Intervention by Beijing Is Worsening China’s Market Woes
Economy is open enough that Communist Party doesn’t fully control it, but leaders can’t resist meddling, exacerbating market turbulence
The convulsions in China’s stock and currency markets this past week fanned investors’ worst fears: The world’s second biggest economy is in trouble and the authorities are powerless to fix it.
The truth is less frightening, but still fraught. China is trying to shift economic growth to a slower, safer path, one less dependent on capital spending and debt. Chinese technocrats know that means opening to ever more market forces, but its ruling elite is still not willing to accept that loss of control.
China’s economy is now open enough that the Communist Party can’t simply state its preferred outcome and expect it to happen. Investors inside and outside the country now have a say, too. The result: As growth slows, its leaders repeatedly try to tame the accompanying market turbulence, often making matters worse. Whether that interventionist instinct ultimately derails the economy’s transformation is very much an open question.
This past week’s market plunge exemplifies the challenge. After a series of ad hoc measures taken to halt the stock bubble’s collapse last summer, China’s securities regulator proposed circuit breakers that would halt trading for 15 minutes if the main stock index rose or fell more than 5%, and for the day if it moved more than 7%.
“It was a sincere attempt on the part of regulators to have a mechanism to prevent panic,” said David Dollar, a China expert at the Brookings Institution.
But the collar was far too narrow, perhaps reflecting an unrealistic aversion to the market’s inherently high volatility. Shortly after the circuit breakers took effect last week, they were triggered as downbeat economic news and a falling yuan spurred selling. Investors worried about being locked out rushed to sell more. That accelerated the slide and made it a foregone conclusion the circuit breakers would be triggered again. The unexpected halts sparked anxiety that spilled over to other countries.
A similar tension afflicts currency policy. China has long strictly controlled flows of capital across its borders, which helped it keep the yuan closely pegged to the dollar. But to make the yuan a more widely held global reserve currency, it has gradually relaxed those controls.
When the economy began to slow last year and the People’s Bank of China cut interest rates, investors naturally sought to take capital out of the country. The PBOC responded by devaluing the yuan last August, describing it as a move to make the currency more market-determined.
China’s political leaders, to whom the PBOC reports, had a more expedient motive: bolster exports and growth. As investors expected more of the same, capital outflows accelerated and the yuan’s value in offshore markets fell sharply below its more controlled onshore value.
The PBOC resisted those pressures, intervening heavily to buy up unwanted yuan. Between July and December, its foreign-currency reserves fell from $3.65 trillion to $3.33 trillion. It also intervened in the offshore yuan market to beat back selling pressure, while other officials ordered banks to crack down on currency speculators.
Then, as the dollar marched higher against other world currencies with the newly devalued yuan in tow, the PBOC resurrected a long-held pledge to manage the currency against a basket of currencies rather than just the dollar, which appeared to be the justification for engineering another devaluation against the dollar in the past week.
Deteriorating fundamentals, not just speculation, are weighing on stocks and the currency. The economy is slowing and may undershoot the party’s informal 6.5% growth goal. The slowdown has been led by heavy industry and real estate, which are plagued by excess capacity and unsold property, in part the consequence of prior stimulus ordered up by the government that helped repel the global recession.
Economists at UBS estimate that if China’s growth slumped to 4% this year (versus their forecast 6.2%), it would slice half a percentage point off U.S. growth, 0.8 point off Europe’s and 2.6 points off Japan’s. This is why global stock and commodity prices have been so sensitive to Chinese developments.
At their Central Economic Work Conference in December, party leaders recognized some slowdown was inevitable when they prioritized reducing excess capacity. That conference also suggested that monetary and fiscal policy would be used not to prop up obsolete industries, but to stimulate demand more broadly and thereby ease the transition for workers laid off by downsizing companies into new jobs. It also indicated that bankruptcy would no longer be off limits for state-owned companies. People’s Daily Online, a party mouthpiece, quoted an “authoritative insider” as saying. “Turbulence cannot be entirely avoided, but it is worthwhile turbulence.”
Such rhetoric isn’t new. A year after becoming Communist Party chief in 2012, Xi Jinping pledged to give markets a “decisive” role in the economy. But reality has been different. An overhaul of state-owned enterprises unveiled in September suggested bureaucrats would seek to merge companies suffering from excess capacity, rather than let such companies fail.
This may be less disruptive economically and politically in the short run because it would avoid loan defaults and minimize job cuts. But Haibin Zhu of J.P. Morgan notes that means debt will keeping mounting, productivity and growth will slide further, and rolling over loans to “zombie companies will crowd out the financing for other companies (especially from new sectors).”
In the long run, then, it might be better for China, and the world, that it suffer the turbulence of market forces now.
