Rto undo China’s securities watchdog is a dangerous job. A market crisis can end your career, or worse. On February 7, after weeks of stock market instability, Yi Huiman, the head of the China Securities Regulatory Commission (CSRC), was suddenly fired and replaced. He is not the first official to fall after a period of plummeting stock prices. Liu Shiyu, his predecessor, was fired in 2019 and later investigated for corruption. Xiao Gang, the then boss, was treated as a scapegoat for the 2015 market crash.
Before his dismissal, Mr Yi was said to have been aware that he was on dangerous ground. This year, more than $1 trillion in market value has already been wiped from stock exchanges in China and Hong Kong. On February 5, the Shanghai Composite fell to its lowest level in five years. All told, the index has fallen by more than a fifth since the start of 2022. And as miserable as the performance of Chinese stocks has been for most of their thirty-year history, the current downturn feels different.
That’s because China’s economic prospects are bleaker than at any time in recent history. The dire state of the real estate market is the main problem. Prices and sales have been declining for more than a year; officials have been unable to stop the correction. During the 2015 stock market crisis, private investors had a slogan: “Sell your stocks and buy real estate.” Nobody sings it now. Worse still, government rescue plans are not up to the task.
For many citizens, it feels as if China never really emerged from its bleak zero-COVID years. An economic recovery that was expected to continue into 2023 faltered in the first half of the year. Pessimism has clouded the market ever since. Goldman Sachs, a bank, recently asked a dozen local clients – asset managers, insurers and private equity types – to rate their bearish stance on China on a scale of zero to ten, with zero equaling their outlook during the lockdowns of 2022. Half gave the country a zero score; the other half said three.
The situation should worry Xi Jinping, the country’s leader, for several reasons. One is that more than 200 million Chinese own stocks and officials risk taking the blame for the downturn. Few things infuriate China’s social media warriors more than a stock market rout. A recent report suggested that food deliveries to the Shanghai Stock Exchange were being searched for dangerous materials, such as bombs or poison. Many have taken to the US Embassy’s social media accounts to complain. And there has been a flood of angry messages directed at Hu Xijin, a nationalist media personality who often tries to drum up support for Chinese stocks. He said last year that he would jump off a building if he lost too much money on stocks – not because of the loss itself, but out of shame. When the Shanghai Composite hit a five-year low on February 5, some advised him to keep his word.
Another reason for Xi to worry is that markets reflect the perception of China and its leadership abroad. Until recently, global investors were enamored with Chinese stocks. Their admission MSCIThe 2018 flagship emerging markets index was welcomed by asset managers and hailed as a step forward in efforts to make China’s stock markets more international. Needless to say, the excitement is gone. Zero-Covid policy damages China’s reputation. Xi’s support for Vladimir Putin despite his invasion of Ukraine has done even more damage. But nothing, most investors agree, has hurt Mr Xi more than the real estate crisis that has dragged on for years.
Although Chinese authorities still hope to attract investment, foreign investors are fleeing. They’ve been net sellers for months, dumping $2 billion worth of stock in January alone. The sell-off has been so intense that some experienced foreign investors have stopped trading. Asia Genesis, a hedge fund from Singapore, announced in January that it would close its doors due to the unexpected price drops.
Most foreign investors have little hope of a quick recovery. An investment manager at a foreign bank in Shanghai suggests the stock market could stabilize in the coming weeks. Indeed, on February 6th CSI 300, a major index, ended the day more than 3% higher, its best performance in more than a year. Still, the low level of confidence will persist until leaders come up with a sufficiently ambitious plan to restore the real estate market. That could take years, the manager notes.
Money talks
Regulators have issued a series of market stabilization statements since late January. Most recently, on February 6, Central Huijin, the domestic arm of China’s sovereign wealth fund, indicated it would start buying shares to help stabilize the market. On February 4, the CSRC said it would prevent abnormal movements in trading while tackling “malicious” short-selling. Such announcements have made fund managers uneasy. Foreign investors must use hedging instruments, such as short selling, to operate normally. Rumors of a crackdown have therefore led them to withdraw from Chinese markets as they can no longer hedge their positions. Some are also withdrawing out of fear that their staff could be arrested and charged with financial crimes.
Both foreign and domestic investors are waiting for a state aid fund, which has been hinted at, but nothing more. On January 23, Bloomberg, a news service, reported that a stabilization fund armed with some 2 trillion yuan ($280 billion, or about 3% of China’s stock market capitalization) could start buying up shares. The “national team,” a handful of state-owned asset managers including Central Huijin, often intervenes during recessions. In 2015, it sucked up about 6% of the total market capitalization through the purchase of individual stocks. More recently, these investment firms have purchased exchange-traded funds to avoid insider trading claims when the names of their targets are leaked. Although investors have seen signs of the national team at work in recent weeks, they have likely bought less than 100 billion yuan worth of shares so far – far below the amount needed to trigger a serious turnaround in the markets to take.
The central government could eventually step in with a bigger rescue package, perhaps after the Chinese New Year holidays, which will keep markets closed for a week from February 12. But Xi is also eyeing major reforms to the way China’s stock markets operate and how investors value the companies that trade in them.
One part of the plan is to shift China’s markets from a focus on raising capital to a focus on helping investors preserve their wealth. The distinction often baffles foreign market observers. Shouldn’t stock markets serve both capital-hungry companies and mainstream investors? In theory, yes. But in China, markets are different because they often also serve state objectives. In recent years, for example, one of Mr. industries.
The government also wanted companies in these sectors to list in China rather than on foreign stock exchanges, which led to the largest wave of IPOs (IPOs) and subsequent issues in Chinese history, making the country the largest country in the world IPO market for several years. Chinese companies raised more capital on local stock exchanges between 2020 and 2023 than in the entire previous decade.
This helped achieve Xi’s goals. But it also drained liquidity from secondary markets, where investor value is stored. Companies often went public at high valuations only to see their share prices fall. Now regulators want to shift to a more “investor-centric” market that protects average investors. That means less IPOs and more liquidity focused on secondary trading.
History repeats itself
Chinese markets have gone through such a cycle before. In 2012, regulators stopped everything IPOs hoping that excess liquidity would support stock prices. As a result, not a single company went public in 2013, even though hundreds lined up to do so in the hope of raising money. IPOIt resumed in 2014. The following year, the stock market embarked on a historic rally that ended in a dramatic crash. This experience damaged the position of both Chinese capital markets and regulators. As officials once again try to make markets friendlier to investors, capital allocators will be acutely aware of this experience.
Another part of the Chinese government’s long-term plan is to increase the market value of state-owned enterprises (SOES). Although such companies already dominate Chinese markets, they are valued at only half that of comparable non-state-owned companies. It is like that because SOEs are seen by investors as clumsy operators who are more loyal to party apparatchiks than to shareholders. Policymakers have therefore proposed creating a “valuation system with Chinese characteristics” to boost their stock prices.
Such a system would aim to educate investors about the broader social role that state-owned enterprises play, such as reducing unemployment during recessions. But it would also entail internal reforms SOEs itself. State managers have historically cared little about investor relations and have not used return on equity as an internal measure to assess performance. This would change. Meanwhile, regulators want the companies to pay regular dividends and buy back shares that reward investors. If the reforms are successful, they will not only raise prices on China’s stock exchanges but also increase the state’s wealth through its stakes in these companies.
These changes would have been easier when China’s stock market was smaller and the country’s economy was still growing rapidly. Most reforms require investors to accept the state’s dominant position in the market, whether directing capital flows or making capital flows. SOEIt’s tastier. Investors now have decades of experience trading Chinese stocks. They remember the first attempts to enter the market and get into the market SOEs, as well as the desire to direct capital to certain parts of the market, and they have witnessed the results. Ultimately, Chinese investors may have little choice but to return to the country’s stock markets. However, foreign investors have other options. ■