Can China’s Policymakers Regain Their Touch?

Sudden shifts in policy toward the stock market and the renminbi exchange rate have sowed doubts rather than confidence in Beijing’s management of the economy.


Watch what they do, not what they say. That adage is time-honored advice for arms negotiators or voters assessing silver-tongued candidates. But it’s insufficient for investors trying to figure out what’s going on in the world’s second-largest economy.

China’s policymakers are facing their biggest challenge since the 2008–’09 global financial crisis, and their handling of it to date is sowing concern rather than confidence. Against a backdrop of slowing growth, mounting domestic debts and vertiginous equity valuations, Chinese stocks began to tumble precipitously in June. Historically, such a development in the world’s last major Communist party state wouldn’t matter. Beijing cared not a whit for the stock market in 2007–’08, when prices collapsed even more sharply, preferring to focus its firepower on the real economy. But times are different today. The authorities effectively promoted the rally that began last year, seeing equities as a means of weaning the economy off debt, promoting a more efficient allocation of capital and fostering the transition to a more consumption- and services-oriented economy.

The world at large has a lot more at stake in China’s markets these days, too. China has been the largest single contributor to global growth over the past decade, and its financial markets, although still in their infancy, are much more integrated with global markets than they were just a few years ago, with the offshore renminbi market growing rapidly and the Shanghai-Hong Kong Connect program bringing more foreign investors into the mainland’s A-share market. So a stock market dive in Shanghai can set the bears running loose in London and New York.

Last month the Chinese authorities intervened directly in a bid to stop the rout, rallying brokerages and state funds to support the market, banning sales by major shareholders for six months and promising to crack down on short sellers. The measures worked for a time, but the selling pressure resumed and intensified this month. Far from calming the market, the heavy-handed intervension gave off a whiff of panic, and appears to have punctured the aura of omnipotence that Chinese policymakers with their $4 trillion of reserves have long enjoyed. The moves also raised questions about China’s commitment to giving market forces freer rein in the economy. As Patrick Chovanec, chief strategist at Silvercrest Asset Management and longtime China-watcher put it in a column in Foreign Policy, “China destroyed its stock market in order to save it.”

Things got even more interesting on August 11 when the People’s Bank of China suddenly altered its formula for setting the daily renminbi fixing. A tightly controlled exchange rate has been a fixture of Chinese policy for two decades. Policymakers resisted the temptation to devalue during the 1997–’98 Asian crisis and again during the global financial crisis, and have instead orchestrated a steady, carefully controlled appreciation for most of the past ten years. With no warning, though, the central bank earlier this month let the renminbi slide against the dollar, then explained it as part of a shift in policy to give greater weight to market prices at the end of the previous trading day rather than the central bank’s own central peg. Then, after the renminbi dropped by 3 percent over three days, the central bank slammed on the brakes to keep the renminbi trading at around 6.4 to the dollar.

The International Monetary Fund has welcomed the exchange-rate move as a shift to a more market-determined rate, one that seems likely to persuade the Fund to include the renminbi in its Special Drawing Right currency basket next year and foster its rise as a reserve currency. But probe beneath the surface with Fund officials and China policy wonks and doubts quickly surface. Most people believe China remains committed to its economic reform agenda in the long term, but in the short run, “we have no idea what’s going on,” as one hedge fund manager with longstanding ties to China put it to me. The Shanghai market plunged by more than 15 percent on Monday and Tuesday when the PBOC failed to inject liquidity in the markets, as many analysts had expected. After the market closed on Tuesday, the central bank announced a 25 basis point cut in interest rates and said it was easing reserve requirements for banks.

François Godement, head of the Asia and China program at the European Council on Foreign Relations, calls the recent confusion over Beijing’s stance “a communications disaster caused by fuzzy government policy, lacking an overall sense of direction.”

Are Chinese policymakers panicking over the equity market collapse and the underlying weakness in the economy? Is there tension between reformers who want to press ahead with financial liberalization, led by Governor Zhou Xiaochuan at the PBOC, and leaders in the State Council who are pressed by big state-owned enterprises to preserve the status quo? Are officials making tactical adjustments in the crisis without losing sight of their long-term goals? All are plausible explanations. One might even be true. But no one really knows, and for now that uncertainty looks set to continue roiling markets.

China’s trade partners will be looking for some clear answers when Group of 20 Finance ministers and central bank governors meet in Ankara, Turkey, next week. China will take over the presidency of the G20 next year, a role that seemed well-timed to mark the country’s emergence as a global financial leader, not just an exporting powerhouse. To play that leadership role, Beijing needs to maintain its commitment to market-oriented reforms and make its actions and goals transparent to investors at home and abroad.

“They’re new at this, both politically and technically,” says Tim Adams, head of the Institute of International Finance in Washington. “A more open financial system requires a more open communications process. That may be the most difficult part of the transition process” toward making the renminbi a reserve currency, he adds.