◎ Foreign investors are awakening to the risk of investing in Chinese stocks and political risks in China in general.
Updated on Aug. 2, 2021.
The Chinese Communist Party again shook financial markets with another technology sector-related move, banning off-campus private and online tuition companies from going public, raising capital, or making profits.
On July 23, the General Office of the CCP and the General Office of the PRC State Council issued a set of guidelines on “reducing the burden of excessive homework and off-campus tutoring” (關於進一步減輕義務教育階段學生作業負擔和校外培訓負擔的意見; henceforth referred to as the “double reduction” guidelines). The guidelines detail measures to curb school homework, improve education quality and school after-class services, and impose a stringent approval and supervision system for off-campus tutoring.
Key points in the guidelines include:
- Local governments shall cease approving the establishment of new off-campus curriculum subject-tutoring institutions for students in compulsory primary and secondary education (nine years). Existing tutoring institutions shall be registered as non-profits.
- Curriculum subject-tutoring institutions are forbidden from going public for financing, and listed companies should not invest in those institutions. Foreign capital is also banned from investing in such institutions (there is now a real risk of tutoring companies who have gone public in China or abroad needing to delist).
- Off-campus tutoring shall provide no overseas education courses and their courses shall not be taught on national festivals and holidays.
- Local governments should reduce students’ homework burden and family education expenditure within one year.
Over 75 percent of China’s K-12 students attended off-campus tutoring in 2016, according to data from the Chinese Society of Education. The private tutoring industry in China has grown to around $120 billion, and was estimated to grow to nearly $155 billion in 2025. The online education sector was also expected to generate $76 billion in revenue by 2024.
The tremendous growth rate of China’s private tutoring and online education industries have attracted plenty of venture capital over the past decade. According to mainland media, online education companies brought in 111 rounds of financing in 2020 and raised more than 53.93 billion yuan, or more than the total financing raised over the previous four years. Of the 53.93 billion yuan, 38.01 billion yuan (about 71 percent) went to companies that catered to K-12 tutoring and homework assistance. Chinese companies that have invested in the online education sector include Alibaba, Tencent, and Bytedance, while foreign investors include Tiger Global, Hillhouse Capital, Temasek Holdings, Softbank Group, and Sequoia Capital.
Dave Wang, a portfolio manager at Nuvest Capital, told Reuters in a July 26 report that “the Chinese government has always been more particular on sectors that have widespread social implications” like private tutoring. Reuters also obtained information about Beijing’s private tutoring crackdown around mid-May.
Chinese online education stocks on the mainland A-shares plummeted on July 23 after the release of the “double reduction” guidelines. OnlyEducation fell 4.85 percent, Beijing Lanxum Technology fell by 4.87 percent, Xueda Education fell by 7.11 percent, and Dongguan Kingsun fell by 5.02 percent.
Chinese online education stocks in the U.S. also nosedived on July 23. New Oriental Education & Technology Group fell 54 percent, Gaotu Techedu Inc. fell over 63 percent, and TAL Education Group fell more than 70 percent. In comparing stock value from their record highs set in January or February this year, New Oriental plummeted by more than 85 percent, TAL by over 90 percent, and Gaotu by more than 97 percent.
The PRC authorities quickly stepped in to calm the markets. Late in the evening of July 28, state mouthpiece Xinhua published a commentary piece titled, “Hot Insights on China’s Stock Market” (中國股市熱點觀察) which claimed that the fundamentals of “China’s continually improving economy” have not changed, the pace of “reform and opening up” in China is steady, and the development of China’s capital market “remains solid.” The commentary added that the industry regulatory policies are meant to be conducive for China’s long-term development, and legislation aimed at combating illegal securities activities are intended to protect the market. The commentary concluded, “Whether it is responding to the needs of the Chinese economy or continuing to crack market deficiencies, [government action] is inseparable from the powerful advancement of the deepening of reforms in the capital market.”
On July 29, China Securities Regulatory Commission vice chairman Fang Xinghai spoke with representatives of global banks and investment firms to assuage their concerns about the PRC’s crackdown on companies engaging in private tutoring, online financial services, and other sectors. Fang added that the PRC has no intention to decouple from the U.S. and global markets. Representatives from Goldman Sachs, JPMorgan, BlackRock, Fidelity, and UBS Group attended the closed-door meeting in Beijing, as did CSRC chairman Yi Huiman.
While the markets rebounded for two days after assurances from Fang Xinghai and PRC state media, the rally ran out by July 30. Shares of Alibaba, Kuaishou, Meituan, and Tencent started falling again, and those four companies have lost about $344 billion of market capitalization (20 percent of their combined worth) since the end of June, according to FactSet data. The Hang Seng Tech Index fell 2.6 percent on July 30 and ended July down 17 percent. Also, the Nasdaq Golden Dragon China Index had fallen 22 percent by the morning of July 30.
Beijing’s crackdown on private tutoring and its impact on the markets appeared to awaken foreign investors to the risk of investing in Chinese stocks and political risks in China in general.
On July 23, CNBC’s Jim Cramer advised investors to stop buying Chinese stocks. “They are killing us. They know that we own these stocks, and they’re showing no mercy … It’s very malice. It’s Stalinist … I think these are very serious violations that make us realize capitalism is not alive in China. We kidded ourselves that we thought the [Communist] Party was somehow going to want to join the rest of the world in being capitalist. They’re not. This is a dictatorship,” Cramer said. He added, “I question every one of those companies. Any one of them could be vulnerable … I mean, the Party may decide tomorrow that Alibaba is charging people too much … I think we’re discovering that they’re communists, but they were communist all along.”
According to a July 29 Bloomberg News report, Goldman Sachs clients have been asking if Chinese stocks have become “uninvestable” in light of PRC regulatory action against the tech sector. A July 30 Wall Street Journal report noted that investors lost hundreds of billions in July as Beijing reined in tech companies, while those “ranging from pension fund Orange County Employees Retirement System in California to money manager William Blair & Co. are rethinking their portfolios.”
Meanwhile, Washington has been alarmed enough to take action. On July 28, U.S. lawmakers sent a letter to Securities and Exchange Commission chairman Gary Gensler calling for an investigation into U.S.-listed Chinese companies, citing the recent Didi incident. On July 30, Gensler issued a statement that essentially forbids Chinese companies from listing in the U.S. unless they fully explain their legal structures and disclose whether or not Beijing approved their listing on U.S. markets. Gensler also asked SEC staff to “engage in targeted additional reviews of filings for companies with significant China-based operations.”
1. Some commentators have likened Beijing’s crackdown on private tutoring and the online education sector to shooting oneself in the foot. After all, the PRC gave up billions of dollars in taking out an entire industry, and is making foreigners hesitant about investing in China. However, there are several strategic and practical reasons for why the CCP and Xi Jinping did what they did.
First, Xi and the CCP need to more fully control the implementation of brainwashing-style education as the PRC struggles for survival and dominance amid growing domestic and foreign problems. Sino-U.S. competition is of particular concern because the CCP has always viewed its rivalry with America in ideological terms, even as it criticizes Washington for having a “Cold War mentality.” The Party also does not fully trust the private sector to properly instill children with the “red gene” (through the teaching of Xi’s revised Party history, for example) and ensure that children are not exposed to “dangerous” Western ideas and values (hence the provision against overseas education courses for private tutoring companies).
Given the importance of K-12 education in shaping future generations and the waging of what the CCP believes to be a protracted struggle against the U.S. and the West, Xi and the Party would consider it the lesser of two evils to sacrifice an entire sector and take in fewer investments now should it mean securing the regime’s long-term survival and building a solid base from which to advance its domination agenda.
Second, Xi and the CCP are overcompensating for and deflecting blame from problems stemming from the “one-child” policy. Beijing is likely painfully aware that failure to reverse the draconian, anti-natalist policy earlier has resulted in a deteriorating economy and other financial woes. Economic and financial pressures, including sky-high property prices and rising inflation, in turn make it difficult for parents to have more children even if they wanted to, and Beijing’s inability to turn around China’s replacement rate will leave it with a demographic and economic time bomb. Further, parents are stressed out in attempting to secure a good future for the children they already have with the scarcity of good schools in China, inequitable distribution of education resources, and the flawed hukou registration system. The “double reduction” guidelines are thus both a practical and ideological solution to the CCP’s aforementioned economic and demographic problem; cutting back on homework and curbing private tutoring makes schooling more equitable (socialism aims for equal outcomes) and less strenuous on the pocket for parents.
The “double reduction” guidelines, however, are clearly a Procrustean approach to delivering equity and resolving the regime’s concerns. Beijing could have taken less disruptive approaches like improving the quality of public school education. However, more holistic approaches are often simply unworkable given the political culture of the CCP (“prefer left rather than right,” endless struggle, etc.) and the PRC governance system, leaving available only the brutal, crude, and inefficient options. Further, Xi and the CCP needed a scapegoat to blame its self-inflicted demographic crisis on after census data collected last year indicated a shrinking population. The overly capitalistic, overseas course-teaching online education sector became the perfect target.
Signs of a coming crackdown first emerged this January when the Central Commission for Discipline Inspection published an article criticizing the online education sector for creating a “capital whirlpool.” During the Two Sessions in March, the online education sector was singled out for charging “high fees” and creating unhelpful conditions for the regime’s pro-natalist push. Subsequently, measures were taken to “rectify” so-called “non-compliant” education companies and “supervise” off-campus education, with the “double reduction” guidelines in July being the latest in the CCP’s series of moves against the sector.
Third, Xi Jinping has long sought to drive investments towards China’s real economy and away from the fictitious economy to generate reliable growth. For instance, Beijing would likely have no qualms with foreign capital entering parts of the technology sector that tangibly contribute to the PRC’s development, such as semiconductors, artificial intelligence, and Big Data. What Beijing does not want is for capital to flow to questionable “technologies” that do little to advance PRC development, such as ride hailing apps, certain types of risky tech-linked payment and financial services, and online education. As CSRC vice chairman Fang Xinghai indicated, the PRC is not looking to decouple from global markets; capital, however, must work in interests of regime security, not at its expense.
Fourth, Xi does not want his factional rivals to enrich themselves at the expense of himself and the regime through their investment or control over tech companies. We previously demonstrated how the Jiang Zemin faction and other Party interest groups opposed to Xi are linked with Chinese tech giants like Alibaba, Ant Group, and Didi, as well as how the business model of some of these companies will, if left to their own devices, saddle the regime with significant financial risks (see here and here).
Online education companies might not be directly linked with factional interests, but Jiang faction-linked big tech companies like Alibaba invest in them and stand to profit from their listing. With Xi looking to secure a norm-breaking third term at the 20th Party Congress in 2022, he has no choice but to curb the influence of Chinese tech giants and consolidate CCP control over them while weakening his factional rivals by ensuring that less money flows into their pockets.
Finally, Xi is likely looking to re-align Wall Street’s relationship with CCP elite interests through the tech sector crackdown. The Jiang faction’s long era of dominance (1997 to 2012) coincided with China’s entry to the World Trade Organization. During that period, Western elites would have established firm ties with Jiang faction elites, and those ties would have lingered into the Xi era. To ensure that the CCP’s elite capture, which Renmin University professor Di Dongsheng bragged about last November, works for rather than against the Xi leadership, Xi would not mind hurting the wallets of those on Wall Street with his tech sector crackdown if doing so would encourage them to switch allegiances.
2. The political rules of the game changed in China after Xi Jinping became Party General Secretary in 2012. Since then, the political environment has only deteriorated, with “you die, I live” factional struggle intensifying as financial and political interests, political legacies, and personal survival are placed on the line the more Xi consolidates power.
Meanwhile, the PRC is revealing itself with each passing day to be the brutal, untrustworthy communist dictatorship that it is, and not a “normal” country. Foreign investors should be very skeptical of the CCP authorities’ “assurances” over the online education sector crackdown. After all, Mao Zedong sold out the Kuomintang to win the Chinese civil war; Deng Xiaoping’s promises to the United Kingdom over Hong Kong have become null and void under Xi Jinping with the imposition of the national security regime in the territory; and Xi’s pledge to President Obama to stop cyberattacks in 2015 has proven empty as recently illustrated by PRC hackers hitting Microsoft servers in March.
Since our founding in 2017, SinoInsider has been consistently reminding our clients and readers about the malign ideology of the CCP regime and the political risks that come with working and investing in the PRC. Those political risks and the communist nature of the regime have now become clear for all to see in light of Beijing’s tech sector crackdown. Political and Black Swans risks in China will rise sharply as factional struggle in the CCP elite escalates in the lead up to the 20th Party Congress.
The window of opportunity for businesses, investors, and governments to acknowledge the dangers of political risks in China and make appropriate contingencies is shrinking fast. Fail to act, and Lenin’s observation that “the capitalists will sell us the rope with which to hang them” will prove prophetic in due course.