WILLIAM PESEK
Xi Jinping’s first public visit to Shanghai in three years signals a new effort to boost China’s private sector. Yet even more important, Xi’s team in Beijing chose this week’s occasion to unveil a series of reforms that are a bigger deal than might meet the eye.
The stocks of Shanghai-centered tech companies like Semiconductor Manufacturing International Corp, Hua Hong Semiconductor Ltd. and Will Semiconductor Co. rallied on the news Monday.
The visit, coupled with new policies to level playing fields and increase private companies’ access to capital, is seen by some as Xi following through on vows made in California earlier this month to make life easier for China’s beleaguered entrepreneurs.
To date, Xi’s attempts to restore investor confidence amid struggles to move past Covid-19 fallout have fallen short. More than US$1 trillion of foreign capital fled mainland share markets since Xi clamped down on Big Tech in late 2020. More recent fears about deflation haven’t helped.
In recent weeks, Xi restarted China’s stimulus machine amid calls for greater government action amid a property crisis and stalling economic recovery. In particular, the People’s Bank of China, China’s central bank, has channeled more liquidity to troubled property developers.
Analyst Zerlina Zeng at CreditSights speaks for many when she says “we expect China’s softening external stance and warming relationship with the US and other developed markets to set a more conducive geopolitical backdrop for China credit.”
But the reforms being outlined this week could be a game-changer. The PBOC and seven other government bodies have unveiled 25 steps to increase the role of the private sector.
They will apply to a broad range of private sector industries, including the ailing property market. Gavekal Research analyst Xiaoxi Zhang isn’t exaggerating when she warns that “debt strains from property developers and local government financing vehicles are spreading across China’s economy.”
There are concerns, too, that Beijing’s criminal probe into the wealth management unit of Zhongzhi Enterprise Group, one of China’s largest “shadow banks,” could soon spook Asian markets the same way China Evergrande Group’s default did in 2021.
The Zhongzhi Group shadow bank is on the verge of collapse.
Broader initiatives include setting clear and transparent targets for widening access to financial services for private enterprises.
With an emphasis on regular performance assessments and financial support, the plan is to increase the proportion of loans to private enterprises while improving organizational structures to increase efficiency.
Areas of particular focus include: supporting technological innovation amongst small and medium-sized enterprises, entrepreneurs in the green and low-carbon space and innovators keen to disrupt China from the ground up.
This will include a greater tolerance for risk-taking and the non-performing loans that startups can rack up. Beijing seeks to recalibrate lending and borrowing practices to increase private sector development while limiting risks.
This also includes increased support for first-time loans and unsecured loans. Financial institutions will be encouraged to develop a wider range of credit-financing products suitable for private enterprises.
Most important of all, Xi’s reform team is eying a great leap forward for China’s corporate bond market. This has long been a stumbling block for smaller, less established corporate credits. In particular, China plans to expand the range of bond financing options — and the scale — to private enterprises.
Under a series of “innovation bills” under the National Association of Financial Market Institutional Investors and China Securities Regulatory Commission, new structures will be welcomed for stock-bond hybrid products, green bonds, carbon neutrality bonds, transition bonds, infrastructure bonds and other financing tools.
Support programs will seek to incentivize private enterprises to issue asset-backed securities to restructure and revitalize existing assets. Registration mechanisms will be streamlined.
And Beijing will prod state-owned entities like China Bond Insurance Co and China Securities Finance Corporation, and even non-government institutions, to adhere to global standards and raise their credit market games.
That means building world-class systems for credit guarantees, credit risk mitigation tools, credit analysis and ratings and expanding China’s universe of bond financing support tools for private enterprises.
At long last, the Communist Party finally seems serious about facilitating increased bond investment in private enterprises. In years past, Beijing worried about a “crowding out” effect if private issuers lured capital from the national and local governments.
China’s bond markets haven’t kept pace with the economy’s needs.
Now, Beijing will encourage banks, insurance companies, pension funds, public funds, and other institutional investors to allocate capital to private enterprises. Regulators will be charged with internationalizing trading mechanisms, market pricing, compliance and disclosure procedures.
Xi’s team also is stepping up efforts to develop a high-yield bond market. Few steps might be more impactful for private sector development – especially tech-oriented SMEs – than creating a dedicated high-yield debt platform empowered by world-class trading systems. It would supersize capital-raising options and pull in new generations of overseas investors.
In June, local media reported that the PBOC and CSRC sought advice from market participants on setting up a high-yield marketplace. As of then, only four high-yield debt issues with coupons exceeding 8% had priced in 2023.
Authorities sought input from fixed-income players, investment bankers, legal experts, rating companies and accountants. This would channel greater financing to tech enterprises, startups and riskier borrowers.
The key, though, is implementation. The disconnect between Xi’s rhetoric since 2012 and execution helps explain why investors tend to be skeptical of China’s past efforts to reboot the reform process.
“Time will tell whether President Xi’s words will first stem the current large foreign direct investment outflows and eventually lead to a resumption of the net FDI inflows that China has enjoyed for more than four decades,” says Nicholas Lardy, senior researcher at the Peterson Institute for International Economics. “A safe assumption is that it will take more than words to accomplish this objective.”
It helps that the news dropped days after Xi’s government drafted a list of property developers eligible for large-scale support, including the troubled Country Garden Holdings. The property crisis remains a major turnoff for overseas investors.
New data, Lardy notes, “imply that foreign firms operating in China are not only declining to reinvest their earnings but – for the first time ever – they are large net sellers of their existing investments to Chinese companies and repatriating the funds.”
The outflows in question exceeded $100 billion in the first three quarters of 2023 and, as Lardy predicts, “are likely to grow further based on trends to date.”
Among the factors Lardy cites as repelling overseas investors and chieftains: tense Sino-US tensions; recent news of Beijing cracking down on foreign consultancy and due-diligence firms vital to evaluating investments; Beijing’s increasingly stringent regulatory environment; new national security laws; and restrictions on cross-border data flows.
Michael Hart, president of the American Chamber of Commerce in China, notes that “foreign business executives here are eager to continue in China. But boards back in the US are wary.”
Hence the importance of Xi and Li ensuring that these new private enterprise policies are implemented in credible and transparent ways. The good news is that Li, party secretary for Shanghai City from 2017 to 2022, has close ties with, and deep understanding of, China’s tech sector.
Li Qiang understands the tech sector. =
Veteran banker Zhu Hexin seems a solid choice as new party chief of the State Administration of Foreign Exchange (SAFE). He will assume management of China’s foreign exchange stockpile from PBOC Governor Pan Gongsheng. Zhu also was appointed as a member of the central bank’s party committee.
Prior to SAFE, Zhu helmed state-run financial conglomerate CITIC Group, meaning he comes to the job with deep market knowledge and industry contacts. Also, Vice Premier He Lifeng has been tapped to oversee economic and financial policy and trade talks with the US and Europe as head of the Central Financial Commission.
It now falls to Li, Zhu and He to ensure that President Xi’s recent pledges to top Western chieftains in San Francisco don’t fall by the wayside.
CEOs on hand to hear Xi speak included Apple’s Tim Cook, Bridgewater Associates’ Ray Dalio, Citadel Securities’ Peng Zhao, ExxonMobil’s Darren Woods, JPMorgan Chase’s Jamie Dimon, Microsoft’s Satya Nadella, Pfizer CEO Albert Bourla and Tesla’s Elon Musk.
There, Xi claimed that “China doesn’t seek spheres of influence, and will not fight a cold war or a hot war with anyone.” Xi also seemed to preview the next phase of reform, stating that “we should remain committed to open regionalism, and steadfastly advance the building of a free trade area of the Asia-Pacific. We should make our economies more interconnected and build an open Asia-Pacific economy featuring win-win cooperation.”
Xi added that “we should promote transitions to digital, smart and green development. We should boost innovation and market application of scientific and technological advances and push forward the full integration of digital and physical economies. We should jointly improve global governance of science and technology, and build an open, fair, just and non-discriminatory environment for the development of science and technology.”
Earlier this month, Xi presided over a private sector symposium in Beijing to highlight its central role in a more innovative and productive Chinese future. There, Xi stressed that private enterprises contribute more than 60% of gross domestic product, 50% of tax revenue, 80% of urban employment, 90% of new jobs and 70% of tech innovation.
“Over the past 40 years, the private sector of the economy has become an indispensable force behind China’s development,” Xi acknowledged.
Yet private enterprise has had a rough few years, from Covid-19 to Xi’s tech crackdown. A major concern now is that China falls into a Japan-like lost decade, so-called “Japanification.”
Economist Takatoshi Ito, a former Japanese deputy vice minister of finance, notes that the Chinese property sector’s “travails echo Japan’s experience” with bad loans and deflation.
But, Ito adds, “perhaps the greatest threat to China’s economic growth and development is Xi himself. Xi has spent the last few years tightening government control over all aspects of life in the country, including the economy. The regulatory crackdown on large tech companies like Alibaba, which began in late 2020, is a case in point.”
Alibaba took the brunt of Xi’s tech clampdown.
Though regulators “have since backed off somewhat, and China’s government is actively supporting high-tech industries like electric vehicles, Xi’s obsession with control continues to pose a serious threat to China’s prospects. Not only does it hamper innovation by domestic firms; it also discourages foreign investment.”
The good news is that the private sector reforms detailed in recent days suggest Xi is serious about bold economic disruption and recalibrating growth engines away from state-owned enterprises and public investment toward private sector innovation.
As long as implementation is swift and credible, 2024 could be a markedly better year for China than many investors now pulling their investments from Asia’s largest economy expect.
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