There is a tendency when it comes to analyzing China to separate the economic situation from the political situation. A day after China’s stock markets spasmed, jargon-filled reports abounded of the varied monetary tools Beijing is using to try and restore confidence in its economy. Certainly understanding these tools is important, but without understanding the political developments that are happening parallel to reports about these economic figures, one is left with an incomplete picture.
Our model says that China is entering a period of slow or no growth. The country is in an economic imbalance as it attempts to move from an export-driven economy to one based on domestic consumption. In our 2016 forecast, we laid out why China’s precise actions are unpredictable. What is certain is that crises will emerge and that they will in part be a result of internal political struggles and in part due to the attempts of China to manage the effects of a weakening economy.
The troubles in the Chinese stock market, including yesterday’s drop in stock prices, are one such unexpected crisis. The day after the plunge triggered a halt in trading, both the Shanghai Composite and the Shenzhen Composite continued to fall, dropping 3.1 percent and 4.4 percent respectively when markets opened in China. However, by the end of the trading day, there was a small rally, with Shanghai down only 0.3 percent and Shenzhen down 1.86 percent. Global markets in turn have breathed a momentary and cautious sigh of relief.
The improvement came in part as a result of China actively intervening in order to improve investor confidence. China’s central bank injected a previously unplanned $20 billion into the market. More importantly, the China Securities Regulatory Commission said it would consider limiting the proportion of shares that major shareholders could sell during a set time. Restrictions on stock sales by shareholders owning more than 5 percent in listed companies were instituted back in July when China’s stock markets declined even more steeply, to the tune of almost $5 trillion. Goldman Sachs estimated at the time that this ban on trading had kept $185 billion worth of shares off the market. The importance is less in the actual number, which is relatively small, and more in the fact that China intervened in the market and the market was unable to stomach those July restrictions that expired at the end of the week. That they were about to expire partly explains yesterday’s sell-off and that China is signaling it may keep the controls has at least momentarily staunched the bleeding.
This also comes in the wake of an announcement by the People’s Bank of China on Dec. 29 that China plans to shift the way it uses required reserve ratios for commercial banks. These ratios define the value of deposits that a bank must hold in reserve. In the past, China has used these ratios as a way of either adding or removing liquidity from the system. Most recently, China reduced the ratio in October, lowering it to 17.5 percent from 18 percent, while also lowering the one-year lending rate to 4.35 percent. But the PBOC reportedly wants to use the required reserve ratio to maintain financial stability. Instead of across-the-board decreases or increases in the reserve ratio, the PBOC will attempt to fine-tune the rates for individual banks.
These are not the only reports coming out of China that caught our attention in the last two days. Yesterday, the same day the markets tanked, the state news agency Xinhua reported that the Communist Party’s Central Commission for Discipline Inspection said 64 officials of Chinese state-owned enterprises, over half of whom were top executives, had been investigated by central authorities. The story of China’s SOEs is long running, and one we updated in December when the Chinese Ministry of Civil Affairs said it was going to make sure SOEs offered preferential hiring to Chinese soldiers let go from the PLA as a result of President Xi Jinping’s ambitious military reform plan.
Meanwhile, the South China Morning Post published a report this morning on an official speech that Xi gave on Dec. 31. This was no simple stump speech, nor was it a state of the union. According to the SCMP, it was a precept speech, one which contained admonishing words for the People’s Liberation Army. Xi is reportedly only the second person to give this type of speech since the People’s Republic of China was founded in 1949 – the first being Mao Zedong. It comes in the wake of reports that there are increasing tensions between the Communist Party and the People’s Liberation Army over Xi’s military reforms, which in part involve significantly cutting the size of the military and the number of staff officers.
To understand what is going on in China, all of these threads must be woven together. The occasional stock market plunge in China by itself means relatively little – Chinese markets do not play the same role in China as they do in the West and China’s stock market is relatively isolated from the global economy. It only becomes important in the context of China attempting to restructure its economy. The stock market shock and Beijing’s attempts to manage it betray a lack of confidence both in the economy’s fundamentals and in the state’s regulatory regime. It also demonstrates the limited extent to which China can let the system go without direct intervention. All the while, the Communist Party continues its purges at all levels of Chinese society, from the military to SOEs, to ensure that its grip on the country is secure. Xi himself will continue to admonish the PLA as he pursues his attempts to subdue any tension between the party and its ultimate enforcer.
This round of China’s stock market woes may well be over – the Chinese, as in July, will do what they must to prop the markets up if they can’t stand on their own feet. But even so, complacency shouldn’t return. This story isn’t about China’s stock markets, or required reserve ratios, or even military speeches – it’s about whether and how the Communist Party will attempt to maintain control over the country. In the end, that’s what our forecasting model tells us is important and that’s what our model tells us this is all about.