Regulatory storm sweeps across China

Putnam Fixed Income Team, 10/25/21


  • President Xi Jinping is calling for “common prosperity” to help narrow the wealth gap amid regulatory restrictions.
  • The Chinese real estate sector is highly leveraged and too big to be ignored.
  • There is risk of an accelerated slowdown in growth as policymakers weigh options.

China’s ever-widening regulatory crackdowns — targeting internet and technology behemoths as well as the education, health care, and real estate sectors — are causing headwinds in the economy and global financial markets. President Xi Jinping’s “common prosperity” campaign to address the country’s wide and persistent wealth gap has also converged with the crackdowns. Together, they are a reminder that investing in China may come with additional risk.

Chinese policy activism

Several goals motivate these crackdowns, including controlling sensitive data and preserving innovation domestically. The five-year plan calls for faster technological innovation. Self-reliance at a national level is the new buzzword. Most of the regulatory curbs were against companies listed on U.S. exchanges. By imposing new rules and disincentivizing firms active in U.S. markets, China is seeking to change the capital-raising system to bypass the United States. President Xi announced the country’s plan to create a new stock exchange in Beijing. The Communist Party’s governing Politburo has also made anti-monopoly measures a policy priority. And as Xi’s “common prosperity” drive takes hold, many companies said they are putting aside or donating resources to pursue social equality.

Regulators have also targeted some of China’s ride-hailing service platforms, retail companies, and private online education firms. They are trying to rein in what the government sees as excesses. China has raised the reporting requirements for payments done via non-bank institutions and put caps on residential rents and medical pricing. These measures — attempting to tackle rising shelter and health-care costs, improve labor conditions, and reduce tax evasion among the wealthy — are aimed at reducing inequality.

The third leg of these actions — to contain leverage in the property sector — is not new. But tighter regulations, which now come with the goal of “common prosperity” and better income distribution, create headaches for the sector. Demand has weakened, loan growth has slowed, mortgage rates have trended higher, and non-performing loans have risen. The key market risk is not spillovers from stressed real estate companies. The government is trying to avoid systemic risks, especially in the run-up to the Party Congress in 2022. Still, policy mistakes are possible down the road.

Drawing a line in the sand?

For years, the property market has been the major source of local government revenue and economic growth. Significant risk aversion in the property sector is a headwind to China’s growth. Even if property transactions stabilize over the next few months, the secondary impact of the slowdown in the housing market will likely filter through the economy. The government is aware of all these risks, but we don’t know where Beijing will draw the line in the sand.

The fact that we haven’t seen any policy response beyond liquidity measures can indicate two things. One possibility is they do not see the current situation as worrying. The other possibility is that authorities see the slowdown as temporary and expect activity to pick up when they ease restrictions. Policymakers may believe they can control the outcome, but we think there is a chance they could wait too long and, subsequently, overstimulate the economy.

Shrinking the wealth gap

Attempts to address inequality and upgrade technology may indicate potential growth has slowed. China is truly an emerging market economy (compared with many others that are classified as emerging markets but essentially are stagnating or stuck). An emerging economy is one that is transitioning from low income and less developed to one that is high income and technologically advanced. There is an inverse relationship between income, proxied by per capita income, and growth. Chinese growth should be slowing as the per capita income rises. The surprise in China was that growth remained above sustainable levels for so long.

Growth and income disparities in China compared with selected countries

Income vs growth

Sources: World Bank, Putnam Investments calculations, as of September 2021. Past performance is not a guarantee of future results.

China’s growth model might be changing toward prioritizing social welfare over short-term growth. Maintaining social stability has been one of the government’s main objectives. When growth rates are high, it is typically easier to do so. But as growth slows, income inequality widens, and social stability is often threatened. During the pandemic, China did not adopt massive fiscal and monetary stimulus. People at the lower end of the income spectrum were not protected. In other words, the Covid-19 crisis has exacerbated inequality. This might be partly why policy initiatives are now happening at an accelerated pace.

Is the end near?

Ad hoc policy announcements and ambiguous messaging are typical of China. Financial markets have probably added a premium for the lack of policy clarity. If growth slows significantly, policy support will likely increase. That said, we don’t know yet if that will be enough to arrest the downtrend. Considering the seemingly never-ending cases of Covid-19 infections, the lagged impact of policy tightening, and the regulatory crackdowns, we believe the risk of an extended slowdown has increased.

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