David Mahon details what the Chinese government's doing as it tackles its largest economic crisis in 40 years

By David Mahon*

The following is a Note to Clients by Mahon China Investment Management Ltd, Beijing, which they have allowed us to repost.

1. Beijing stimulated the economy in recent weeks to rebuild consumer and investor confidence. Measures announced to decrease residential real-estate supply and lower deposit and mortgage requirements will help to stop the sector’s decline and eventually revive demand. But the initiatives will take longer to restore faith in the sector to the extent intended by government.

2. China is facing its largest economic crisis in 40 years, a period over which the West experienced multiple crises and learned how to forecast and navigate them a little better each time. Lacking experience, the Chinese Government and the Chinese people are uncertain how they may resolve the underlying economic issues. The present actions, even if clumsily executed at times, are better than the inaction of the past eight months.

3. In concert with real-estate sector initiatives, Chinese financial regulators triggered a 30% stock market rally last month by encouraging banks to lend to listed companies so they could buy back stocks, and allowing qualified institutions to secure low interest loans from the People’s Bank of China to purchase shares. Retail investors also borrowed heavily to buy shares, and there are rumours of some even selling their apartments in the hope they would reap the windfall of a lifetime. The rally has been fragile, but more reforms and stimulus are to come.

4. If the Securities Regulatory Commission (CSRC) can commit to improving the quality of IPOs and the accuracy of earnings reporting, governing bourses more rigorously and cracking down on corruption, China’s capital markets would expand swiftly and supply much needed capital to businesses and investment options for citizens. It was fine to use SOEs to trigger recovery, but Beijing must give private investors more confidence to invest in capital markets for the present trend to turn into a bull run.

5.The Chinese Government can adapt to the role of capital markets regulator, rely less on intervention, and allow companies representing China’s present and future growth — such as privately owned technology and service firms — to list. They must disincentivise those who see IPOs as one-off capital raising events without long term obligations to investors, and others who bribe listing authorities and accounting firms to help create illusions of value while obscuring risks and liabilities.

6. Beijing must reform its capital markets to augment the strength of its manufacturing sector, which in itself cannot compensate for the role real estate fulfilled in the past to drive domestic growth and retail investment. China’s recent stimulus focus indicates Beijing does recognise it must reform its financial systems, especially its capital markets, and China may be on the cusp of a capital markets revolution.

7. The fundamentals are compelling. China has more banking assets and foreign exchange reserves than any other country. Its bond, stock and insurance markets are second only to the US. Despite quality and governance issues in its capital markets, Chinese equities do not reflect the strength of an economy, the factories of which contribute more than 30% to global manufacturing. Chinese equities are arguably the most undervalued in the world, and with Chinese households holding less than 8% of their assets in shares (as opposed to the US average of 48%), retail investors will be a crucial spur in any expansion of capital markets. The Chinese Government values social stability above all else, and as only radical capital market reforms can ensure Chinese households’ share portfolios are not exposed to inordinate risks, it is likely to undertake such reforms, which in turn will attract foreign portfolio investment.

8. It is a misconception that one man makes all economic decisions in China and that the state acts as a monolith, deaf to the masses. There appears to be an intense debate in Beijing on how to best restore confidence and growth, and if an initiative from one part of the government fails, another will launch an alternative. In the West, governments change swiftly while policies are usually slow to change. In China administrations change slowly, yet policies may change swiftly once the government understands an issue.

9. Western politicians and regulators frequently announce policy changes by speaking directly to the public, explaining the reasons and benefits. In China the government tends to reveal initiatives incrementally as it instructs its own numerous, far flung institutions regarding new policies’ functions and how cadres should implement them. Now, more than ever, the leadership needs to talk directly to the people and explain how the multiple new stimulus packages, and those it will launch in the near future, will benefit individuals’ economic lives.

10. Recent stimulus measures applied in individual cities may be harbingers of national policies to come. The Beijing City Government, for example, is offering to reimburse money spent by lower income households and retirees on apartment renovations, particularly to accommodate those with diminished mobility and disability needs. Many in the wider population share the anathema with which the government holds direct cash handouts, seeing them as a weakness of developed economies causing low productivity and competitiveness. Yet the state needs to offer reimbursements for extra health and education costs until they have reformed these sectors and lowered their cost to citizens.

11. If the Chinese Government issued time-constrained, non-transferable vouchers to its citizens to help them pay for essential services, it would boost consumption significantly and release some of the money householders now hoard for future welfare needs. Basic medical care and education are free or at least inexpensive in China, and these have been extended to even the most remote regions and are better than those offered by most developing countries. But the costs of more complex medical treatments increase exponentially and are out of reach of the majority of Chinese people.

12. The Chinese Government has begun reviewing the status of the 170 million domestic migrant workers, and should begin allowing those employed gainfully to transfer their hukou (residency permits) to the towns where they presently work beyond the few recent experiments in selected cities. In becoming residents, these former migrants would benefit from local health and education services, motivating them to buy homes and generally consume more. Domestic migrant workers save more than city residents because they must pay for the social services local residents receive gratis. Such a move would add at least RMB 1 trillion annually to the national GDP.

13. Over 900 million Chinese people earn less than USD 300 per month. With some coastal cities possessing annual per-capital GDP of over USD 35,000, the income disparity is striking, but on the other hand China’s developmental potential is considerable. Perhaps the current administration needs to reflect on the capacity for political and social risk of their predecessors and apply some of their radical thinking to today. There are a few signs the leadership is at least trying to do so: the slogan for the current slew of stimulus measures is ‘bold and steady’, a phrase used by Deng Xiaoping in the early years of economic reform.

14. The air of geopolitical insecurity among ordinary people will take more than a recovering economy to change. Foreign direct investment is 7% of what it was pre-pandemic and foreign business travellers and tourists are few. Throughout the lead-up to the US elections in November, Republicans and Democrats have threatened even more punitive tariffs and strategic containment when referring to China. Chinese people are beginning to understand how politically isolated they have become from a West that once treated their country with respect or at least curiosity, and whose businesses were keen to realise the economic opportunities it offered.

15. Hope that the European Union would not follow the US in trying to block China’s economic growth is also waning. Chinese people think the EU’s choice to place tariffs on Chinese EVs is unjust, revealing to them the harsh reality that Europe is as much, if not more, a trade fortress as a source of global partnerships and prosperity. They point to the fact that European automobile companies have been dominant in China until recently and that three foreign companies — Volkswagen, Tesla and Toyota — remain in the top ten domestic sedan manufacturers. It is reasonable to hope, however, that as the Chinese economy recovers foreign investors will return and more companies will come to take advantage of China’s growing consumer market.

16. Some early signs of economic recovery are encouraging. At RMB 1 trillion, 6% of GDP, the stimulus to date is the largest in China’s economic history and is just the beginning. The government is likely to do more, now that it seems to know it has no choice but to fuel confidence and consumption wherever it can. It understands this is needed to prevent a deeper downturn this year and avert a full-blown economic crisis in the near future.

*David Mahon was also a guest on an episode of our Of Interest podcast. You can listen here.

*David Mahon is the Executive Chairman of Beijing-based Mahon China Investment Management Limited, which was founded in 1985. This Note is here with permission.