Xi knows what it takes to support China's rally

Last week, as Chinese stocks posted their biggest gain since 2015, Lu Ting, chief China economist at Nomura Holdings, warned investors not to forget another, more traumatic memory from that same year.

Given current market dynamics and our monitoring of sentiment on Chinese social media, the risk of a repeat of 2015's epic boom and bust could increase rapidly in the coming weeks, Lu notes.

Lu adds that in a worst-case scenario, a stock market frenzy would be followed by a crash, similar to what happened in 2015. As such, he adds, although investors could still be agreement to indulge in the boom for now, we wish Beijing could be more restrained.

However, sobriety seems to be returning, and quite quickly. While this may not be a crash scenario, well-known names like JPMorgan Asset Management, HSBC Global Private Banking and Invesco Ltd. also recommend caution. Invesco, for example, fears that the continent's stocks are actually overvalued.

This is obviously very debatable. Count investment giant Fidelity International among the financial giants that still see great value in the continent's stocks after years and billions of US dollars in losses.

The Goldman Sachs group as well. The Wall Street giant has revised its view of the continent's stocks upwards, moving to overweight with a potential upside of 15 to 20% if the authorities follow through on their promises on recovery measures.

As Goldman strategist Tim Moe points out, recent policy moves by Beijing have led the market to believe that policymakers have become more concerned about taking sufficient steps to reduce the risk of left-wing growth.

BlackRock also hasn't publicly backed away from its bullish call on Chinese stocks. As its strategists wrote on October 1: “We believe there is room to be slightly overweight Chinese stocks in the near term,” given how attractive valuations have become relative to their developed market counterparts, write -they.

Even so, Xi Jinping's government must remain focused on the fact that the world so rarely before watches foreign funds debate how far China has really come since 2015. That's the year Shanghai stocks lost a third of their value in just three weeks. Beijing's response last week to the fall in stocks was not as overwhelming as after the July 2015 plunge.

A week ago, the People's Bank of China cut borrowing costs, reduced bank reserve requirements, cut mortgage rates and unveiled new market support tools to put a floor on stock prices. Bold fiscal stimulus measures are also being considered.

In the days that followed, Chinese stocks soared. However, as the week ended and Monday approached, some sobriety returned as traders began to wonder what lessons the 2015 Xi team had learned.

Perhaps most troubling is what they didn't do. Indeed, treating the symptoms of China's difficulties with waves of liquidity is no substitute for supply-side reforms that address the underlying problems.

In China, around 2024, the biggest problem is a real estate crisis that Xi's reform team has yet to end. The consequences have pushed Asia's largest economy into deflation this year and, in the eyes of some economists, it risks repeating Japan's mistakes since the 1990s.

The most obvious lesson is that we should go no further in short-term recovery than through structural improvements that repair balance sheets, increase competitiveness, and reduce the risks of boom-bust cycles.

The 2015 episode saw something of a whole-of-government response to falling stocks. At the time, China Inc directed waves of public funds into the markets, suspended operations of thousands of companies, scrapped all IPOs and allowed mainlanders to pledge their homes as collateral for margin loans. He even launched loud marketing campaigns to encourage stock buying as a form of patriotism.

Although this response worked for a time, it was at odds with Xi's pledge two years earlier to let market forces play a decisive role in economic and financial policy decisions.

Since then, this pattern of treating symptoms rather than reforms has been repeated too many times for comfort. All of this explains why investors fear that mobilizing state-friendly funds to buy stocks and save the situation could backfire again.

As a result, valid arguments can be made that gains in Chinese stocks have too often not been accompanied by measures to defend the private sector, increase transparency, or strengthen corporate governance.

Only time will tell whether Xi's most recent measures to prop up falling stock prices could also slow the reform process. But this latest rise in Chinese stocks poses a test that Xi's Communist Party cannot afford to fail.

Nomura's case is that nearly four years of turmoil in the real estate sector, compounded by Covid-19 lockdowns, have exacerbated problems related to rising local government debt. These pre-existing conditions were met with trade wars with the United States and Europe and a Middle East in flames.

Although investors may still be ready to take advantage of the boom for now, a more sober assessment is needed, Lu says.

What's needed, say economists like Michael Pettis, a senior fellow at Carnegie China, is a rebalancing effort that marks a decisive shift in the economic model to end decades of explicit and implicit transfers in which households subsidized investment and production. And according to Pettis, Xi's latest fiscal effort “is not really part of a true structural rebalancing.”

The problem, Pettis adds, is that if China doesn't shake up its growth model, imbalances will continue to widen, meaning the nation risks facing the same problem in the future as it does today. but without a clean central government balance sheet to back it up. help them manage potential disruptions.

It is entirely possible to get out of this cycle for good. Particularly in light of the party's most recent political conclaves, including July's closely watched Third Plenum. There, Xi and Premier Li Qiang demonstrated once again that they fully understood what needed to be done to move China upmarket, increase its competitiveness, and increase its productivity.

Among the signals that pleased investors' ears were the following commitments: relentlessly encouraging the private sector; pivot towards high-quality development; accelerate modernization with Chinese characteristics; defend innovative vitality; and actively develop domestic demand.

Belinda Schpe, a China policy analyst at the Center for Energy and Clean Air Research, says it's no small feat that the Plenum communiqué mentions reducing carbon emissions for the first time. This takes China's commitment to reducing emissions and tackling climate change to a new level.

However, urgent implementation has been lacking since then. This is about recalibrating the engines of growth, reducing the dominance of inefficient state-owned enterprises that still dominate the economy, and financial imbalances, from falling property values ​​to municipalities facing crushing debt.

To prepare for these and other disruptive reforms, says economist Brad Setser, a senior fellow at the Council on Foreign Relations, Beijing must overcome its aversion to priming the fiscal pump.

The Chinese central government's necessary reforms aim to free itself from largely self-imposed constraints, Setser says. Such constraints have limited its ability to use its considerable fiscal space to help China resolve its current predicament of a shrinking real estate sector and loss of household confidence.

Setser says the central government has sufficient room to maneuver both to ensure that real estate developers respect pre-sales or make a refund and to expand the provision of social insurance while reducing regressive taxes. The central government also has the option of adjusting revenue sharing formulas to provide fiscal aid to struggling provincial governments, even if this means a larger public deficit.

Conversely, Setser adds, if China's central government has fiscal space and uses that space in a way that gives households the confidence to spend more, China might be able to recover from the crisis on its own. slowdown in real estate, without counting even more on exports.

Major policy action must also involve measures to build larger and more dynamic social safety nets to encourage households to spend less and save more.

Xi has made clear time and again that he understands how to shape a more innovative, more productive and more market-friendly China. His team just needs to act or pay the price of yet another disappointment to global investors.

Follow William Pesek on @WilliamPesek