Even if you resent China for being the epicenter of Covid-19, you’ve got to admire Beijing’s leadership skills. Less than a year after the pandemic erupted, life is back to normal, while Europe and the U.S. are still struggling. The country is now the world’s shining economic outlier.
Many good things can be said about China. Wearing a mask isn’t a political debate. Bureaucrats take virus testing so seriously that some measures go overboard. The central bank resisted the temptation to take the cheap, zero-rate shortcut to boost the economy, and is opening financial markets. No wonder yield-hungry foreigners are buying Chinese assets at a record pace, despite angry objections from U.S. President Donald Trump.
But there’s always room to improve. Come January, there will be a more rational occupant of the White House, which will give China the space to focus on structural reforms. And it’s here I’d like to raise some quibbles with Beijing because for the thousand things it did right this year, it got three big things wrong.
Underestimating the K-Shaped Rebound
Just months into the pandemic, the world quickly realized the myriad ways Covid-19 was exacerbating income inequality. Large technology companies and their employees, who could work from home, were flush with cash, while storefront businesses were forced to close.
As early as April, when China first emerged from lockdown, small restaurants were starting to voice their complaints about the exclusive arrangements food-delivery super-apps asked them to sign, forcing them to choose one platform over another, and the exorbitant fees they charged. These apps threatened the recovery of the hotel and catering industry, and the livelihood of its workers. The sector, which didn’t fully bounce back until October, employed as many as 33 million people last year.
Yet Beijing didn’t start to address this economic imbalance until mid-November, when it published a vaguely worded, 22-page document on antitrust regulations aimed at reining in the country’s tech giants. On Christmas Eve, in a one-sentence statement, the State Administration for Market Regulation said Alibaba Group Holding Ltd. was under investigation for the so-called “pick one out of two” practice. Alibaba’s shares are down 28% from their October high.
The K-shaped rebound shouldn’t have come as a surprise: The macro statistics gave plenty of cues. Manufacturing bounced back quickly, while retail sales, a barometer of broader consumer confidence, lagged for months. Luxury items were doing well, with high-end cars selling fast and the likes of Chanel and Louis Vuitton raising prices.
In the U.S. and elsewhere, consumer confidence has been partially shielded from the Covid-19 recession thanks to stimulus checks and augmented unemployment benefits. China, on the other hand, took a page from its 2008 playbook, revving up the economy by building new bullet trains and 5G telecom stations.
Over 170 million migrants live and work in China’s cities, mostly in the construction, manufacturing and services sectors. During the pandemic, they not only lost their jobs, but didn’t get to collect unemployment checks. As far as Beijing was concerned, they weren’t jobless; they could always go home to farm. China went for trickle-down economics.
The decision to aid business owners over workers may have stemmed from the government’s obsession with control. While Beijing feels it can tell factories to run their machines at full speed, households may just stash away their stimulus checks. Businesses have a higher marginal propensity to spend.
Was this fiscal recipe wise? China has been eager to transform into a consumer society because an economy that relies on industrial production is vulnerable to global business cycles. The lack of a social safety net, however, may have permanently dented household confidence. China’s old-fashioned stimulus is setting back its own economic goals.
Muzzling Billionaire Critics
Even as Americans flooded the polls to choose their new president, China found a way to steal the show. On Nov. 3, it suspended the $35 billion public listing of billionaire Jack Ma’s Ant Group Co. — just two days before the fintech’s trading debut.
The bright side of gridlock in Washington is a strong investment case for China: a weaker dollar, which makes its currency more attractive; a sovereign bond yield differential at a record high; and a wave of mainland unicorns going public. But the sudden antics pulled with Ma can unsettle even the savviest investors.
In a terse statement announcing its decision, the Shanghai Stock Exchange cited regulatory changes and Ant’s inability to fulfill listing conditions. Beijing has a point. During Covid-19, consumer credit was expanding too fast, and abuses, such as predatory interest charges and misuse of tenants’ prepayments, became a social issue. On Dec. 27, the central bank said in a published Q&A that Ant has “little legal awareness” and asked the fintech giant to return to its core, less-lucrative digital payment business. To China’s credit, bureaucrats have been debating how to regulate Ant’s lucrative lending business for at least two years.
Yet the timing was suspect. What captivated a global audience was a suspicion that China pulled the IPO not because of regulatory changes, but because of a blunt speech Ma made in Shanghai two weeks earlier. In it, he criticized China’s broken financial system, saying banks were like “pawnshops,” where only those with collateral and guarantees could get loans. President Xi Jinping, who read government reports about the speech, was reportedly furious.
No doubt, Ma loves the limelight, singing and dancing on big stages. Still, what he said wasn’t wrong. In fact, China’s own central bankers have taken the same policy positions – and even used the same words. It just came out of the wrong mouth.
The Ant fiasco thus becomes a fine reminder that Beijing bureaucrats tend to forget how to govern when they feel they have lost face. Assumed standards can be tossed at whim.
It’s also a lesson to billionaire businessmen: Don’t be blunt and don’t criticize the government, just bury your head and make money quietly. After all, China Evergrande Group’s chairman Hui Ka Yan, who turned his real estate business into the world’s most indebted developer, still manages to survive, even though his company poses a systemic risk to the banking sector. In October, Hui laid low when Xi snubbed him during a visit to Shenzhen. A month later, the Shenzhen government gave him a lifeline. Ma, on the other hand, is still nursing the billions of dollars lost from his loose lips.
After four years of incessant berating from Trump, China may no longer care about public relations. But it does want foreign money to help finance its own fiscal deficits. The untimely Ant fiasco puts all that at risk.
There’s a persistent perception that rules in China run on a dual track: Private-sector businessmen get summoned and dressed down by government officials whenever they cross the line – as Jack Ma witnessed in November. Meanwhile, state-affiliated entities can sit cozy, with plenty of local resources at their command.
An ugly wave of defaults among state-owned enterprises is only further evidence of this trend.
Pinched by oversupply and dwindling profit margins, SOEs started to default here and there as early as 2015. Yet the latest wave, which began in September – after China’s economy bounced back from the Covid slowdown – was the first batch to test marketplace rules. The few that missed repayments are the biggest SOEs in their regions.
A default on its own is unpleasant, not unacceptable – this is a risk bond investors are prepared to take. But now there is a deepening suspicion that SOEs will move good assets out before creditors drag them to court. In less than one month, three unrelated companies – an auto giant in the northeast Liaoning province, a coal miner in the affluent central Henan province, and a chip manufacturing powerhouse – shifted their subsidiaries’ stock holdings out before defaulting. That makes a pattern.
For years, Beijing has been trying to break the notion of implicit guarantees – that is, the belief that the government will step in to bail out any SOE. This is for good reason: Loss-making ones somehow get AAA ratings, and there’s not enough credit spread in China’s $4 trillion corporate bond market to differentiate between quality and riskier assets.
But Beijing must apply the same rules universally. If a private-sector real-estate developer defaults, its creditors could get some land bank back for consolation. Will investors be able to carve off an SOE’s assets when these businesses go bust?
The first look isn’t good. China’s regulators have been beating around the bush, punishing bond underwriters and nudging local governments to make empty promises instead.
So while SOEs are less likely to default – thanks to their local connections, they tend to be more resourceful with financing – they’re quite capable of shielding core assets from their creditors after missing repayments.
This is another mistake because foreigners would have happily bought SOEs’ yuan-denominated bonds, which pay higher coupons than their offshore dollar issues. This year, portfolio inflows have been so strong that foreigners are promising to take over city commercial banks as the second-largest buying bloc of government bonds. They have largely stayed away from the corporate bond market, which is known to be a playground of SOE entities. The latest defaults only give them more reason to sit on the sidelines.
President Xi has always been a reformer, keen to upgrade China’s economy and rid the system of excess debt. For the past few years, Trump’s trade war and Covid-19 derailed him. Now that both roadblocks are gone, he can get back on track.
Yet China needs to update its approach. Sticking to a 2008 fiscal playbook feels antiquated, particularly compared with the “run-it-hot” strategies in the U.S. To establish a functional marketplace, China needs to dismantle the two-track system the state and the private sector run on. It also needs to give successful billionaire businessmen a forum to make policy recommendations. They know what’s happening on the ground better than anyone sitting in a government building. Sure, a private citizen’s comments can be hard to swallow, but as our ancestors like to say, bitter medicine is good for your health.