China – Market Volatility Highlights Challenges
The New Year has brought fresh problems for officials in the higher echelons of the Communist regime, and considerable uncertainty for investors rocked by another spate of financial market instability. The sudden fall in the value of Chinese assets, and the accompanying currency depreciation and widening of spreads between onshore and offshore renminbi, stems mainly from concerns that policy makers in Beijing are failing to engineer a soft landing for an economy transitioning from an industrial- and export-based development model to a consumer-driven one. The high degree of improvisation evident in efforts to stem the slide in the stock indexes has only served to reinforce doubts.
The immediate trigger for a second major episode of market volatility in less than six months was the approach of the scheduled end of a ban on stock sales by major shareholders, which encouraged smaller investors to dump their holdings. The failure of “circuit breakers” introduced after a massive sell-off in June-July 2015 to halt the recent plunge prompted the government to suspend the new rules, and it was instead an extension of the deadline for lifting the ban on large shareholder sales that took some of the momentum out of the decline, but the market has remained on a downward trajectory.
Steps to stabilize a currency weakened by a massive outflow of capital have included restrictions on state bank dollar sales to households and corporations in Shanghai and Shenzhen, new documentation requirements, and the reported introduction of temporary restrictions on the trading of offshore (free-floating) and onshore (managed) renminbi by foreign-owned banks. The evidence of intensifying pressure on the local currency—the central bank reportedly used $108 billion of its reserves propping up the yuan in December—has stoked fears of a devaluation that could trigger a chain-reaction of similar action by export-dependent regional competitors, setting up a beggar-thy-neighbor scenario that would have significant negative implications for the global economy.
However, a devaluation would increase the cost of imports, undermining the government’s efforts to promote increased consumption. The alternative of bolstering the currency by means of interest-rate hikes would put an added strain on heavily indebted companies, such as Sinosteel, which is teetering on the brink of default, and local governments. Given those equally unpalatable options, it is likely that the government will continue to rely on capital controls to manage the exchange-rate, but the recent dissemination of warnings of legal action against speculators in the state media suggests that authorities are genuinely concerned that sustained downward pressure on the yuan could force undesirable action.
The political ramifications of the market volatility are not entirely clear. The recent repeated references in state communications to President Xi Jinping as the country’s “core” leader—a status never attained by his predecessor, Hu Jintao—suggests that an anti-corruption campaign that has frequently (and conveniently) targeted Xi’s political rivals has cemented his dominant position in the political hierarchy. However, the fact that those references have typically been attached to commands to the CCP rank-and-file to maintain unflinching allegiance to Xi betrays a perception of threats to his authority that presumably are grounded in reality.
The state of play will become clearer when the ruling party holds its five-year congress in 2017, at which Xi is expected to be confirmed for a second five-year term and to seek the promotion of loyal allies to key positions in the CCP hierarchy. In the meantime, the significant concentration of political authority and decision-making power in the person of the president will increase the danger of delays in taking corrective action in the event of policy mistakes, and ensure that much of the blame for any damage incurred as a result will fall on Xi.
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