Commentary on Political Economy

Friday 22 September 2023



Xi’s grand fin­an­cial exper­i­ment

By using list­ing and trad­ing rules to dir­ect cap­ital into sec­tors that fit his pri­or­it­ies, the pres­id­ent wants the mar­ket to serve the state — a major break from past admin­is­tra­tions and his own pre­vi­ous pos­i­tion.

A behind-thescenes ‘traffic light’ system sees regulators greenlight listings in fields deemed strategically important to Beijing, such as chipmaking, biotech and electric vehicles

When Jilin Joinature Poly­mer made its debut on the Shang­hai Stock Exchange on Septem­ber 20, it became the 200th com­pany to float on China’s domestic mar­kets this year. Col­lect­ively they have raised over $40bn, more than double the amount raised on Wall Street and almost half the global total.

Yet the coun­try’s CSI 300 index is down 14 per cent since Janu­ary, hav­ing fallen by a fifth in 2022. It has under­per­formed other major mar­kets amid wor­ries about China’s slow­ing growth and a liquid­ity crisis in the real estate sec­tor.

The highly unusual situ­ation of a seem­ingly stag­nant mar­ket wel­com­ing hun­dreds of new com­pan­ies is a con­sequence of policy shifts in Beijing that have ramped up over the past year. Pres­id­ent Xi Jin­ping is intent on boost­ing invest­ment into sec­tors that fit his pri­or­it­ies for national secur­ity and tech­no­lo­gical self-suf­fi­ciency, and is using stock mar­kets to dir­ect that cap­ital with the aim of reshap­ing China’s eco­nomy.

“The old play­book of whenever there’s growth weak­ness, you stim­u­late the prop­erty mar­ket or build infra­struc­ture — that’s no longer rel­ev­ant,” says Kinger Lau, chief China equity strategist at Gold­man Sachs. “Mean­while, the IPO mar­ket remains quite vibrant, and clearly there’s a policy incent­ive to dir­ect cap­ital to areas that are deemed stra­tegic­ally import­ant to China.”

Lance Noble, head of China Real­ity Research at invest­ment bank CLSA, says the new approach centres on the top-down co-ordin­a­tion of resources from gov­ern­ment, industry, fin­ance, uni­versit­ies and research labs to accel­er­ate tech­no­logy break­throughs and help reduce China’s reli­ance on the west.

But mak­ing mar­kets serve the state’s pri­or­it­ies is a big depar­ture from past admin­is­tra­tions and the pro-mar­ket pos­i­tion ini­tially espoused by Xi after he became party leader in 2012.

“These meas­ures and reforms are run­ning up against the pre­vi­ous mind­set of set­ting up a rel­at­ively mar­ket-ori­ented mar­ket mech­an­ism, and there’s a huge gap between the policy guid­ance and mar­ket expect­a­tions,” says Zhang Jun, dean of the School of Eco­nom­ics at Fudan Uni­versity in Shang­hai.

Nor is there any guar­an­tee that con­vin­cing China’s IPO investors to back new list­ings or lean­ing on large asset man­agers and insurers to become long-term investors in key sec­tors will res­ult in the job and wealth cre­ation for ordin­ary Chinese that prop­erty and infra­struc­ture invest­ment pre­vi­ously did.

The big idea

Roughly a year ago, Xi told top lead­ers in Beijing that China needed to mobil­ise a “new whole-nation sys­tem” to accel­er­ate break­throughs in stra­tegic areas by “strength­en­ing party and state lead­er­ship on major sci­entific and tech­no­lo­gical innov­a­tions, giv­ing full play to the role of mar­ket mech­an­isms”.

That “new” in “new whole-nation sys­tem” and the ref­er­ence to “mar­ket mech­an­isms” dis­tin­guish Xi’s vis­ion from that of Mao Zedong, who ruled China from 1949 to 1976. Mao’s ori­ginal “whole-nation sys­tem” entailed Sovi­et­style top-down eco­nomic plan­ning, deliv­er­ing satel­lites and nuc­lear weapons, but not prosper­ity for the masses.

Xi’s calls for innov­a­tion co-ordin­a­tion at higher levels of gov­ern­ment came after a string of dis­astrous ven­ture cap­ital-style invest­ments in regional chip­makers by local gov­ern­ments and alleg­a­tions of cor­rup­tion at the National Integ­rated Cir­cuit Industry Invest­ment Fund, a key player in China’s semi­con­ductor strategy.

Noble says high-pro­file ref­er­ences to this “new whole-nation sys­tem” in Xi’s speeches and art­icles pub­lished in top Com­mun­ist party journ­als were “clearly blink­ing sig­nals that this is a big pri­or­ity . . . and very import­ant in terms of what China’s sci­ence and tech­no­logy future will look like.”

Whereas Mao shut down China’s stock exchanges, Xi wants to use domestic equity mar­kets to reduce depend­ence on prop­erty and infra­struc­ture devel­op­ment to drive growth. But his “new whole-nation sys­tem” pri­or­it­ises party policy above profit.

This helps explain why the party’s top cadres have been fast-track­ing IPOs but remain reluct­ant to deploy large-scale prop­erty and infra­struc­ture stim­u­lus to rein­vig­or­ate eco­nomic growth. In their eyes, return­ing to the old play­book would only post­pone an inev­it­able reck­on­ing for debt-laden real estate developers and delay the planned trans­ition to a new Chinese eco­nomy.

Key to that shift, Gold­man’s Lau says, is get­ting com­pan­ies in sec­tors such as semi­con­ductor man­u­fac­tur­ing, biotech and elec­tric vehicles to go pub­lic. With stock mar­ket investors back­ing them, they can scale up and help drive the growth in con­sumer spend­ing needed to fill the gap left by China’s downs­ized prop­erty mar­ket.

Red light, green light

Xi’s admin­is­tra­tion was already chan­nel­ling hun­dreds of bil­lions of dol­lars in so-called gov­ern­ment guid­ance funds into pre-IPO com­pan­ies that served the state’s pri­or­it­ies. Now it is speed­ing up IPOs in Shang­hai and Shen­zhen while weed­ing out list­ings attempts by com­pan­ies in low-pri­or­ity sec­tors through the launch of two inter­twined sys­tems.

The nation­wide “regis­tra­tion-based” list­ings sys­tem, rolled out in Feb­ru­ary, made China’s formal pro­cess for stock mar­ket list­ings more trans­par­ent and ended an often lengthy pro­cess of vet­ting by the China Secur­it­ies Reg­u­lat­ory Com­mis­sion for every IPO applic­a­tion.

Just as import­ant is a behind-thes­cenes “traffic light” sys­tem, in which reg­u­lat­ors instruct Chinese invest­ment banks inform­ally on what kinds of com­pan­ies should actu­ally list. Com­pan­ies such as bever­age makers and café and res­taur­ant chains get a “red light”, in effect pro­hib­it­ing them from going pub­lic, whereas those in stra­tegic­ally import­ant indus­tries get a “green light”. The CSRC did not respond to a request for com­ment on the traffic light sys­tem.

But a dir­ector at one large Shang­haibased broker­age says offi­cials are clearly “try­ing to push those stra­tegic sec­tors like high-tech man­u­fac­tur­ing, renew­ables and other new eco­nomy-related indus­tries to list and raise cap­ital and flour­ish.” List­ings in those sec­tors pro­ceed quickly while those com­pan­ies that do not align with poli­cy­makers’ pri­or­it­ies find them­selves without the invest­ment bank back­ing needed to go pub­lic, the dir­ector adds.

This approach could run into dif­fi­culty if shares in those com­pan­ies going pub­lic are sold down imme­di­ately by investors hop­ing to cash out at a profit when prices rise appre­ciably in the first few days of trad­ing. Reg­u­lat­ors have guarded against that risk by extend­ing “lock-up” peri­ods, dur­ing which Chinese invest­ment banks and other insti­tu­tional investors who par­ti­cip­ate in IPOs are not per­mit­ted to sell stock.

“Keep­ing these investors locked in for longer keeps share prices stable,” says Xia Mi’ang, an ana­lyst with Pacific Secur­it­ies. “It will push lis­ted com­pan­ies to focus on improv­ing prof­it­ab­il­ity and make investors bear invest­ment risks while let­ting them enjoy dividends.”

Reg­u­lat­ors have also restric­ted the abil­ity of com­pany insiders — be they dir­ect­ors, pre-IPO back­ers or so-called anchor investors — to sell their shares, espe­cially if a com­pany’s shares fall below their issue price or it fails to pay dividends to its share­hold­ers.

The day after these changes were announced, at least 10 com­pan­ies lis­ted in Shang­hai and Shen­zhen can­celled planned share dis­pos­als by insiders. An ana­lysis of the new rules’ impact by Tepon Secur­it­ies showed that almost half of all lis­ted com­pan­ies in China now have share­hold­ers who can­not divest.

Mar­ket dis­cip­line

This new and co-ordin­ated approach to cap­ital mar­kets is already res­ult­ing in dis­rup­tion that offi­cials are scram­bling to con­tain. One con­cern is that the flood of new list­ings has dragged down valu­ations of exist­ing stocks; indi­vidual investors often sell share­hold­ings in lis­ted com­pan­ies to raise money to bid for shares in new arrivals.

The down­ward pres­sure on the wider mar­ket from this year’s list­ings glut has promp­ted China’s secur­it­ies reg­u­lator to announce plans to slow the pace of new list­ings in order to “boost cap­ital mar­ket investor con­fid­ence”.

But that effort has so far had little vis­ible impact. Even a big cut in trad­ing fees only man­aged to push the mar­ket about 2 per cent higher the day it was announced. A sim­ilar reduc­tion in 2008 caused shares to rise by 9 per cent.

With the mar­ket fail­ing to respond in the way it once did, author­it­ies are encour­aging a wide range of domestic insti­tu­tional investors to buy and hold shares in stra­tegic sec­tors in order to prop up prices. This month, China’s insur­ance industry reg­u­lator lowered its des­ig­nated risk level for domestic equit­ies in an attempt to nudge nor­mally cau­tious insurers to buy more stocks. Such meas­ures show that Xi’s plan to give “full play” to the role of mar­kets comes with a rider: those mar­kets will take expli­cit and fre­quent dir­ec­tion from the party-state.

“They’re list­ing the firms and they’re mak­ing them attract­ive because they have gov­ern­ment sub­sidies or enjoy low taxes,” says Thomas Gat­ley, an ana­lyst at con­sultancy Gavekal Drago­nom­ics. “The strategy is mar­ket driven, but not fully mar­ket driven — the gov­ern­ment’s thumb is on the scale.”

Risky busi­ness

Those who can still freely cash out of Chinese stocks — namely for­eign investors — have been busy doing so. Last month, off­shore investors trad­ing through a mar­ket link-up between Hong Kong and main­land bourses sold a record $12bn of Chinese equit­ies, accord­ing to Fin­an­cial Times cal­cu­la­tions based on stock exchange data. Fund man­agers say the coun­try is in the middle of a struc­tural derat­ing, whereby inter­na­tional invest­ment funds per­man­ently reduce the pro­por­tion of cap­ital they judge prudent to alloc­ate to China’s stock mar­ket.

That under­mines long­stand­ing efforts, includ­ing ini­ti­at­ives launched early in Xi’s ten­ure, to per­suade for­eign fund man­agers to take up lar­ger pos­i­tions in Chinese com­pan­ies. Back then, the belief that inter­na­tional cap­ital would help damp share price volat­il­ity — largely stoked by the coun­try’s trend­driven retail traders — helped push pro­mar­ket reforms that res­ul­ted in Chinese secur­it­ies being included in the global index bench­marks.

As for­eign funds are dump­ing their hold­ings, traders and strategists say China’s “national team” of state-run investors is buy­ing in as part of an effort to pre­vent a more ser­i­ous mar­ket rout.

“For gov­ern­ment-related entit­ies, their par­ti­cip­a­tion in the equity mar­ket has gone up quite a bit over the past few months,” says Lau at Gold­man. “And what they’ve been buy­ing is very much in line with long-term stra­tegic sec­tors.”

Vet­er­ans of Chinese fin­ance say this approach is unsus­tain­able and warn that park­ing money in stocks to sup­port valu­ations wastes cap­ital that could be put to bet­ter use else­where. “Rather than chan­ging mar­ket expect­a­tions through alter­ing sup­ply or demand, [poli­cy­makers] are guid­ing buy-and-hold funds into the mar­ket . . . which can­not work in the long term,” says a banker at one of China’s largest brokers. “The reason they’re doing it is because it’s the easi­est option.”

Costs of con­trol

Some investors are warn­ing that the ever-expand­ing sys­tem of state con­trols over equity invest­ment could do last­ing dam­age to Chinese equit­ies’ domestic and global appeal. Jerry Wu, a fund man­ager at Lon­don-based Polar Cap­ital, says that “at a min­imum, investors want to see a con­sist­ent and per­sist­ent trend in poli­cy­mak­ing that shows Chinese poli­cy­makers are prag­mat­ists again, that they care about eco­nomic growth and private busi­nesses”.

But Zhang, at Fudan Uni­versity, warns the ten­sions between the “pre­vi­ous mar­ket-ori­ented path and the cur­rent new whole-nation approach . . . may con­tinue for the fore­see­able future.”

Even if the dis­rup­tion to China’s stock mar­kets even­tu­ally fades and poli­cy­makers’ plan to trans­ition to a con­sumer-focused eco­nomy powered by heavy invest­ment in com­pan­ies that serve Xi’s policy pri­or­it­ies suc­ceeds, there are doubts about whether the res­ults will live up to his vis­ion.

Eco­nom­ists say that the tech sec­tors being favoured for list­ings by Beijing are simply not cap­able of provid­ing the scale of employ­ment oppor­tun­ity or driv­ing the levels of con­sumer spend­ing anti­cip­ated by top Chinese lead­ers.

“There’s two prob­lems with focus­ing on invest­ing in tech,” says Michael Pet­tis, a fin­ance pro­fessor at Pek­ing Uni­versity and senior fel­low at Carne­gie China. “Tech is very small rel­at­ive to what came before [from prop­erty and infra­struc­ture], and invest­ing in tech doesn’t neces­sar­ily make you richer — it’s got to be eco­nom­ic­ally sus­tain­able.”

Rising share prices could cre­ate a power­ful wealth effect for China’s middle classes in the same way that rising house prices once did. But the gov­ern­ment’s inab­il­ity to engin­eer a stock mar­ket rally this year has fur­ther under­mined retail investors’ con­fid­ence. If Chinese equit­ies con­tinue to lag other mar­kets over the long term, that could start to weigh on house­hold spend­ing and fur­ther hobble growth.

Fraser Howie, an inde­pend­ent expert on Chinese fin­ance, points out China is not the only coun­try where arti­fi­cial intel­li­gence, semi­con­duct­ors and EVs are the hot invest­ment tick­ets. “A year ago, every­one was talk­ing about how China was the global AI leader. Then Chat­GPT came along and every­one went: ‘oh, well, maybe mar­kets aren’t as stu­pid as we all thought’,” he says.

He points to a global rally in AI-related stocks that has largely excluded Chinese com­pan­ies and the list­ing of UK chip designer Arm in New York. That IPO gen­er­ated $5bn for Arm’s par­ent com­pany Soft­Bank, more than any single list­ing in China has raised this year.

“Xi Jin­ping wants all these things, but he wants them in a par­tic­u­lar way because self-suf­fi­ciency and polit­ical con­trol are very import­ant to him,” says Howie. “That comes with lim­its. It’s like say­ing, ‘you must do all of this with one hand tied behind your back’.”

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