China stock market crash will hit Xis

economic reform programme

Hindustan Times
|

Updated: Jul 10, 2015 03:09 IST

Illustration: India and China

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New Delhi should take greater interest in the enormous stock market crash in China than events
in tiny Greece. The original crash wiped out $3.2 trillion from Chinas main stock markets
notionally an amount worth over a dozen times Greeces entire GDP. Beijing has virtually shut
down the stock markets since then and through a number of government interventions, including
forcing state-owned firms to buy stocks, will begin to force up the market. But it has probably
only postponed a further correction or transferred the damage from the book of stock investors to
those of government entities.

The real impact of Chinas stock market crash will be less on the fortunes of domestic and
foreign investors but on the future of Xi Jinpings economic reform programme. This, in turn,
will be the key determinant of the trajectory of Chinas future economic growth. The stock
market crash has taken place just as Chinas leadership is meeting in Beidaihe to decide on what
steps to take to revive the countrys flagging economy.
The Chinese Communist Partys Third Plenum had promised to allow market forces to govern
economic decisions. This was more than ideology: The original State-driven investment model is

slowly running out of steam and Beijing accepted that this had to change. Both the passive
response to the stock market bubble and the means that Beijing has tried to arrest its bursting
were textbook examples of non-market based policy responses. Beijing seems to have let the
bubble grow because it saw an opportunity to inflate the wealth of State-owned firms and reduce
their debts. It then intervened in a manner that has now generated a new layer of debt, largely in
the manner of money borrowed to buy inflated stocks.
The sense that this has all been about saving the commercial interests of the communist party
rather than managing the economy is difficult to escape. Clearly, independent regulation was
wholly lacking when the bubble began to expand and market forces were the last thing on Mr
Xis mind when Beijing moved in to arrest the collapse. There had been expectation of a raft of
new reforms in the latter part of this year, especially in finance. It is possible Mr Xi will plough
forward anyway, possibly freeing interest rates and allowing Chinese savings to be invested
overseas, but the credibility of his reform pronouncements has taken a severe beating. In his first
domestic economic crisis, the Chinese leader failed to live up to his own words. He will have to
double down on his reforms to make up for this debacle.