There has been an almost perfect storm in recent weeks in terms of Chinese regulatory initiatives against private sector companies and related equity market collateral damage.
The latest panic selling was triggered by government moves to stop quoted education companies making money from marketing after-school tuition services for core school subjects.
Under the new rules, all existing institutions offering tutoring on the school curriculum will be registered as non-profit organisations while no new licences will be granted.
Such tutoring institutions will also be barred from raising money through listings or other capital-related activities, while listed companies are banned from investing in such institutions.
This initiative followed the gathering regulatory assault in recent months on the internet sector, be it driven by regulating fintech lending models, controlling ownership of data or curbing excessive market power on an anti-trust agenda.
The Chinese Internet index is down by 58% since mid-February.
CSI China Internet Index
To add to the general angst, there has also been the growing concerns over the financial predicament of Evergrande, the highly leveraged Shenzhen property developer which faces the risk of becoming the first victim of China’s so-called “three red lines policy” first announced last August, where property developers were ordered to comply with specific financial ratios.
Evergrande’s share price is down 85% from its peak while its US dollar bond due 2025 yields 40%.
China Evergrande share price
China Evergrande US dollar bond due 2025
China is Not at War With the Private Sector
All of the above have caused many foreign investors to assume that China has now declared war on its private sector.
This is not this writer’s view.
The private sector accounts for over 80% of job generation in China and it would be insane for the central government to take such a stance.
Chinese technocrats understand this as well as anyone.
But it is also clear that under Xi Jinping, who first assumed power in 2012, China has long since stopped prioritising growth for its own sake.
This was partly because of financial stability concerns in terms of excessive debt and the like.
Hence the deleveraging campaign of recent years and the related squeeze on shadow banking.
But there has also been a social stability concern in terms of unfettered free markets leading to both extreme inequality and excessive monopolistic power.
In the case of the Internet giants, their economic power is perceived as increasingly threatened SME businesses and related jobs.
While their successful payment systems threaten the disintermediation of the banking system.
This latter point, in particular, has raised a political issue.
That is that the Internet giants were getting big enough to pose a potential challenge to Party rule.
And that is, clearly, unacceptable.
It has now become crystal clear, if it was not already clear before, that under Xi the interests of the Party will be put before the market.
In this respect, the Chinese Communist Party has returned to its socialist roots.
But it is also the case that it never fully abandoned them.
The reform era initiated by Deng Xiaoping in late 1978 was viewed as a practical way of moving China out of poverty on the back of the export-led model.
Now Xi’s formal goals are for China to become a “moderately developed country” in per capita GDP terms by 2035, by doubling economic output or per capita income, and to build China into a “great modern socialist country” by 2049 when the People’s Republic of China will mark the 100th anniversary of its founding.
Meanwhile, it should be remembered that Xi’s first goal on assuming power in 2012 was to restore the legitimacy of the Party at a time of seemingly out-of-control corruption.
Hence the anti-corruption campaign executed from late 2012 under then Secretary of the Central Commission for Discipline Inspection Wang Qishan.
In this writer’s view, the Chinese leader has succeeded in that goal which is why he is probably more popular than many of his Western critics would imagine – just as Russian President Vladimir Putin has long been.
Education Stocks in the Crosshairs
Moving to nearer-term investment issues, the major quoted education companies New Oriental Education and TAL Education, both with New York listed ADRs but New Oriental also listed in Hong Kong, are down 73% and 75% respectively since the move was announced on 23 July.
China Education Stocks
Here the crackdown reflects the central government’s concern about parents spending excessive sums of money to cram their only child in order to get through key exams.
This raises an issue of fairness in terms of those children whose parents cannot afford such tuition.
But it also highlights one of the many perverse consequences of China’s One-Child policy, introduced in 1979 and only abandoned in 2015.
Indeed probably the biggest mistake of China’s reform era policies, was not to abandon the One-Child policy much earlier.
China Leaders are Worried by a Rapidly Aging Population
The latest census data released in May, which showed that China is ageing more quickly than previously thought, has only served to focus the leadership’s attention on whether China will be able to meet its GDP per capita targets.
The mainland population aged 60 and above rose to 264m or 18.7% of the total population in 2020, up from 177.6m or 13.26% in 2010.
While those aged 65 and above increased to 190.6m or 13.5% of the total in 2020, up from 118.8m or 8.87% in 2010.
China National Population Census: Share of mainland population aged 60 and above
This compared with previous UN estimates made in 2019 of 12% of the population aged 65 and above and 17.4% aged 60 and above as at the end of 2020.
It should be noted that China’s target is to double its GDP per capita by 2035 from US$10,500 in 2020.
China GDP per capita
In this bigger picture context, there are two key challenges which have long preoccupied senior PRC officials.
The first concern is that China grows old before it grows rich.
The second is China falling victim to the so-called “Middle Income Trap”.
Hence the obsession with upgrading the economy and boosting productivity, which is why China will not abandon its private sector.
Digital Renminbi and the ‘Walled Gardens”
Meanwhile, the frictions with America in recent years over technology transfer, most particularly in terms of semiconductors, have led to massive focus in China on the need to become self-sufficient in technology.
Returning to the nearer term issues at hand, the regulatory focus on the Internet stocks should also be seen in the context of the seemingly imminent launch of the digital renminbi.
A successful digital renminbi will erode the dominance of Alibaba’s Alipay and Tencent’s WeChat Pay since both payment systems will no longer be able to flourish in their own “walled gardens”.
At present most of China’s 1.4bn people use at least one of the two services to make mobile payments in what has become a near cashless society, but the two systems are not interoperable.
In this respect, the launch of the digital currency should create a business opportunity for others, such as China’s state-owned banks.
So, the pending launch of the digital renminbi has been a clear catalyst for the regulatory assault on fintech, just as it has been for the attack on Bitcoin mining in China discussed here recently (“Will China’s Crypto Crackdown Push Bitcoin Into The Arms of The West?”, 5 July 2021).
For those interested in the project the People’s Bank of China published a 16-page white paper on the digital renminbi last month (see PBOC white paper: “Progress of Research & Development of E-CNY in China”, 16 July 2021).
According to the report, more than 20.87m personal digital renminbi e-wallets and over 3.51m corporate wallets had been opened as of 30 June, with transaction volume totaling 70.75m and transaction value approximating Rmb34.5bn.
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