Two years ago, China promised market forces will enter the financial arena. But is has been a mixed message from the start, and after the government tried to save a dropping stock market, financial analyst Arthur Kroeber looks for the Brookings Institute at what has happened.
In countries such as the U.S.—where about half of the population own stocks, equities make up a big chunk of household wealth, and corporations rely heavily on funds raised on the stock market—a big stock-market fall can inflict great pain on the economy by slashing household wealth and spending, and making it harder for companies to finance their investments. China is different: less than 7% of urban Chinese have any money in the market, and their equity holdings are dwarfed by their far larger investments in property, wealth management products, and bank deposits. Equity-raising accounts for less than 5% of total corporate fund-raising; bank loans and retained earnings remain by far the biggest sources of investment funds.
But hold on—if the market were really so economically irrelevant, then why did the government panic and try to prop it up with such extreme measures? It’s a fair question. One plausible answer is that the China Securities Regulatory Commission (CSRC), which oversees the market, got worried by the chaos and begged the State Council to mobilize support so that it could gain time to deal with the underlying problems, such as excessive margin borrowing. This explanation certainly seems to be the one the State Council wants people to believe. Despite its strong actions, the Council and its leader, Premier Li Keqiang, have stayed studiously silent on the stock market. The implied message is: “Okay, CSRC, we’ve stopped the bleeding and bought you some time. Now it is up to you to fix the mess and return the market to proper working order. If you fail, the blame will fall on you, not us.” If this interpretation is right, we can expect restrictions on trading and IPOs to be gradually lifted over the next several months, and rules on margin finance tightened to ensure that the next rally rests on a firmer foundation.
The episode highlights the built-in contradictions in China’s present economic policies. Based on numerous statements and policy moves over the last 15 years, there can be no doubt that influential financial reformers want bigger and more robust capital markets—including a vibrant stock market—in order to reduce the economy’s reliance on politically-driven bank lending. Moreover, the success of proposed “mixed ownership” plan for SOE reform likely depends on having a healthy stock market, in which the state shareholding in big companies can be gradually diluted by selling off stakes to private investors.
But the financial reformers are not the only game in town. As analysts like me should have taken more care to emphasize when it was released, the Third Plenum Decision is no Thatcherite free-market manifesto. In addition to assigning a “decisive role” to market forces, it reaffirms the “dominant role” of the state sector. Like all big policy pronouncements during China’s four decades of economic reform, it is less a grand vision than an ungainly compromise between competing interests. One interest group is the financial technocrats who want a bigger role for markets in the name of more efficient and sustainable economic growth. Another consists of politicians and planners who insist on a large state role in the economy so as to maintain the Party’s grip on power, protect strategically important industries and assets, and provide a mechanism for coordination of macro-economic policies.
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