No Profit Without Pain: Why China’s Reform Attempt Should Hurt Investors

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SINGAPORE – Carnage in China’s financial markets heralds the dawn of a new era, investors say, as the government pushes socialism for shareholders and regulatory changes tear apart the old playbook.

Stocks and sentiment have taken a major knock as Communist Party rulers attempt to reshape the real estate, technology and education sectors to curb cost pressures and better serve ordinary people.

The new model appears to place communal prosperity, as President Xi Jinping has put it, above helter-skelter growth, investors say.


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According to some analysts, it is the most significant philosophical shift since former leader Deng Xiaoping made development the ultimate priority 40 years ago.

“Chinese entrepreneurs and investors need to understand that the era of reckless capital expansion is over,” said Alan Song, founder of investment firm Harvest Capital. “A new era has dawned that puts honesty above efficiency.”

Bankers and investors say it was announced last November when regulators torpedoed the listing of Jack Ma’s fintech Ant Group, clipped Ma’s wings publicly and burned the global funds that had deposited, anticipating part of the world’s largest float.

In the nine months that have passed since then, developers, commodity speculators, crypto miners, other tech giants and, lately, engineering firms have all faced radical rule changes or regulators have been aggressive about their businesses.


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The Hang Seng Tech Index, launched with much fanfare last July and made up of internet fanatics turned giant blue chips like Tencent and Alibaba, has plunged 40% since February to record lows.

“The specter of state intervention to control the private sector has led to a crescendo of panic selling,” analysts at investment bank Jefferies said in a note. “Authorities are trying to reduce social inequality while curbing excessive price increases that undermine the cost of living.”

Zhaopeng Xing, senior China strategist at ANZ, said the set of policies unveiled around the centenary of the Chinese Communist Party underscores the political will to strengthen the party’s roots.


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“This policy was announced to reflect the party’s progressiveness” and to appeal to the masses, Xing said. “They are sending the message that China is not a capitalist country, but embraces socialism.”

Reporting in the months leading up to the party’s centennial celebrations on July 1 was also unequivocal, analysts say. “Community prosperity” is the main long-term goal, Xi said early this year, and China’s development should focus on people’s expectations of a better life, the urban-rural gap and income gap.

The China’s State Council Information Office did not immediately respond to a request for comment.


Investors have reacted so far with alarms that turned into panic on Tuesday. They have dumped health stocks on the expectation that the sector will be next in the line of fire, even as the real estate and education sectors falter.


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Housing, medical care and education costs were the “three big mountains” that are choking Chinese families and crowding out their consumption, said Yuan Yuwei, a fund manager at Olympus Hedge Fund Investments, which had shortchanged developers and education companies.

“This is the most powerful reform I have seen in many years, and the most populist. It benefits the masses at the expense of the richest and the elite groups,” Yuan said.

The relatively declining share price of the mobile company Didi, which was in the crosshairs of regulators for days after its New York listing, has raised questions about China’s full future involvement with foreign capital markets.

Credit risks are also mounting in a country that is still recovering from COVID-19, as authorities seem comfortable with letting state-affiliated or very large companies – previously considered protected species – teeter into default.


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“Over the past 20 years, Chinese authorities have been able to turn a blind eye to some illegal business practices, tax evasion or misdeeds as the economy has experienced solid growth,” said Ming Liao, founder of Beijing-based private equity firm Prospect Avenue Capital.

As the economy slows, “the question becomes how to split the pie. So the need to balance justice against efficiency.”


As the party prepares for a 20th national congress that will decide whether Xi will remain its general secretary for an unprecedented third term, analysts believe he will continue with his pillars of reform, which include a thriving middle class.

The party seems determined to emphasize its socialist roots and contrast them with a perception of social problems in capitalist centers like Hong Kong, they say.


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Investors also say the resilience of exports provides a buffer for policymakers to build a new growth leg of domestic demand and avoid dissatisfaction with inequality.

While household income is outpacing economic growth, both are slowing and according to research published by the Institute of International Finance (IIF), a banking industry association, household income is still below pre-pandemic levels.

The top 10% of families in China account for 47.5% of family wealth, the IIF estimates, while a 2019 survey by recruiting firm 51job Inc found that nearly 40% of parents donate 20-30% of their income to the raising their children – seen as unsustainable .

“The old era has passed and a new era has begun,” said Jack Liu, an accomplished math teacher at Gaotu Techedu Inc, one of the companies rocked by educational reforms.


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“For many tutoring companies, a teacher’s ROI (return on investment) is the North Star measure… Going forward, industry players need to fully understand government policy and unite the interests of individuals, companies and the country,” he said.

Foreign fund managers say they are keeping their spirits up, but are changing course. Citi Private Bank said in a note this week that it was increasing its exposure to China but was looking for domestically listed companies out of the sight of regulators.

Prashant Bhayani, chief investment officer in Asia at BNP Paribas Wealth Management, was also seeking exposure to the broad range of onshore stocks outside the tech and education sectors, as clients expressed questions about the crackdown.

“We’ve seen concerns, not only from North America and Europe, but also from Asia, about what the endgame is in terms of policy,” he said.

“It’s definitely a concern in the sense that these are the areas that have made the most of the pandemic and have been thematically identified as megatrends, so it’s also about positioning.” (Edited by Vidya Ranganathan and Nick Macfie)


In-depth coverage of The Logic’s innovation economy, brought to you in conjunction with the Financial Post.


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