Great Fall of China dents party's prestige

Tomorrow, the new graduates of Tsinghua University are set to gather in their smartest attire to celebrate earning degrees from one of China's most prestigious institutions, a place that has fostered generations of political leaders.

Just after the ceremony starts - according to a written agenda - the graduates must "follow the instruction and shout loudly the slogan, 'Revive the A shares, benefit the people; revive the A shares, benefit the people' ".

To outsiders, this might seem a curious sentiment with which to send China's best and brightest forward into their careers.

More commonly, the tropes of patriotic education are concerned with issues such as national unity and strength, socialist ideology, the recapturing of China's past glories and the washing away of a century of shame inflicted by imperialist Japan and Western powers.

The elevation of A shares into this rarefied pantheon of national priorities hints at the centrality of the battle that Beijing has joined to restore calm to its slumping stock markets and, in the process, revive its own credibility.

An investor in Beijing tracking share-price movements. The market slump underlines the need for China's party leadership to rethink the role of the state in the financial system before it loses further credibility. Critics say it has used equity markets to funnel people's savings into state-owned enterprises, but neglected to prioritise investor returns or promote sound financial development. PHOTO: AGENCE FRANCE-PRESSE

This is because the A-share rout puts something at risk that is much bigger than lost investments - the Communist Party's basic definition of how power and the people are supposed to interact is also in jeopardy.

China's financial industry - and much of its stellar economic growth over the past 36 years - has been founded upon a repression of returns to savers.

The deposit rate in banks has been kept artificially low by administrative fiat, driving down the costs of borrowing for companies. The terms of corporate bond issues have also ensured cheap funding costs.

Moreover, the stock market since its establishment in the early 1990s has followed a design utterly different from that of its Western counterparts.

Investor returns - along with corporate disclosure, shareholder rights, dividend payments, rigorous audits and the policing of insider trading - occupy a marginal position next to the market's role of funnelling people's savings to state-owned enterprises as cheaply as possible.

"In China, the markets are operated by the state, regulated by the state and legislated by the state, and raise funds for the benefit of the state by selling shares in enterprises owned by the state," wrote investment bankers Carl Walter and Fraser Howie in Privatizing China, which looks at how Beijing has perverted the market to make stocks serve socialism.

The rout now under way could unpick this cosy construct.

The slump of nearly 30 per cent in the Shanghai and Shenzhen stock indexes - which has wiped some US$3 trillion (S$4 trillion) off the value of all listed companies in three weeks - stems from a collapse in confidence that the Communist Party can continue to effectively manipulate the market.

It is a sharp indictment of the party's prestige. Beijing has not only orchestrated a propaganda blitz over months to drive stock prices higher - it has also fostered a surge in margin lending that has lured millions of retail investors into leveraging up their exposure to a share bubble.

A World Bank report last week - albeit in a chapter removed later as it did not meet the bank's "usual standards of discourse with member governments" - made searing criticisms of the state's role in a dysfunctional financial system.

The redacted chapter, written in concert with a Chinese think-tank, identified three roles of the state in China that "are articulated poorly, overlap and conflict".

The report noted that, elsewhere in the world, the state is important for financial systems as a strategic promoter, an owner and a regulator of sound financial development but, in China, these roles are misaligned.

"Instead of promoting the foundations for sound financial development, the state has interfered extensively and directly in allocating resources through administrative and price controls, guarantees, credit guidelines, pervasive ownership of financial institutions and regulatory policies," the report said.

In a crisis, paternalistic control can be useful - as evidenced by a modest rebound in shares on Thursday after a concert of state-directed measures. Still, as the report notes, the big drawback of China's misallocation of financial resources is waste on an epic scale.

It is not just investors who are seeing their savings evaporate in the Great Fall of China. About half of China's fixed asset investments between 2009 and 2013 - equal to about US$6.8 trillion - went into "ineffective" projects, according to government research.

The rout in A shares reminds Beijing of the urgency of reforms to introduce more free-market mechanisms for allocating capital.

But so far at least, the party leadership seems to be putting its faith in old reflexes of command and control - along with the patriotism of Tsinghua graduates.


A version of this article appeared in the print edition of The Straits Times on July 11, 2015, with the headline 'Great Fall of China dents party's prestige'. Print Edition | Subscribe