Whether by coincidence or design, Beijing is unveiling new stock market reforms just as China Evergrande Group’s spectacular plunge reminds investors why just such reforms are so badly needed.
On August 27, futures markets telegraphed a surge in the CSI 300 Index on reports that Chinese leader Xi Jinping’s team is rolling out a series of measures to cheer equity investors, including cuts in stamp duties on trades, lower deposit ratios for margin financing and a more selective process for executing initial public offerings (IPOs).
After opening 5.5% higher on the weekend news while markets were closed, the CSI 300 Index of mainland stocks yielded its gains to close just 1.2% higher on Monday (August 28) as foreign funds accelerated their selling over the day.
Beijing’s levy on trades is dropping to 0.05% from 0.1% effective August 28, the first such reduction since 2008. The step is meant, as the Chinese Ministry of Finance explains, to “invigorate capital markets and boost investor confidence.”
So, too, is the China Securities Regulatory Commission’s decision to slow the pace of IPOs amid “recent market conditions” characterized by extreme price volatility. Moreover, Xi’s regulators are moving to limit share sales by top stakeholders when prices drop below IPO levels or net asset levels. They will also cut margin ratios for leveraged trades.
“The increasing force of the policy tools will lift market confidence, amplifying the positive signal for the market,” opines analyst Pu Han at China International Capital Corp. It helps, too, that “the scale, force and speed of the measures all beat expectations.”
And all not a moment too soon as China’s property crisis and rising critiques of the sustainability of Beijing’s growth-at-all-costs development model come to dominate global headlines.
The August 17 bankruptcy filing by China Evergrande put an even harsher spotlight on a troubled sector that in the recent past has generated as much as 30% of China’s gross domestic product (GDP).
In the 17 months since trading in China Evergrande’s shares was halted, and in the days since its bankruptcy filing in the United States, the nation’s most indebted property developer disclosed more losses.
On Sunday, disclosures to the Hong Kong stock exchange showed another loss to shareholders of more than US$4.5 billion between January and June. That’s on top of an earlier $80 billion loss in the previous two years.
Of course, China Evergrande’s 2021 default has been the tip of the proverbial iceberg. Since then, other large Chinese developers have made global headlines for missing bond payments. More recently, Country Garden’s missed payments put China’s default risks back at the center of global market discourse.
In some ways, Country Garden’s stumble was even more damning to investor sentiment than Evergrande’s.
“In contrast to troubled peers such as Evergrande, Country Garden had been a relatively compliant player in Beijing’s deleveraging campaign, effectively reducing its debt ratio and adhering to deleveraging requirements,” observes analyst Anna Ashton at Eurasia Group, a political risk consultancy. “Nonetheless, an ongoing debate rages in China about potential government intervention to stabilize investor confidence.”
Hence the importance of the timing of the new stock trading reforms. In short order, estimates analyst Wang Yi at Huatai Securities, the reforms will pull at least $100 billion in new funds into mainland equity bourses.
At the same time, Yi says the “new restrictions on share sales in effect keep around 250 billion yuan ($35 billion) of funds from selling and bring the strongest benefit to liquidity.”
The key, though, will be meticulous and transparent implementation. As property investment loses its appeal in Asia’s biggest economy, the argument for building deeper and trusted capital markets is strengthening by the day.
There are well-understood reasons why Chinese stocks are as cheap today from a valuation perspective, as they’ve been in the last decade of relative underperformance.
All of the risks global funds try to avoid when betting on developing markets, namely questions about economic growth, regulatory certainty, exchange-rate mechanics and the potential for political turbulence, are present in spades in Shanghai and Shenzhen shares.
It was 10 years ago, after all, that Xi took power pledging to let market forces play the “decisive” role in financial reform decisions. For all those promises, China is more of a buyer-beware market in 2023 than many investors expected.
The clampdown on Big Tech that Xi’s regulators launched in late 2020 only added to the reasons why foreign investors have throttled back on entrusting capital to China.
Economist Jimmy Jean at Desjardins Group speaks for many when he says regulatory uncertainty, along with trade tensions with the US, have complicated China’s post-pandemic recovery.
“We were always skeptical of the narrative that China’s reopening would save the global economy this year,” Jean says. “So far, there isn’t much proving us wrong.”
The external environment sure isn’t helping, either. Yet this works both ways, as China’s troubles reverberate around the globe, dampening growth prospects everywhere.
“It doesn’t necessarily help things, but I don’t think it’s a major factor in determining the outlook in the next six months,” says economist Neil Shearing at Capital Economics. Things could darken further, Shearing notes, if “the outlook for China becomes substantially worse.”
Yet the most recent stock reforms could be a boon for Premier Li Qiang’s standing in market circles. Just five months into the job, Li has had something of a baptism by fire as new challenges seemingly emerge daily.
Last month, Li proclaimed that Xi’s government is stepping up efforts to normalize China’s regulatory environment. The goal, Li said, is to “reduce the costs of compliance and promote the healthy development of industry.”
Li explained that “on the journey of building a modern socialist country, the platform economy has great potential.” He told tech chieftains in the audience, including officials from Alibaba Group, TikTok owner ByteDance and food delivery group Meituan, to “push to increase their international competitiveness and dare to compete on the global stage.”
Analyst Kelvin Wong at OANDA isn’t alone in believing that such rhetoric “is likely to boost positive animal spirits in the short-term at least.”
But credible reform is needed to ensure those innovative, entrepreneurial spirits are facilitated and unleashed by deep and vibrant capital markets. In that direction, Li’s reform team has been stepping up efforts to build a world-class bond market.
Generally, China’s market infrastructure hasn’t kept pace with the tidal waves of capital racing its way. Chinese government bonds being added to top indexes, including the FTSE Russell benchmark, has been a game changer.
FTSE inclusion has increased financing options for China Inc and offered myriad opportunities to build diversified and resilient portfolios via new asset classes to drive the economy’s growth and development.
The problem, though, is that China’s bond market is underpinned by a financial architecture with limited liquidity and hedging tools, a giant and opaque state sector, and a rudimentary credit-rating system that often obscures risk and thus enables the misallocation of capital.
China has long had a financial sequencing challenge. During the Xi era that began in 2013, as before it, China has too often seemed to believe that attracting more foreign capital is a reform in and of itself. However, regulators have been slower to strengthen China’s financial system ahead of the arrival of those waves of foreign capital.
In 2001, many top Communist Party assumed inclusion in the World Trade Organization alone would increase Chinese competitiveness and recalibrate its growth engines. Nor did the yuan’s 2016 inclusion in the International Monetary Fund’s “special drawing rights” program hasten Beijing’s capital account liberalization nearly as much as hoped. The yuan still isn’t fully convertible.
A-share stocks’ addition to the MSCI index in 2019 didn’t magically make China’s financial system sounder, the government more transparent, companies more shareholder-friendly or the shadow-banking industry more productive and resilient.
Raising China’s economic game requires significant heavy lifting to curb the dominance of state-owned enterprises, increase economic space for the private sector and eliminate the risk of dueling bubbles in debt, credit, assets and pollution. Li’s reform team insists it’s on top of things.
The stock reforms unveiled this past weekend were well-timed. In the interim, odds are the People’s Bank of China will come under greater pressure to support growth, exactly what new Governor Pan Gongsheng wants to avoid. Prior to the stock trading reform announcement, the MSCI China index had plunged 11% so far in August, its worst run since October.
Economist Maggie Wei at Goldman Sachs speaks for many when she says the PBOC’s recent 15 basis-point cut in the loan prime rate was “disappointing” and “would not help with building confidence” as Xi’s government tries to revive economic confidence.
In place of fresh stimulus, bursts of the kind China has served up time and time again over the last 15 years, Xi and Li seem determined to boost investor confidence through accelerated reforms rather than aggressively pulling fiscal and/or monetary policy levers.
And any progress China makes to ensure its stock market is more open, dynamic and ready for the global prime time will be crucial to reversing the loss of confidence in China’s prospects that seem to be gathering by the day.
Follow William Pesek on X, formerly known as Twitter, at @WilliamPesek