The writer is director of China markets research at Rhodium Group
China’s crackdowns against the property sector and its technology giants have jolted financial markets, sparking a debate about whether or not China is still “investable”.
Longer-term bullish investors argue that Beijing’s commitments to economic growth and market liberalisation remain unchanged. They maintain recent actions such as tougher rules on property developer debt loads are efforts to reduce froth in the sector. Necessary adjustments in credit risk pricing will improve the functioning of China’s financial markets over time.
In contrast, bearish investors argue that under Xi Jinping China’s fundamental political objectives have changed and maintaining growth and liberalising capital markets are now less important to the country’s leadership than goals related to “common prosperity”. They claim this summer’s campaigns, including the attacks on technology firms and education and tutoring businesses, imply that China is increasingly unsafe for investors.
As interesting as this debate may be, it is the wrong one. The most important question now confronting markets concerns Beijing’s policymaking process, rather than political objectives — the means rather than the ends.
Combating contagion from the woes of Evergrande and other property developers spreading into the broader economy requires an effective countercyclical policy response. But that response has not been forthcoming so far and the reasons for Beijing’s inaction are unclear. Are China’s technocrats holding back because the current property market turmoil is part of a controlled effort to reduce risk? Or have new political factors prevented China’s technocrats from acting?
Despite an unprecedented credit expansion lasting more than a decade, China has not faced a debilitating financial crisis or a sharp slowdown in growth (apart from last year’s pandemic-related slump).
Stability cannot be easily explained by macroeconomic factors such as China’s high savings rate or the internal nature of its debt, nor by political factors such as the state’s administrative tools or Beijing’s lack of legal constraints.
Rather, Beijing’s obsession with political stability has generated a long record of authorities being credibly expected to respond to even minor episodes of financial stress in order to calm markets.
But the credibility of this expectation depends upon the policymaking process working as it has in the past. At some point, waiting too long to respond to the current property market turmoil will generate too much contagion and several factors will weaken China’s economy and financial system. They include the effects of falling property prices on household consumption, the impact of falling land sales on local government finances and the use of property as collateral for lending.
Beijing’s long-term objectives will not matter if the near-term tools of economic adjustment falter. Most economic analysts argue that Beijing will be forced to back down on controls targeting the property sector, given its importance to the economy.
But political analysts argue there is growing evidence that the leadership’s campaigns to reshape the economy are constraining the countercyclical responses that markets are accustomed to seeing.
As economic policy tools are newly infused with political significance, technocrats face fresh difficulties reversing course or balancing messages from leadership. Similarly, these analysts argue the centralisation of authority has weakened some of the balancing forces within the party-state system that might correct policy mistakes midstream. As a result, while the outcome of this debate is still uncertain, policy overshooting has become a far more significant risk.
In 2013, China’s central bank tried to reduce speculation in the interbank market by staying silent in the face of a sudden payment default. The banking system almost shut down in response, with short-term rates reaching 20 to 30 per cent. The central bank was forced to relent and inject liquidity, a precedent that facilitated the rapid expansion of the shadow banking system.
Beijing’s objectives were understandable, but the methods used created the opposite effect to what was intended. Given the political salience of China’s campaign against the property sector, a similar about-face is difficult to envision. But how and when Beijing responds to the market contagion is now more important than the leadership’s original objectives and will determine how investable China remains.