21 February 2019
The government should show no mercy to companies in sectors, such as coal mining, that have severe excess capacity and allow them to go bankrupt. But it should ensure a safety net for their workers. Photo: Reuters
The government should show no mercy to companies in sectors, such as coal mining, that have severe excess capacity and allow them to go bankrupt. But it should ensure a safety net for their workers. Photo: Reuters

Where is China’s economy heading?

The stock market has been focusing on the interview with an unnamed “authoritative person” published in the People’s Daily last week.

Several rumors last week also heightened the market’s volatility.

The China Securities Regulatory Commission is reportedly considering measures to curb the flow of overseas-listed Chinese companies seeking backdoor listings in the domestic equity market.

The news caused the share prices of many companies in the process of privatization and shell companies to plunge.

Later, it was reported that the securities regulator also intends to prevent listed companies from issuing shares for raising funds to be invested in the high-flying fintech, virtual reality, gaming and filmmaking sectors.

Mergers and acquisitions and refinancing activities in the four sectors has halted.

It seems that the publication of the interview with the “authoritative person” may be the prelude to a series of tightening measures.

I noted early this year that China’s economic growth will follow an “L-shape”, which means Beijing is determined to tackle overcapacity and economic restructuring to pursue long-term sustainable growth.

For that to happen, the government has to abandon strong short-term stimulus measures.

That’s easier said than done. The issues are not cyclical but structural.

In the meantime, the central government unveiled measures to phase out excessive capacity, clear inventory, reduce leverage, cut costs and improve weak points.

The past assessment system focused on growth in gross domestic product is changing.

China has to push ahead innovation and reform and find new growth engines to make sure the economy won’t fall off the cliff.

If the bottom line for annual economic growth is 6.5 percent, the economy has yet to come out of the woods.

China’s economy continues to struggle, and company earnings might worsen this year.

Many companies in traditional industries have suffered for years, but they may go out of business eventually.

Economic restructuring has given them less room for survival, as the government has very limited policy ammunition.

Obviously, economic restructuring and stabilizing growth have caused some contradictions.

If Beijing has a firm resolution to push ahead supply-side structural reform, it might accelerate the elimination of overcapacity and shift more resources to emerging industries.

To solve the long-standing issues, the government has to step up its efforts on structural reform.

The country must suffer some pain in that process, otherwise it might face even more pain in the future.

The remarks of the “authoritative person” stunned many market participants, since they were the opposite of the market’s expectations.

“L-shaped” economic growth will affect the micro economy and companies’ earnings growth.

Some of my friends from investment banks are busy in carrying out the debt-to-equity restructuring program in the mainland.

If the pilot program fails to go ahead, many companies in financial difficulties might go bankrupt.

At present, China’s overall economic performance is in line with expectations or even better than expectations.

Nevertheless, the existing issues have yet to be resolved, and we’ve also seen some new problems.

Therefore, it’s not correct to describe China’s economy as showing a “good start” this year.

That means the “L-shaped” growth of the economy may not end in one or two years.

What policies will China adopt to stimulate growth?

Investment stimulus should be appropriate rather than excessive.

In addition, China should not add leverage to push growth — it has to focus on the real issues.

It’s unsustainable to rely on short-term growth stemming from overcapacity, and the country would pay an even heavier price in the future to get rid of such excessive capacity.

The government should increase effective supply and breed new growth momentum, as well.

To stabilize market expectations, it’s critical to stabilize policy and prevent too many policy changes.

The market turmoil in equities and foreign exchange early this year reflected the intrinsic fragility of the financial markets and should not be considered merely as short-term volatility resulting from speculation.

The government should abandon the mindset of accelerating economic growth through expanding monetary easing measures.

It should show little mercy to companies with no hope, letting them either shut down or go bankrupt.

Also, the government should provide a safety net for workers in these “zombie firms” and treat that as the top priority when weeding out excessive capacity.

This article appeared in the Hong Kong Economic Journal on May 16.

Translation by Julie Zhu

[Chinese version 中文版]

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Senior investment banker

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