One of the hallmarks of the Chinese economic miracle was the willingness of Deng Xiaoping and his successors to allow the Chinese communist system to evolve into a more market-oriented model in which private enterprises coexist alongside state-owned enterprises. . However, since Xi Jinping became the Chinese leader in 2012, he has taken steps to reverse the trend. In the process, the role of state-owned enterprises has increased as private enterprises face increasing restrictions, especially in the technological field.
Until recently, global investors seemed oblivious to what was going on. Last November, when Chinese authorities canceled the IPO for Ant Group which was set up by Alibaba a decade ago, investors saw it as a one-time rebuke to Alibaba founder Jack Ma. (He had referred to the “pawnshop” mentality of the Chinese banking system in a public forum.) This was followed by a record fine of $ 2.8 billion for Alibaba’s alleged anti-monopoly violations.
Last month, however, international investors worried about the government’s crackdown on several large tech companies and companies raising capital abroad. According to the Wall Street newspaper, four large companies – Alibaba (BABA), Kuaishou Technology, Meituan, Tencent Holdings (TCEHY) – lost about 20% of their market capitalization in July.
The sale intensified when the government confirmed that strong actions to restrict the booming out-of-school tutoring industry in the country. New rules were announced that would require these businesses to be run as nonprofits, ban them from raising capital and foreign ownership, and ban teaching on weekends and holidays. The crackdown was said to have taken place because the costs of education were skyrocketing and the authorities deemed the tutoring unfair.
These developments have raised many concerns among investors. The first is whether similar action could be taken against private companies in other rapidly growing sectors such as healthcare and real estate. Another question is whether Chinese companies will face restrictions on listing outside the country, as evidenced by a 22% drop in the Nasdaq Golden Dragon China index in July which brought the cumulative decline this year to around 50% (see graph).
As a result, investors are wondering why the Chinese government is mining some of its most successful and productive companies. Official explanations have varied. Shortly after Didi Global Inc.’s IPO in the United States, the Wall Street Journal reported that Chinese regulators announced they would tighten supervision of companies listed abroad and they launched a cybersecurity investigation at the company. The article quoted a leading securities regulator as saying that “financial fraud, insider trading, market manipulation and other illegal activities by listed companies are on the increase.”
The big picture is that the Chinese leadership is pursuing the economic strategy that Xi Jinping telegraphed years ago. While he began his tenure by promoting the continuation of the reform process pursued by his predecessors, Xi’s policies have in fact increased the role of state-owned enterprises. In a book written in 2019, Nicolas lardy of the Peterson Institute documents how China’s private sector has been dramatically shrunk over the past decade. At the same time, the Chinese public sector has grown considerably, which has reduced the overall efficiency of the Chinese economy.
To some extent, the recent crackdown on Chinese entrepreneurs reflects Xi’s view that they should put the nation ahead of their business interests. Jerome Cohen, an expert on Chinese law, is said to be concerned that the actions against Jack Ma and Sun Dawu, a billionaire sentenced to 18 years in prison, signal a broader campaign to limit the influence of major entrepreneurs who do not follow the Party line.
As this message permeates, some prominent Chinese observers have taken note and are now wondering if China’s economic miracle can continue.
In an article for The Atlantic, Michel schuman, observes that China’s pivot from market-based reforms to increased regulation and reduced dependence on overseas may come from the Trump administration’s restrictions on Huawei Technologies and large tariff increases on Chinese products. He concludes, “But if Xi succeeds in replacing more of what China buys from the world, it will also undermine the economic rationale for continued engagement with a brutal authoritarian regime. Xi believes he is protecting China from isolation. Rather, it could be the cause.
A similar sentiment is shared by Steve roach, a self-proclaimed “congenital optimist” on the Chinese economy in an article for Project Syndicate. He observes that there is no shortage of explanations for the Chinese repression on companies, security being the most common. However, he believes he has reached the point where he is undermining business and consumer confidence. He concludes that “China’s growing animal spirits deficit could deal a severe, potentially fatal blow to my own long-held optimistic prognosis for ‘Next China’.
The bottom line is that many people consider China’s actions to target its dynamic technology akin to killing the goose that lays the golden eggs. It is the key sector that the Chinese government relies on to lead the economy as it moves to a higher stage of development. If it were to be curbed by regulatory constraints, the risk is that China’s growth trajectory will slow even more than currently envisaged.
Finally, the impact of regulatory changes on companies and stock prices is causing foreign investors to reassess whether China is investable. A recent JP Morgan Private Bank report observes that while the new regulations have wiped out billions of market capitalization, he concludes that investors can still navigate Chinese assets. However, the report also states that investors should realize that “at the moment, China seems more focused on establishing what it sees as sound financial and social policies at the national level rather than on satisfying consumers. foreign investors ”.
My personal view is that investing in China has always been a challenge due to the difficulties in understanding the accounting and political complexities of doing business there. Today, the recent plethora of regulatory edicts means that investments are also subject to much greater “event risk” which is extremely difficult to assess. In these circumstances, the best advice for individual investors is Warning.