “sloppy”—for its heavy-handedness. Other government actions were equally clumsy and haphazard: prosecuting brokers, blaming financial journalists for the market crash and forcing state-owned companies, including financial institutions, to buy stocks en masse. The consensus is that the measures failed, hurt investor confidence and probably prolonged the volatility rather than easing it.

We had circuit breakers on top of trading limits … yet with all these policies in place, we have more volatility, not less.

~ Hao Hong, Bank of Communications

Fast-forward to December. President and Communist Party general secretary Xi Jinping decided to oversee market reform himself, following last summer’s bumbling performance by premier Li Keqiang (the premier in China traditionally oversees finances and markets) and China Securities Regulatory Commission chairman Xiao Gang. Xi proclaimed a new financial era after announcing measures to stabilize markets. Three weeks later, on January 4, the Shanghai Stock Exchange’s new circuit breaker rules shut down trading for the day. The market closed again on January 7. At that point the government reversed its new measures—including the circuit breakers—and as of mid-January, investors remained tense.

A repeated blunder is unusual for Xi’s tenure, and the market chaos damaged his aura of invulnerability and cast doubt on some of his other policies. For example, investors fear the government’s anti-corruption drive has turned reckless, pursuing private-sector companies rather than concentrating on state-owned businesses, as it had before. That fear coalesced around Guo Guangchang, chairman of non-state-owned conglomerate Fosun International, who went missing for four days in December. A Twitter message that announced he had been assisting an official investigation and was traveling overseas to attend a performance of Cirque du Soleil, in which Fosun owns a 25% stake, hardly reassured shareholders. The stock has been trending down ever since—even after the chairman came home.

JUST A BLIP?

Some experts say the market turmoil interrupted a generally steady march toward real reform, especially in the banking system. In July 2013, the PBOC lifted all restrictions on commercial banks’ lending rates. It was a bold move, given that an attempt to rein in risky lending had ended up creating a credit squeeze only weeks before. Next, in April 2015, the government launched a long-awaited deposit insurance system, a key step toward deregulating domestic interest rates and introducing market- and risk-based pricing into capital allocation.

Diron, Moody’s: Capital outfl ows indicate the government has trouble sticking with its reform plans when growth falters.

Last June, China’s State Council drafted a proposal to relax rules requiring banks to cap loan-to-deposit ratios at 75%. The proposal is likely to become law this year. When it does, banks will be able to obtain funding in interbank markets, as overseas financial institutions do. (For context, London-based Capital Economics estimates that China’s big four—ICBC, China Construction Bank, Bank of China and Agricultural Bank of China—have loan-to-deposit ratios of under 65%. The average ratio in Australia is 111%.)

In October 2015 came the PBOC’s landmark decision to remove the ceiling on bank deposit rates, allowing lenders to compete for funds against one another and against online financial wealth management products. Then, in late December—possibly as a riposte to the government’s ungainly efforts to curb market volatility—the central bank announced a new mechanism to address macro risks in the financial system, starting this year.

Rather than focusing on loans, the so-called Macro-Prudential Assessment System will enable the PBOC to evaluate a broader range of products, including bonds and equity investments. It will monitor banks’ capital adequacy and leverage ratios, asset and liability ratios, liquidity, interest rates, asset quality and foreign debt risks, in addition to managing loan growth. In a statement, the central bank defined its goal as to “more effectively guard against systemic risks, play a countercyclical role and adapt to a growing trend of asset diversification.” 

“The move will strengthen the PBOC’s supervision of the entire financial system,” says BBVA’s Xia Le, who is among those who think the mechanism may have come “in response to the lack of coordination among regulators” and their “heavy-handed measures to curb the crash.”

Of course, the assessment system’s effectiveness will depend on its use. China’s central bank isn’t independent; it functions as an extension of the government, which has shown a determination to control markets. However, the PBOC now has a bigger toolkit, and other regulators have been discredited.

In this, Le sees a hopeful sign. “A strong regulator will be needed,” he says, “to manage the difficult task of limiting short-term volatility while simultaneously pushing financial deregulation forward.”

GFmag.com Data Summary: China

Central Bank: People’s Bank of China

International Reserves                 

$3.9 trillion

Gross Domestic Product (GDP)

$11.4 trillion*

Real GDP Growth

2013
7.69%

2014
7.30%

2015*
6.81%

GDP Per Capita—Current Prices

$8,280*

GDP—Composition By Sector*  

agriculture:
9.2%

industry:
42.7%

services:
48.1%

Inflation

2013
2.62%

2014
1.99%

2015*
1.50%

Public Debt (general government
gross debt as a % of GDP)

2013
39.42%

2014
41.14%

2015*
43.20%

Government Bond Ratings

(foreign currency)

Standard & Poor’s
AA-

Moody’s
Aa3

Moody’s Outlook
STA

FDI Inflows

2012
$121,080 million

2013
$123,911 million

2014
$128,500 million

* Estimates                                                                                                           
Source: GFMag.com Country Economic Reports

 

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