Can Xi Jinping Win Back the Markets?
TA YEAR investors in Chinese stocks have been on a hair-raising journey. Even like America S&P 500 index hit record highs, markets in China and Hong Kong lost $1.5trn in January alone. Retail investors have taken to Chinese social media to express their frustration. The decline was so brutal that the president of China, Xi Jinping, was informed on February 6; the next day Yi Huiman, the head of China’s security regulator, was dismissed. Prices recovered slightly when state-owned companies started buying stocks. In the coming days they may rise even further.
Take a step back, though, and there’s no doubting the terrible picture either. The market value of China and Hong Kong shares is down almost $7trn from its peak in 2021 – a drop of around 35%, even as American stocks have risen 14%, and India’s 60%. The decline points to a fundamental problem. Investors abroad and at home once saw the Chinese government as a reliable steward of the economy. Now this trust is gone, with negative effects on China’s growth.
Less than ten years ago the mood in the Chinese markets was dire. Foreign investors were eager to take advantage of the potential of the world’s rising economic star. China was expanding at a steady and impressive rate of over 6% per year. Overseas portfolio investment surged as offshore investors gained direct access to Chinese stocks through Hong Kong in 2014. Four years later msci, financial company, which began to include mainland stocks in its global indexes. The Chinese government, for its part, hoped to professionalize its markets to attract foreign capital and expertise, and build an asset class to replace property. A group of wealthy businessmen and investors appeared who were inspired by Mr. Xi himself to live the Chinese dream.
The clear understanding was that regardless of politics in China, its officials could be trusted to steer the economy to prosperity. China would continue to grow at an enviable pace, its citizens would still place wealth and economic stability above political freedom, and foreign investors would reap good returns. Everyone could get rich.
What went wrong? One problem that has been widely identified is Mr Xi’s lean policy making. A regulatory crackdown on technology that began in 2020 sapped investor confidence. The emergence from zero-covid was a fiasco. The government has intervened in a property crisis that has sapped savings and sentiment and dragged the economy into recession, with prices falling in the year to January at their fastest rate since the 2007 financial crisis. -09. It’s okay to avoid a regeneration bubble. But it also wants to avoid handouts and focus growth on “high-quality” sectors that it believes will help China compete with America’s technological, economic and military prowess. Profits were down last year even in those sectors, however. And China does not have the motivation it needs.
Less popular is how foreign investors have fallen out of love with China. They have to contend not only with bad policy design, but also with the threat that their relationship with America could jeopardize their investments. They have been net sellers of mainland stocks for months. While asset managers once celebrated the inclusion of China in global indexes, they are now crafting products that leave it out. Instead, investors are looking at India, with its large population, and Japan, with its modern technology. Hong Kong, too, has suffered. Companies from the mainland make up three quarters of their market capitalization. On January 22nd India briefly passed to become the fourth largest stock market in the world.
What is more worrying is that investors on the mainland are also losing confidence. After three decades of spectacular growth, China’s wealth is suffering a painful reversal in fortunes, as our briefing this week reports. Both their property and their financial investments are sinking, and surveys show that many white-collar workers took pay cuts last year. The evidence suggests that more capital is flowing out of China. Those who can’t get around China’s capital controls are moving into safer money market funds, or fleeing into mainland-listed funds that track stocks foreign
All this will hit China’s growth. Our analysis of household surveys reveals that a small but influential group of people hold the majority of China’s financial assets. Their tight position will have an impact, reducing consumption and weighing on investment decisions. Investors stuck in the mainland may have little choice but to put some of their hard-earned cash into stocks. In contrast, foreigners may find it more difficult to withdraw. That will come at a cost to China, even though foreign investors still hold a small portion of their shares. Over the years they have provided a useful external analysis of asset prices. In addition, the entry into the market ten years ago was associated with increased capital spending and investment in research and development by Chinese companies. Their departure, on the other hand, could harm innovation.
Mr. Xi seems to know that something is going wrong. In addition to ousting Mr. Yi, the government has banned short selling, and state-owned fund managers have been ordered to buy stocks. This could temporarily increase stock prices. But such an intervention betrays only the trust in the Chinese markets, confirming why investors have left.
Far from accepting the need for sweeping change, Mr. Xi is making matters worse. At home, he cracks down on criticism of the economy. At the same time, China is becoming more suspicious of foreign businesses. Financial data is becoming increasingly difficult for offshore investors to obtain. In December new regulations were proposed on the gaming industry, only to be quietly withdrawn after markets reacted badly. In January the central bank refused to cut interest rates, despite persistent deflation, sending markets reeling. All this is just to scare investors.
The real obstacle to change is Mr. Xi’s iron belief that he and the Communist Party must be under total control. To regain the trust of investors it is necessary to reconsider the role of the state in the economy. But Mr Xi is unlikely to loosen his grip. Investors once believed that China’s politics need not affect their ability to make money. Now that they know that there is no escaping politics, they walk with more fear. ■
For subscribers only: to see how we design a cover each week, sign up to our weekly Cover Story newsletter.