BUSINESS President Xi had too much riding on his nation’s stock market boom

LONDON: The real damage in China’s stock market crash is subtle, bringing into question the fundamental economic model, the reform agenda and the political authority of its leadership.

Over three millennia, China’s leaders have ruled by the mandate of heaven. Each new dynasty, like that of President Xi Jinping, must establish a new dynasty, consolidating power and authority. This requires ensuring general prosperity, especially for key groups whose support is essential. The officially sanctioned “state bull market”, or “Uncle Xi bull market”, was cheered by state media and brokers – encouraging participation.

But instead of diverting attention from other existing challenges, the stock market correction has drawn attention to challenges such as the end of the property boom.

Chinese real estate represents 23 percent of GDP – a pro- portion around three times that in the US at the height of its property bubble. Prices appear inflated relative to incomes and rental yields.

Despite vacancy rates of more than 20 percent and inventories equivalent to five years’ demand in some cities, new housing starts are around 12 percent above sales.

In China, investment spending as a percentage of GDP is unprecedented in history, creating massive overcapacity.

The accompanying credit bubble is an immediate concern. By 2014, total Chinese debt was $28 trillion, or 282 percent of GDP – up from $7 trillion (158 per cent of GDP) in 2007 and $2 trillion (121 percent) in 2000. The $20 trillionplus increase since 2007 repre- sents one-third of the rise in global debt over the period.

The stock market falls raise the risk of significant problems within the financial system. This will ultimately affect China’s potential growth, which has, since 2009, contributed greatly to global economic activity. The episode may slow down or defer necessary economic reforms.

A liquid and well-functioning stock market is essential for appropriate pricing of capital and reducing excessive reliance on bank loans. It is important in any possible privatisation of state- owned enterprises, and attracting foreign investors and long-term, stable capital inflows.

The fear is that China’s proposals are rhetoric, primarily for foreign consumption. In 2013 the Communist Party stated that market forces must play a “decisive role” in allocating resources. But the market crash and the response suggest that the Chinese authorities are likely to rely more on Communist dogma than market forces when events develop in an unwanted way.

The crash has drawn attention to the underlying repressive economic processes. China’s financial system is predicated on directing the savings of ordinary Chinese people into areas suiting policy purposes, especially maintaining economic growth. The regime relies on keeping the cost of funds artificially low, usually below inflation rates. This allows firms connected to the Communist Party and privileged insiders to benefit.

The stock market boom allowed elites to gain access to cash from Chinese savers. In the first group to benefit were those able to list or sell shares to take advantage of artificially high prices. In the second group were those who gained preferential access to shares in hot listings, or benefited from private data about earnings and corporate actions.

The fall in prices affects both groups. The financial elite are deprived of easy moneymaking options, especially as other sources of profits, such as property, are unavailable. Ordinary savers, encouraged by the government to invest in stocks, face large losses, increasing resentment at the nature of the game and growing wealth gap.

Intended to offset opposition to the aggressive anti-corruption campaign that affected their ability to profit, the engineered boom was designed to reward elites and ensure support for the president’s agenda and consolidation of power. Instead, the bust has undermined the new regime.

In April, when the Shanghai stock index rose above 4 000, the Chinese Communist Party trumpeted the new “Chinese dream”, part of which was increasing prosperity through rising share prices. That dream may yet turn into a nightmare for China. – The Independent

LEADER: President Xi Jinping.