Fred Hu
Founder and Chairman of Primavera Capital Group; member Berggruen Institute’s 21st Century Council
BEIJING -- The rout in China's stock markets has sent shockwaves
across the world, dragging global equities, currencies, bonds and
commodities into the worst tailspin since 2008. Both domestic and
international investors seemed to have lost faith in China's once fabled
ability to manage its economy, hence the deepening gloom and spreading
panic everywhere. While there are very valid concerns about China's
economy and financial system, market reactions are vastly exaggerated.
To
start with, China's falling domestic equities do not necessarily herald
a sharp contraction in its broader economy. Historically the country's
immature and extremely volatile stock market has been a poor predictor
of GDP growth. With retail trading dominating the market place, share
prices are mostly driven by short-term sentiments, not by any rational
expectations of economic fundamentals.
Since mid 2014 the Chinese
equity market was gripped by sudden spikes of speculative frenzies, in
part fanned by the official Party media, and started a stunning rally.
As valuation quickly soared to astronomical levels, a sharp correction,
and even a spectacular crash, just seemed inevitable. That is exactly
what has happened over the past few months. With Shanghai now down by
more
than 42 percent
from its peak, the current stock valuation has factored in most of the
bad news -- manufacturing malaise, weakening exports and capital
outflows. Chinese equities are now traded at a discount to major
emerging market peers that face far worse macroeconomic conditions. The
risks of further sharp decline in China equities appear to be limited.
The Chinese stock market remains a sideshow as far as China's Main Street is concerned.
Unfortunately,
the Chinese authorities' market interventions have done more harm than
good. Far from stabilizing the markets, massive stock buying by
state-owned institutions such as
China Securities Finance Corp and
Central Huijin Investment Ltd. have
distorted the functioning of the stock market, caused widespread confusion and aggravated the
risk of moral hazard, further undermining investor confidence at home and abroad.
The unprecedented stock market interventions, many pundits speculate, must have revealed the Chinese government's
deep worries
about the rapid deterioration of the underlying economy. Yet the
Chinese stock market, though second only to the U.S. by market
capitalization, remains a sideshow as far as China's Main Street is
concerned.
So what has happened to China's economy? Accustomed to growing at the double digit pace, it is now
struggling to
reach the official target growth rate of 7 percent. But the GDP growth
slowdown has been both gradual and moderate, far from being the disaster
that has so spooked global investors. Even at 5 percent, China would
generate
more growth than any other country.
China's New Growth Model
Partly
to address the longstanding concern about China's over dependence on
investment and export led growth and its impact on global imbalances,
the Chinese leadership has vowed to transform China into a more consumer
centric and innovation-led economy. Recent data clearly show such a
shift has been well underway, with consumption accounting for
over 50 percent of overall GDP growth in 2014 and
60 percent
in the first half of 2015. True, headline GDP growth has been trending
down, but growth is now broader-based, more balanced, higher quality and
possibly more environmentally friendly -- if only judging by the
increasing count of blue sky days in Beijing.
Moderating growth
rates in the range of 5-7 percent per annum reflect the higher per
capita income level and the changing growth paradigm in China. A modest
slowdown is a necessary and healthy adjustment for China to transition
to a new trajectory of more efficient and sustainable growth. But
instead of greeting such a positive "new normal" with enthusiasm, the
naysayers have reacted with dismay as though they would rather prefer
the old growth model.
To be sure, the shift to a wholesale new
economic model is always fraught with uncertainty and risks, let alone
for a country of China's size and scale. Compounding the challenges is
the messy legacy the old growth model has left China with --
manufacturing glut, excess real estate inventory, heavily indebted local
governments and severely damaged environment. To manage such a
transition successfully, China must implement broad structural reforms
while maintaining macroeconomic and financial stability.
What Is to Be Done?
Except
for the stock market interventions, the authorities have so far avoided
costly policy mistakes and China's track record of deft economic
management remains remarkable. In response to the latest economic and
market headwinds the People's Bank of China has already
lowered interest rates and reserve requirement ratios.
While China does not need a new credit boom, there is still a scope for
additional monetary easing, to ensure adequate liquidity in the
financial system, ease the debt service burden of heavily indebted
corporates and local governments and forestall a possible debt deflation
vicious cycle.
On the fiscal front the Chinese leadership has
taken a more cautious stance in recognition of past fiscal profligacies
and local debt buildup. Even so, there is room for significant fiscal
actions. China should follow on recent tax cuts for small and medium
enterprises with carefully targeted public spending increases.
Despite early signs of housing price stabilization, unsold housing inventory across China remains at
elevated levels, especially in the so-called
third-tier and fourth-tier cities.
The central government should provide significant tax and credit
incentives for first time homebuyers, especially rural migrants and low
income families, to spread affordable home ownership and broaden the
urban middle class base, while redressing the overhang of pass real
estate excesses.
The central government should provide significant tax and credit incentives for first time homebuyers.
China
should significantly increase transfer payments to the elderly to raise
their retirement income, improve health and medical benefits coverage
for both urban and rural populations, and provide more generous
financial aid for secondary, vocational and university students with
less income means. While China is right about resisting the European
style social welfare state, it is imperative to reform and strengthen
the country's basic social security system. Academic studies have
identified inadequate social protection as a key factor for
extraordinarily high household savings. Improved pension, health and
education benefits for China's rapidly growing urban population would
weaken the incentive for precautionary savings and boost personal
consumption.
While past over-investment has led to excess
industrial capacity, China's environmental infrastructure, a vital
public good, is woefully
underinvested.
Though China has made encouraging initial efforts, it should launch and
can afford a far more ambitious public investment program to promote
clean energy and control pollution. Public Investment in clean tech is
essential for China to meet its climate change targets. Increased
investment spending in clean tech not only helps make up the near-term
demand shortfall caused by falling manufacturing exports and
infrastructure spending, but also may likely spurt a new growth industry
that could establish China's global leadership in renewable energy and
clean technology.
Contrary to prevalent market fears, China
retains a broad range of monetary and fiscal policy options to cope with
its stock market woes and economic downward pressures. But perhaps the
most powerful weapon of all in China's policy arsenals is the
opportunity to pursue sweeping economic reforms. Indeed, ever since the
inauguration of the Xi Jinping leadership, investors have been expecting
the so-called "
reform dividends,"
because robust reforms promised by President Xi will correct structural
imbalances, curb intrusive and arbitrary powers of the state
bureaucracy, stamp out endemic corruption and level the playing field
for private sector and small medium sized enterprises. In other words,
President Xi's
reform agenda, if fully implemented, should allow the market forces to play a
decisive role in resource allocation
-- promoting open competition, increase market transparency, boost
efficiency and productivity gains and stimulate entrepreneurship and
innovation.
Public investment in clean tech is essential for China to meet its climate change targets.
Perhaps
nothing is more disappointing than the lack of progress to date on
reforms concerning state-owned enterprises. Despite early achievements
of
SOE reforms initiated by former Prime Minister Zhu Rongji, there has been
little new progress
and possibly backtracking in recent years. It is plainly clear that the
SOE sector has impeded competition from the private sector and dragged
down economic efficiency.
Privatization, restructuring, better
corporate governance, strong market-based incentives and professional
management are, among others, required to turn SOEs into productive
commercial enterprises. As shown by the
case of PetroChina,
China's biggest state-owned petroleum company, there is a close linkage
between political patronage, abuse of state assets and corruption.
Hence, a complete overhaul of China's large SOEs should also bolster the
effectiveness of President Xi's popular anti-corruption campaign.
The Stock Crisis Will Prompt Faster Market Reforms
True,
the string of recent bad economic news and the stock market selloffs
have dampened short-term sentiments, but worse still, investors and the
Chinese people might completely lose hope for the country's medium and
long-term prospects if the government fails to deliver genuine reforms.
Fortunately,
China has the capacity to contain the near-term economic and financial
pressures through a judicious combination of strong monetary and fiscal
stimulus measures. More importantly, the recent market gyrations have
sent a loud and clear message to the Chinese policy makers and will
likely prompt the top leadership to embark on fundamental reforms as
pledged at the Third Party Plenary two years ago. Bold reform actions
can restore investor confidence that the stock market interventions
could not. Pessimists are wrong to declare that China is out of options.
It is a loser's game to bet against China's new generation of reformist leadership.
For
several decades China has been a major engine of global growth and a
strong anchor of global stability. Now China is being tested again
whether it can weather the current market turbulence. The short term
challenges are real and the transition will be bumpy. However, China
will likely manage its current financial and economic problems far
better than expected.
China has the financial resources, the
policy tools, and crucially -- the political will -- to meet its
challenges. Past reforms have laid a solid foundation and expected new
reforms will significantly improve the outlook for future growth.
China's accelerating urbanization, rapidly expanding middle class, a
strong human capital base, tremendous entrepreneurial energy and
innovative potential portend an attractive prospect ahead. It is a
loser's game to bet against China's new generation of reformist
leadership.
The Huffington Post
