China Downturn Shows Policy Strains – Analysis

By Michael Lelyveld

China’s economic troubles are deepening divisions over government policies as officials try to encourage investors while cracking down on markets with tighter controls.

Speaking at a World Economic Forum meeting in the eastern port city of Dalian on Sept. 9, Premier Li Keqiang sought to assure investors of China’s economic stability, but instead sent a mixed message about steps that the government has taken to keep problems in check.

“The government took measures to stabilize the market and prevent risks from spreading,” Li said, according to Reuters.

“We have forced out the possibility of any systemic risks,” he said.

The comments were aimed largely at China’s stock market after a series of swings and a nearly 40-percent drop since July.

Li’s reassurance followed a week of relative constancy in the Shanghai Composite Index, which may have been purchased at a cost of increasingly non-market controls.

In a flurry of unpredictable rules changes, regulators have barred major investors from selling shares, threatened short-sellers with arrest, slapped brokers with fines for “illegal operations,” clamped down on margin financing, and discouraged futures trading in the yuan.

The measures may have limited short-term losses in the market, while damaging prospects for investment and growth.

“They’ve set themselves back a couple of years” in attracting investment, one hedge fund manager told The New York Times.

Doubts overshadow the economy

But the thinly-traded stock market has only been a reflection of doubts overshadowing China’s economy, despite official growth rates of 7 percent.

Recent trade figures for August have been seen as signs of a deepening economic slump, affecting both producers and consumers.

While exports dropped 6.1 percent, signaling struggles for manufacturers, imports plunged 14.3 percent in a symptom of slack domestic demand.

So far this year, exports have slipped 1.6 percent as China’s traditional growth engine stalls. Perhaps more important, imports are down 14.6 percent, raising doubts about China’s new model of consumer-led growth.

The “lower-than-expected import figures pointed to domestic sluggishness,” The Wall Street Journal said.

Inflation data released during the forum told much the same story.

While the consumer price index (CPI) for August rose 2 percent on increased food costs, the producer price index (PPI) fell 5.9 percent. The PPI slide marked the 42nd consecutive month of declines in factory-level demand and the sharpest drop since 2009.

Monthly data on industrial output and fixed-asset investment also disappointed, falling short of consensus forecasts. Growth in property investment so far this year has been the weakest since early 2009, Reuters said.

As with the stock market, the signs of poor performance in the broader economy seem to have split the government on whether to forge ahead or fall back in its pace of reforms.

In recent weeks, it has been doing both at the same time, piling up new controls on the stock market and currency trading while outlining major changes for state-owned enterprises (SOEs), according to state media.

On Sept. 13, the Chinese Communist Party’s Central Committee and the State Council, or cabinet, released their long-awaited guideline for SOE reform to great fanfare.

But China’s stock markets dropped the next day in apparent disappointment with the “mixed ownership” plan, which falls far short of privatization and sets a cautious deadline of 2020 for implementation.

The reforms “should be government-led and market-driven,” said a senior official quoted by the official Xinhua news agency, undercutting other statements that the plan would “avoid direct government intervention” in SOE businesses.

On Sunday, the Central Committee issued an additional guideline on the SOE program, making clear that the party would remain deeply involved and firmly in control.

“The guideline stressed the principle of the CPC in charge of executive selection in SOEs,” Xinhua reported.

“To strengthen the CPC leadership in SOEs, the statutory status of the Party organizations in firms should be clarified in corporate governance structure,” the Central Committee said.

Growth through reforms

At the forum, Li said the government has promoted growth through reforms and “has not printed excessive money or staged massive stimulus,” despite “strong downward pressure” and a series of monetary easing measures, Xinhua reported.

The messages, meant to convey balance and resolve, may have instead signaled the intensity of policy strains.

“The forces at work inside China don’t have the monolithic character that we ascribe to their political system,” said Harvard University economics professor Dale Jorgenson in a phone interview.

“There are competing interests and competing bureaucracies with different responsibilities,” Jorgenson said.

That may help to explain the inconsistency of China’s policies in pursuing its reform plans.

But a look back at the Communist Party blueprint for reform changes, issued after the Third Party Plenum in 2013, suggests that deep divisions have been inherent in the agenda itself.

Under the 62-point plan, there is no single provision that deals with stock market operations or government intervention, while nearly all reform steps are couched in the most general terms and carefully qualified with controls.

“Efforts are to be made to build a market system that is uniform but open, orderly and competitive,” the outline states in its goal for the broader economic market.

“Improve macroeconomic regulation and control,” says the heading of key Plenum directives on the economy.

“Government review and approval procedures will be removed for investors except in areas relating to national security, ecological safety, important arrangements for manufacturing capacity, development of strategic resources and crucial public interests,” the document states.

Clearly, order and control have taken precedence over openness and competitiveness in the government’s management of the current crisis.

Jorgenson is critical of surprise moves like the Aug. 11 devaluation of the yuan, which caused confusion in world markets, but he continues to see China’s economic growth as relatively strong.

“It’s not as if China’s economy is falling off the cliff,” he said, arguing that growth of gross domestic product (GDP) is likely to be at or near the government’s 7-percent claim.

But recent efforts to control the market have only contributed to uncertainty, a problem that should be addressed by a clear communications policy, Jorgenson said.

“They need to have a clear demarcation between areas that they’ve turned over to the market and those they haven’t,” he said.

A blow to confidence

Others see the handling of the stock market crisis and the economic challenges as a blow to confidence in the government.

Lowell Dittmer, a China scholar and political science professor at the University of California, Berkeley, said recent events have broken the tacit understanding with the public that it should be relatively free in economic matters as long as it submits to political controls.

“They’re willing to go along with that as long as the market goes up, but if it doesn’t go up, they’re not going to be as confident,” Dittmer said.

That reasoning may account for the government’s heavy-handed efforts to manipulate the stock market, even though its performance is only tangentially related to the economy as a whole.

But confidence in the government is likely to suffer if “downward pressures” continue to undermine its economic growth claims.

“There’s been an implicit trust in the government. The government steers the economy, it goes up and everybody’s happy,” he said.

“Now, there will be a decline of trust in the government. I don’t know how they get around that,” Dittmer said.