1 China’s plunging stock markets signal worsening financial risks
Jan. 18
Bloomberg News reported that the state-owned CITIC Securities had stopped lending stocks to individual investors and raised the requirements for institutional clients in the week of Jan. 15, 2024 after receiving window guidance from regulators, citing people familiar with the matter.
Jan. 19
1. The Chinese Securities Regulatory Commission held a regular press conference where the relevant person in charge of its nine departments addressed various market concerns.
According to mainland media reports, those at the press conference discussed progress in various institutional developments, the implementation of “practical measures,” and “current market concerns” through the framework of promoting the registration-based IPO system.
2. China Securities announced on its website that it will ban clients from using margin loans to buy and return stocks they sold short from Jan. 22. The move closes a popular channel for short sales.
GF Securities previously issued a similar notice to the one by China Securities on Jan. 9. The GF Securities notice banned clients from margin financing for the purpose of repaying securities used in covering margin trading liabilities, with effect from Jan. 15, 2024.
Jan. 22
1. China’s stock markets fell across the board, with a number of individual stocks and indexes hitting record or interim lows. A total of 5,253 stocks fell in both the Shanghai and Shenzhen exchanges, with just 153 stocks seeing gains. The total trading volume on both the Shanghai and Shenzhen exchanges amounted to 794.1 billion yuan, of which net outflows exceeded 55.4 billion yuan.
- The Shanghai Composite Index fell as much as 3.42 percent to 2,735 points during inter-day trading. The index closed at 2,756 points, or down 2.68 percent, the largest single-day decline since the end of April 2022.
- The Shenzhen Component Index fell as much as 4.06 percent to 8,430 points during inter-day trading. The index closed down 3.50 percent to 8,479 points.
- The ChiNext Index fell 2.83 percent to 1,666 points.
- The CSI 300 Index fell to a five-year low, shrinking by 1.6 percent.
According to mainland media reports, some Chinese financial analysts said that the PRC the “national team’s” (i.e. an ad-hoc task force of large state-affiliated financial institutions and funds that intervene to prop up the stock market) efforts to rescue the markets on Jan. 22 were stronger than those on Jan. 18, but they were not able to do much. The financial analysts added that the markets immediately fell after the “national team’s” buying intensity weakened at the end of the trading session.
Hu Xijin, the former editor-in-chief of the CCP mouthpiece Global Times, wrote about his disappointment in the performance of his stocks in a post on Chinese social media. Hu reviewed that he had lost more than 10,000 yuan (10,444 yuan) in a single day for the first time and his total losses to date were over 70,000 yuan (71,024 yuan).
2. The Hang Seng Index fell by more than 510 points to 14,794 points during inter-day trading before closing down 2.4 percent to 14,961 points. This was the first time that the Hong Kong stock market had closed below 15,000 points since the end of October 2022.
The main index turnover for the day was approximately 112.2 billion yuan. The Hang Seng TECH index fell below 3,000 points during inter-day trading to 2,994 points before closing down 3 percent at 3,035 points, a 15-month low.
The Hang Seng Index is down 12 percent for the year, making it the worst-performing major index in Asia.
3. Reuters reported that major PRC state-owned banks tightened liquidity in the offshore foreign exchange market while actively selling U.S. dollars onshore as stocks fell to support the yuan, citing four sources with knowledge of the matter.
One of the sources said that the goal was preventing the yuan from falling too fast as A-shares plummeted.
4. Bloomberg reported that the PRC authorities were considering the mobilization of about 2 trillion yuan, mainly from offshore accounts of state-owned enterprises, as part of a stabilization fund to buy shares onshore through the Hong Kong exchange link, citing people familiar with the matter. The authorities have also set aside at least 300 billion yuan of local funds to invest in onshore shares though Central Huijin Investment Ltd. and China Securities Finance Corp., according to the people.
The people added that PRC officials are also considering other options and may announce some of them if approved by the top leadership, noting that the plans can still be changed.
Bloomberg reported that more than $6 trillion has been wiped out from the market value of Chinese and Hong Kong stocks since a peak in 2021.
Jan. 24
1. Wang Jianjun, vice chairman of the CSRC, responded to China’s stock market troubles and capital market supervision issues in an interview with mainland media. Wang made the following points:
- The PRC authorities need to build investor-oriented capital markets.
- Investors purchase stocks with the expectation of returns. For sustained viability, the long-term returns from the stock market should surpass those of savings accounts and bonds.
- The PRC authorities will improve the evaluation mechanism for sponsoring institutions to ensure that companies without long-term returns do not join the markets.
- The PRC authorities will make further efforts to strengthen the system for preventing and combating fraud in the capital markets, including maintaining a high-pressure “zero-tolerance” stance.
- Serious illegal activities that severely harm the interests of investors, such as fraudulent issuances, will be resolutely punished (culprits will “lose their money and rot in jail” [傾家蕩產、牢底坐穿]). Intermediaries that are involved in fraudulent activities will also be held accountable and be made to feel consequences that would deter them from future misconduct.
2. People’s Bank of China governor Pan Gongsheng announced at a press conference that the central bank would make a 50-basis-point cut to the reserve requirement ratio, effective from Feb. 5, to inject 1 trillion yuan worth of liquidity into the market. Pan also said that PBoC would cut re-lending and re-discount interest rates by 25 basis points (1.75 percent from 2 percent) for the rural sector and small firms from Jan. 25.
The Hang Seng Index rallied after Pan’s announcement:
- The main index went up from 2 percent to about 4 percent during inter-day trading before closing at up 3.56 percent.
- The Hang Seng TECH index rose nearly 5 percent during inter-day trading.
- Alibaba and NetEase rose by more than 7 percent during inter-day trading, while Baidu and Kingsoft were up by over 5 percent. Baidu closed up 3.86 percent and NetEase at up 3.56 percent.
Background
1. The PRC authorities announced an annual GDP growth of 5.2 percent for 2023 on Jan. 18, but the figure and the true performance of the Chinese economy was met with skepticism by many observers.
Beijing’s unconvincing data dump appeared to impact the markets. The Shanghai, Shenzhen, and ChiNext indexes fell sharply after the opening on Jan. 18, with the Shanghai index declining by more than 2.5 percent at the lowest during inter-day trading to hit 2760.98 points. The markets saw a V-shaped rebound on Jan. 18 (the Shanghai index closed up 0.43 percent), likely due to intervention from the “national team.” Data from Wind showed capital inflows of 90.5 billion yuan on Jan. 18, the highest in four months and an increase of over 60 percent as compared to the previous day.
At the time this newsletter was published, the Shanghai Composite Index had fallen by more than 5 percent for the year since the start of 2024, the worst for the period in the past four years. Meanwhile, about 27.2 billion yuan has left the mainland markets through the Shanghai-Hong Kong Stock Connect, compared with an inflow of 112.5 billion yuan during the same period in 2023.
2. PRC financial regulators have employed various measures in recent months to prop up the stock markets, including preventing major shareholders from reducing their holdings and limiting short selling by investors and financial institutions.
- Sept. 26, 2023: The CSRC announced that the controllers of listed companies that have sold shares that have fallen below the IPO value (破發) and sold shares that were trading below their net asset value (破淨), as well as controllers of listed companies that have not issued cash dividends in the past three years or whose cumulative cash dividend amount is less than 30 percent of their average annual net profit over the same period, are not allowed to reduce their holdings of shares in their own companies in the secondary market.
- Oct. 14, 2023: The CSRC announced an increase in the margin requirement for securities lending from a minimum of 50 percent to 80 percent. The CSRC also raised the margin requirement for private securities investment funds participating in the lending of securities to 100 percent. The new regulations also prohibit investors who hold shares that were transferred in a block sale from lending those securities during the “lock-up period.”
- Nov. 17, 2023: The CSRC again revised a draft measure for the supervision and administration of derivative trading (衍生品交易監督管理辦法) to explicitly prohibit major shareholders from utilizing derivative channels to engage in securities lending.
- The PRC Ministry of State Security issued multiple articles in November and December 2023 warning that there were “some people with ulterior motives” who were talking negatively about the Chinese economy, shaking the international community’s confidence in investing in China, and attempting to trigger financial turmoil in China. The MSS also issued a statement noting that it would harshly crack down on illegal and criminal activities that “endanger national security in the field of economic security.”
Our take
1. China’s plummeting stock markets reflect a lack of optimism and confidence in China’s growth prospects by investors in general and hints at a worsening of financial risks.
We believe that there are several factors behind the current market slump.
First, investors appear to be unimpressed by and distrustful of the latest official economic data released by the PRC authorities. As we analyzed at the time, “Unreliable official data will also affect public confidence in the economy and the government. For instance, people may believe that the central government is not likely to implement strong stimulus and will therefore become pessimistic about China’s growth prospects … Foreign investors could increasingly come to believe that the PRC government has no credibility and is untrustworthy, and would become more inclined to invest less or pull funds out of China.”
Second, investors appeared to be disappointed by the People’s Bank of China keeping the medium-term lending facility rate (announced Jan. 15) and loan prime rate (announced Jan. 22) unchanged. The central bank preserving the loan rates and the announcement of 5.2 percent GDP growth in 2023 appeared to signal that the CCP authorities believe that the Chinese economy is still healthy and does not need more monetary easing or stimulus, dashing investors’ expectations and likely contributing to the sell-off in stocks.
Third, investors could be troubled by Beijing’s promotion of the registration-based IPO system at this time. More companies going public at this time would result in the diversion of funds from some stocks to others and the lowering of share prices. Investors are also likely not confident in the supervisory capabilities of the PRC regulators, and could be concerned that the registration system could produce more financial irregularities among newly listed companies and weaken market integrity.
Wu Xiaoqiu, the vice president of Renmin University, noted in his keynote speech at the 2024 Macro Situation Forum in Beijing that the regulatory authorities should consider postponing IPOs given the current state of the capital markets. Wu noted that the successful implementation of registration-based IPO system requires at least three prerequisites, namely, legal obligations for issuers to disclose information, strict law enforcement, and the impartiality of intermediary institutions. Wu added that the current IPO registration system has not “perfected” the aforementioned prerequisites and the restoration of investor confidence should be the top priority at the moment.
Fourth, investors appear to be increasingly concerned about Xi and the CCP’s tightening of political control over the economy and financial sector. Political control includes the anti-corruption campaign and its focus on the financial sector, as well as Xi’s promotion of ideology-heavy policy guidance such as the “road of financial development with Chinese characteristics.”
An example of Beijing’s recent strengthening of control over the financial sector is Xi’s speech at the opening session of a study session at the Central Party School for leading cadres at the provincial and ministerial levels. In his speech, Xi urged officials to “adhere to the central government’s centralized and unified leadership over financial work,” pursue a “road of financial development with Chinese characteristics” that is fundamentally different from “Western financial models,” and ensure that financial supervision has “teeth and thorns.”
Xi’s indication that he would step up efforts to rectify and rein in the financial sector, as well as take the Chinese economy in a direction unlike the West, would naturally spook investors. In an editorial published on Jan. 23, The Wall Street Journal criticized Xi Jinping for thinking he can “command the Chinese stock market” and urged Xi to “ease up on the Party’s political control of the economy” to rescue the economy.
2. Beijing’s “positive energy” financial propaganda, liquidity injection, “national team” work, and other measures to rescue the markets could stabilize things for short periods, but are unlikely to arrest the downward trajectory of China’s economic and financial situation or restore investor confidence.
Plummeting stock prices and indexes will either compel or incentivize financial institutions and investors to take actions that would worsen the situation. For instance, financial institutions, investors, and brokerages could take advantage of falling prices and indexes to engage in short selling, arbitrage, the sale of over-the-counter derivatives, and other financial products or strategies to make short-term profits and hedge against risks. Sharply falling stock prices could also force the liquidation of pledged stocks, which would in turn increase the downward pressure on prices and indexes.
The PBoC’s announcement of liquidity injection led to a slight market rebound, but sustained recovery would be difficult. Increased liquidity only expands the upper limit of bank lending (a less crucial problem at this time because banks are already struggling to find qualified borrowers) but does not reduce the cost of borrowing unlike interest rate cuts.
Bearish sentiments are also unlikely to improve as investors fundamentally reassess their China plans in light of growing political and geopolitical risks. The fundamental change in how investors view China would partly explain why efforts by the “national team” to rescue the markets and the PRC authorities’ measures to boost confidence about investing in China have failed to take off.
Finally, it cannot be ruled out that Xi Jinping’s factional rivals, including those with substantial financial interests and a degree of control such as the “white gloves” of Party elites and some princelings, could be taking advantage of economic deterioration in China to engage in short selling and other activities with an eye on exacerbating economic decline and indirectly weakening Xi’s “quan wei” (authority and prestige). This view, however, is currently speculative and will require further analysis and verification.
What’s next
The Xi leadership will likely step up anti-corruption efforts in the financial sector and other measures to arrest stock market decline as it looks to prevent “small risks from becoming big risks, regional risks from becoming general risks, and economic and social risks from becoming political risks.”
Beijing’s attempt to rectify the situation, however, could prompt “anti-Xi” forces to intensify their attacks on Xi.
2 Liu Jianchao to serve as China’s next foreign minister?
The Wall Street Journal reported on Jan. 24 that CCP International Liaison Department head Liu Jianchao is “on track to be named China’s next foreign minister” at the upcoming “Two Sessions” in March, citing people familiar with the matter.
The people said that senior PRC foreign affairs officials had recommended Liu to Xi Jinping “for his Party experience and demonstrated political loyalty.” Xi had “decided to give Liu a trial run first” by having him handle a U.S. congressional delegation’s visit to Beijing in the fall of 2023 and by sending him to the U.S. for various diplomatic activities in early January 2024.
The people said “that no final decision on the timing of [Liu’s] appointment has been made.”
A U.S. official told the Journal, “The Chinese were basically telling us that he’s going to be the next foreign minister. They were saying, ‘He’s going on to bigger things.’”
Daniel Russel, a former career State Department official now with the Asia Society Policy Institute, told the Journal, “The indications are that Xi Jinping wants to stabilize relations before the U.S. election season and for domestic reasons.”
Meeting foreign ambassadors
According to the International Liaison Department’s official website, Liu Jianchao met with the Japanese ambassador to the PRC and the Indian ambassador to the PRC on Jan. 24.
Our take
1. The Wall Street Journal’s report that Liu Jianchao is likely to be named the next PRC foreign minister and Liu’s recent meetings with foreign ambassadors indicate that there is an increased likelihood of the appointment becoming official. In particular, Liu engaging in diplomatic activities with foreign ambassadors and his high-profile trip to the U.S. in early January exceed the International Liaison Department’s purview, but can be rationalized within the regime if Liu is tipped for a future posting where his partaking in those activities is relevant. We previously analyzed that it cannot be ruled out that Liu will become the next PRC foreign minister given his diplomatic background and experience.
2. We earlier noted that Xi has to bypass several personnel appointment norms if he wants Liu Jianchao as foreign minister, with Liu’s lack of ranking (he is currently three levels below the expected rank of a foreign minister) and Party qualifications (not a full or alternate Central Committee member) being the most glaring. If Xi is indeed keen on making Liu foreign minister despite his currently “ineligibility” for the job, then he could go about it in two ways.
First, Xi could hold a Third Plenum before the “Two Sessions” and add Liu to the Central Committee. Liu could also receive an “exceptional promotion” up the official ranks over the next two months. While Xi has the authority as paramount leader to elevate Liu in this manner, he could still meet with pushback from the Party elite for “breaking” personnel appointment norms.
Second, Xi could appoint Liu as foreign minister first and gradually grant him the expected ranking and Party qualifications given the changed dynamic between the CCP and state governing apparatuses. In analyzing the amended State Council work rules in March 2023, we noted that “the State Council has been reduced to being an administrative office (習辦) of Party Central and the Xi leadership.” In this arrangement, the importance of the foreign ministry, which is a part of the State Council, would be correspondingly reduced vis-à-vis the Central Foreign Affairs Commission (akin to the power relations between the Central Military Commission and the PRC defense ministry). And if so, then Xi can rationalize to the Party elites who are concerned about personnel appointment norms that Liu does not need to immediately have the usual ranking and qualifications to become foreign minister given the reduced importance of the position in the “Xi new era.”
