Beijing to the world: Jump on in, the water’s fine.
That was the message out of China on Tuesday as officials laid out plans to reform the country’s debt-laden, mostly state-backed corporate sector.
This reform was always in the cards as part of China’s New Normal plan to move its economy from one based on foreign investment to one based on domestic consumption.
According to the plan, the government sells off assets that are “zombifying” companies, steps away, privatizes, and allows the market to have a more free hand.
The thing is, no one thought this massive reorganization would have to be done with the Chinese economy sending out warning flares as it is now.
Ideally, the corporate sector was supposed to undergo this reform with GDP growth humming along at a pretty 7%, with a booming stock market, and a stable currency.
But that’s not what China looks like right now. In fact, it looks opposite.
As a result, China’s statements about foreign investment in its evolving corporate sector are incredibly confusing. On the one hand, the government wants to continue on a path that limits foreign investment in favour of domestic ownership.
On the other hand, China needs cash.
“China should be committed to attracting foreign investment and expertise, and improve opening-up policies,” Preside Xi Jinping said on Tuesday, addressing the 16th Meeting of the Central Leading Group for Deepening Overall Reform.
Sounds good. This doesn’t sound like the New Normal, but fine. More foreign investment. Everyone in the China pool.
Conversely, in the same statement Xi also said that his “government will not change its policy toward foreign investment.”
Under those unchanged policies, foreign direct investment in China declined 26% in the first half of 2015. Investors know that they’re invited, but they’re not attending the party.
Confused? Understandable. On the one hand Xi is saying the country will improve its policies and open up to the world (please send us money).
Meanwhile, on the other hand he is saying China’s policies on foreign investment will stay the same (the state is still going to have a heavy hand in the market). The party will continue as usual.
That dissonance is also clear in the reform plan the government outlined. The reform process will consist of the government choosing which underperforming assets of so-called “zombie companies” will be sold.
That money “will be used by companies that need it more,” said Zhang Xiwu, deputy chairman of the State-Owned Assets Supervision and Administration Commission.
Of course, the government will determine what “need” means.
It will also develop a “negative list” of sectors that are forbidden to investors.
So why the double talk? It all boils down to the fact that China is going to need the world’s help with this one. And that is because everything it was depending on to make this reform process work has fallen apart in the last few months.
See, the ideal situation for China would have been to finance this reform process domestically. That is why for the last year and a half the government encouraged regular Chinese people to get into the stock market.
As a result, until June, both mainland indices — The Shanghai Composite and the Shenzen — completely exploded up to 150%. It was exactly what the government wanted. Companies would have the cash to handle their debt loads while reorganising assets.
Then on June 12th the stock market started to fall apart. Total bloodletting. Now, the Shanghai Composite — which had been up 60% year-to-date before the crash — is down over 7% for the year.
China’s markets are still a whipsaw. That even after the government did everything it could to stop the bleeding. It froze IPOs and new share issues, went after “malicious” actors (think: short sellers) in the markets, and has thrown at least $US240 billion at the markets since June.
Debt is still an issue, guys
What’s more, China devalued its currency on August 12th. This is key, because it means any dollar or euro denominated debt companies are holding is now more expensive.
And they are holding.
Bloomberg estimates that China’s $US529 billion in offshore euro and dollar denominated debt jumped by $US10 billion after the yuan was devalued by 1.9%. At this point the yuan has now depreciated by about 4% against the dollar.
The government has promised to defend that position, but in August alone doing so cost it up to $US110 billion according to analysts at Societe Generale. It can’t maintain the yuan forever, and the fact that the government had to use so much money to defend it for half a month shows that market forces are trying to drag it down.
Meanwhile, China’s corporate sector is still struggling with PPI deflation, which means profit margins are thinning. Debt was already getting hard to pay back.
Don’t you want in?
It’s not like investors don’t know this stuff already. Confidence in China’s ability to navigate this period is at an all time low. Hard landing scenario news stories are everywhere now.
Plus, indicators from fixed asset investment (down to 9.2% in August) to industrial production (up only 0.1% in August to 6.1% — expectations were 6.5%) have disappointed across the board.
That’s especially worrisome since the the government ratcheted up on-budget spending from 27.1% yoy in July to 28.4% yoy in August. It’s spending the cash, but the economy isn’t responding yet.
This is the worst possible time for China to ask foreign investors to jump in.
But it doesn’t really have much of a choice if it wants to get on with this already.