Market researchers have come to a consensus that the bursting of the A-share bubble in June/July is unlikely to damage China’s economic and financial systems.
Global financial contagion is also well contained, as the A-share market has a very low correlation (averaging 0.15) with the 10 most-traded global markets (excluding Hong Kong).
So why did Beijing intervene so heavily to obstruct market clearing in an attempt to salvage the stock market?
Since President Xi Jinping took office, he has implemented a series of financial reforms in all major areas, from the domestic banking system to the external capital account.
These measures had only just started to earn the trust of many China skeptics before the heavy intervention in the A-share market quickly destroyed Beijing’s hard-earned credibility regarding financial reform.
The international community is now questioning whether China is ready to let market forces run the system, as well as Beijing’s policy transparency and consistency and its willingness to tackle moral hazard.
From the perspective of a foreign investor or regulator, these questions boil down to two key problems — transparency and liquidity — which organisations such as the International Monetary Fund and MSCI want to see China improve before considering any change in the role of the renminbi and renminbi assets in international official reserves and international investment.
Observers have offered various explanations for Beijing’s intervention, including installing a “Xi Jinping put” to pre-empt a financial meltdown; ensuring a rising stock market to help attract foreign investors and advance renminbi internationalisation and domestic structural reforms; and shoring up the leadership’s reputation.
While these notions are valid to some extent, in my view they all miss the most important point of local political economy.
At the heart of Xi’s vision for reform is the need to strengthen the foundation of the Communist Party’s political control.
To do that he needs to reconstruct China’s social contract, which Beijing has been using to govern the country since the start of economic reform in 1978.
For the people, the deal is for the party to retain a monopoly on power in exchange for economic freedom that has delivered unprecedented economic growth and reduction of poverty.
For the [arty, the “red line” is anything that it perceives as a threat to its survival.
However, things have changed, leading to the breakdown of the social contract.
Years of lopsided economic growth have deepened inequality in income and wealth, creating a big economic divide between the rich and the poor.
This has raised the awareness of the grass-roots population that the corruption and incompetence of local officials are only a small part of the problems that prevent them from sharing the benefits of economic reform.
The major problem, which the government is now trying to fix through structural reforms and anti-corruption measures, is rooted at the higher levels.
This has, in turn, prompted the intellectuals and the wealthy to take more interest in politics and the reform process, either to fight for their interests or to exploit rent-seeking opportunities to enrich themselves.
Signs of China’s social contract fracturing are ample, including the yawning inequality between rich and poor, rampant corruption, serious environmental damage and human rights abuses.
Thus, the key objective of Xi’s administration is to reconstruct this social contract to restore the political monopoly and legitimacy for the Communist Party.
The president and the party are very conscious of the “Gorbachev syndrome”.
When Xi hands over power to the next generation of Chinese leaders in 2023, the Communist Party will have ruled China for 74 years, exactly the same length of time as the Communist Party ruled the former Soviet Union before it fell apart.
From this perspective, the stock market plays a pivotal role in helping to restore the legitimacy of the party’s rule and divert public grievances.
Rising stock prices provide ordinary Chinese with an opportunity to improve their income, just as economic liberalisation did in the 1980s and ’90s, thereby reducing the likelihood of political and social unrest.
That is why Beijing is so keen on protecting the A-share market even at the expense in the short term of some of its credibility as regards reform.
Opinions expressed here are the author’s and do not necessarily reflect those of BNPP IP.
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