The crash of the Chinese stock market on the first day of trading in 2016 is a stark reminder of the urgent need for reform in China’s financial system in particular and its economy in general.
Initial reaction from commentators pointed to some incidental circumstances — China’s disappointing manufacturing data, reported earlier Monday, and the coming removal of a ban on major shareholders from selling stakes that was instituted during last summer’s stock rout.
However, the size of the crash — over 7% in a few hours of trading that prompted closing the market the same day and an ensuing wave of panic it sent through world markets — hints at a different and more complex scenario.
I offered an analysis last year of the factors behind the 2015 summer stock crash. These same factors were in play during the latest plunge. The reasons are threefold: State-Owned Enterprises (SOEs) have not been reformed; private entrepreneurs are losing confidence, and the stock exchange is still bedeviled by endemic insider trading.
There’s a deeper reason: China’s old business model based on corruption and political patronage has collapsed, thanks to Xi Jinping’s anti-corruption campaign. But the new business model supposed to replace it is yet to take shape because conservative forces inside China’s communist party oppose the changes.
The necessary reforms can be described as follows:
1) SOEs must be privatized. This cannot be done overnight but it must follow a process. These huge government enterprises are too inefficient to survive and they are in danger of dragging down the Chinese economy.
2) Private entrepreneurs must be encouraged to regain confidence in the system. Part of this involves issuing an amnesty for past economic crimes. This will help link the private sector to the government under a new political contract. While some entrepreneurs will be forgiven, they will have to obey new business rules.
3)The state must take a more active role as a final and real referee that controls the markets. Regulators must ensure that the new rules will be obeyed. This differs from the current situation where regulators and those they regulate share the same rooms, the same meals and can manipulate the markets behind the backs of naïve common investors.
If these problems are not addressed in a radical way, any passing market wind will crash the Chinese stock market and take others with it due to the sheer size of China’s economy. Therefore, these reforms are not only necessary, they are an urgent matter for China and the rest of the world.
But there is big political question that hangs over the question of reforming China’s financial system: Does Xi have enough political clout to carry out these reforms which threaten to smash the old networks of vested interests that have dominated China’s politics and economy for decades?
Two signs point to the fact that Xi has accrued greater political capital. After a lot of arm twisting, Xi eventually managed to get local court tribunals to become more independent of local governments. This will help in effecting legal changes that counter the old power networks. (See China Grants Courts Greater Autonomy on Limited Matters ) Perhaps more significantly, Xi has launched an overhaul of the People’s Liberation Army (PLA), the traditional kingmaker of Chinese politics (See Xi’s Reforms to Make Military Slimmer and Stronger)
However, in the midst of such larger challenges, focusing on economic and financial reforms can be an extremely technical and time-consuming task. Will Xi be able to tackle such issues while he’s absorbed in more pressing matters like the crucial PLA changes? Perhaps not.
The upshot is that China could face further market uncertainties in the next few months. All this while the EU is being shaken by various political and economic problems and the Middle East is being impacted by dangerously low oil prices.
Francesco Sisci is a Senior Research Associate of China Renmin University. The author of Asia Times’ Sinograph column, he was also Asia Editor for the Italian daily La Stampa and Beijing correspondent for Il Sole di 24 Ore, and has written for numerous Italian and international publications. He was the first foreigner admitted to the graduate program of the Chinese Academy of Social Sciences, he is the author of eight books on China and a frequent commentator on CCTV.