A year ago, my colleague Nicholas Consonery and I wrote an article for The Fletcher Forum arguing that China’s transition into an era of slower economic growth is a positive sign because it gives Beijing a political window to address more acute structural challenges and vulnerabilities. This past summer, some symptoms of slower growth surfaced, including declining exports, a stock market crash, and a devaluation of the RMB, triggering an exodus among investors and reviving doubts regarding President Xi Jinping’s administration. But this is not unexpected, and we had said that the “government (and economy) will face major bumps along the way.” China’s volatility represents setbacks but not the fundamental derailment of reform, and it remains premature to fear an inevitable “hard landing” for Chinese markets.
For all the hysteria, financial disruptions have not fundamentally damaged China’s real economy. Despite short-term shocks, the A-shares stock market correction has had limited impact on consumption, as most household wealth remains in banks or real estate, and on investment, as corporate financing relies mainly on debt. Furthermore, despite the much-publicized 30 percent crash in June, the Shanghai A-shares index is still up roughly 40 percent over the last year. On the currency side, rates have stabilized and even appreciated after the recent devaluation. The decision to devalue now looks less like a policy blunder and more as an intentional move to boost the RMB’s bid for inclusion in the IMF’s Special Drawing Rights foreign exchange reserves.
Beijing’s experiment to reform capital markets over the past two years has been a push-pull process. On several occasions, regulators rolled back relaxations when markets spun out of control, taking some missteps in the process. When securities on the stock market looked destined to enter freefall, regulators backtracked on ceding control and engaged in an ill-advised intervention, bailing out state-owned enterprises (SOEs) and halting initial public offerings. Recognizing its own mistake, Beijing went on to arrest top individuals who oversaw the rally and then executed the intervention. When investors again panicked after Beijing allowed the RMB to devalue by 3 percent over two days in August, the People’s Bank of China instituted tighter capital controls to stem speculation, cooling down short-term volatility at the cost of backtracking on capital account liberalization. Yet, these setbacks only occurred because China is experimenting with reducing control and opening up its capital markets. These experiments are a positive sign for reform, even if it means greater financial volatility in the future.
This same push-pull process is reflected more broadly in efforts to implement President Xi’s ambitious reform plan to put the economy on a more sustainable path, as outlined in the Chinese Communist Party’s Third Plenum in late 2013. China’s leaders want to liberalize the economy and address the needs of a rising middle class, but must balance those priorities against both political and economic forces resistant to change.
In the political realm, the Communist Party has centralized power to overcome resistance against reform. The Xi administration launched an unprecedented anti-corruption campaign led by Politburo Standing Committee member Wang Qishan, cracking down on toughened sectors such as energy and finance, and setting the stage for reform in those sectors. Also, the Party set up “leading small groups,” running parallel to government ministries but commanded by a core team under Xi or other members of the Politburo Standing Committee. The tightened grasp on power dismayed observers hoping to see more political reform, but has arguably better equipped President Xi to implement his economic reform agenda and pursue economic liberalization.
On dealing with the slowing economy, reform goals have sometimes given way to short-term relief for growth. Under pressure to achieve a GDP growth rate target of around 7 percent this year, already the lowest since 1991, the Ministry of Finance announced in September that it would adopt a “more forceful” fiscal policy to stimulate the economy. The increased spending will not be a repeat of the 4 trillion RMB injection of 2009, but it is nonetheless perverse to Beijing’s aim to expand services and consumption as the main drivers of growth. China has also had to relax its aggressive effort to cap local debt, as slowing growth dwindles local revenues and undermines local governments’ ability to repay. In June, the National Development and Reform Commission allowed local government financing vehicles to refinance their debt, partially rolling back efforts by the Ministry of Finance to restrict backchannel financing and replacing it with provincial bond issuance.
Looking more broadly, however, China’s economic transition under President Xi and Premier Li Keqiang has remained largely on course. A landmark reform plan for China’s SOEs, finally passed in September, will bolster private-sector participation and transparency. On factor price reform, the government authorized an electricity sector reform plan in March, while more reforms on the oil and gas sector are expected by the end of this year. Strides have also been made to meet the rising demands of China’s middle class: environment and food and drug safety regulators have all been given more authority, and the government has taken steps to dismantle both the hukou household registration system and the one-child policy. Finally, pessimism over the sluggish 6.9 percent growth rate in the third quarter of this year misses a more important data point: for the first time, services and consumption accounted for more than half of the country’s GDP. Concerns about China’s financial volatility, political centralization, or increased economic stimulus are certainly valid, but to fixate over them is to ignore progress in these significant areas that had long stalled under the Hu-Wen era.
Recent volatility in the financial system is not the beginning of the end for China, but rather the growing pains of a government experimenting with relaxing its tight grip. Despite challenges posed by slower growth, there is little indication that China has abandoned reform, or is on course for a hard landing. As President Xi told the Wall Street Journal in September, his government will have to “crack hard nuts and ford dangerous rapids” on the path to reform. Reforms have not been smooth, and the push and pull in different areas testify to the magnitude of this challenge. But as long as Beijing recognizes that it is in its own best interests to allow the economy to slow down and move toward a more sustainable path, then reform will continue.