China's central bank wants to purge the stock market in pursuit of Schumpeterian ends
Our briefing on China's key economic and financial developments as of 14 January, 2025.
Our briefing on key economic and financial developments in China as of Tuesday, 14 January, 2025:
China’s central bank wants to improve the quality of the stock market, calling for the removal of low-quality A-share companies in its role as the regulatory agency tasked with financial stability.
Xi Jinping hopes that the transformation of China into the world’s largest unified market will reap greater economies of scale, and help to deal with the challenge of industrial overcapacity.
Chinese central bank wants to boost stock market with Schumpeterian purge
The Chinese central bank has called for improving the health of the nation’s share market, by purging it of shady corporations and accelerating the Darwinian/ Schumpterian process of “the strong surviving and the weak declining” (优胜劣汰).
The call arrives as Beijing pushes for capital markets to play a greater role in financing China’s real economy, with an especial focus on tech companies that could reduce dependence on imported US goods.
In order to achieve this, China’s top policymakers want to enhance the image of its stock market in the eyes of both domestic and overseas investors, by applying stricter quality controls to listed corporations.
PBOC calls for delisting of more companies from stock market
In its “China Financial Stability Report (2024)” (中国金融稳定报告（2024）) released on 27 December, the People’s Bank of China (PBOC) - which is the Chinese central bank - called for “expanding the intensity of the withdrawal of listed companies from the market.”
PBOC outlined several measures for achieving this, including diversified withdrawal criteria, stronger legal enforcement, as well as the “vigorous provision” of compensation to those investors in companies that have been forced to delist.
Chinese stock commentator Pi Haizhou (皮海洲) wrote that the statements from PBOC are sign of deep concern amongst China’s top policymakers with the health of the nation’s share market.
“These forceful statements on matters relating to the stock market in the central bank’s report show the central bank’s concerns over the capital market, as well as concern over China’s stock market amongst the government’s top decision-makers.”
The move, however, triggered deep concern amongst Chinese investors.
Threat of arbitrary delistings triggers market jitters
The long-standing goal of Chinese policymakers is to expand the economic allocation role of the stock market, by improving its quality and thus the confidence of investors.
In the short-term, however, measures for the forcible removal of ailing companies from the stock market may have had the opposite effect, triggering concern amongst investors that their equity holdings could be wiped out by arbitrary delistings.
Towards the end of 2024, news that 36 A-share firms would be forced to delist sparked a wave of concern amongst both listed companies and investors.
The China Securities Regulatory Commission (CSRC) was forced to make an emergency statement, declaring that a number of companies had managed to deal with their delisting risk via improvements to their operations, or the adoption of restructuring measures.
Compensation for investors mooted
In order to facilitate the process of expunging defective companies without triggering market panic, Pi Haizhou says a key measure will be ensuring that the investors in such firms obtain adequate compensation.
“Many investors have expressed deep concern upon hearing that the withdrawal of listed companies will intensify, especially when the central bank’s report makes reference to the need to ‘expedite the triumph of the strong and removal of the weak’ from the capital market,” Pi writes.
“Investors will naturally associate this with a greater number of passive withdrawals of companies, when at present investors are forced to foot the bill in most cases.”
For this reason, Pi highlights the importance of the Chinese central bank’s plan to “vigorously implement investor compensation.”
“When it comes to the withdrawal of listed companies, the issue that investors are concerned about most is compensation,” Pi writes.
“If this problem is addressed, investors will naturally not dread the withdrawal of listed companies, and the intensification of listed company withdrawal will not have a negative impact on the market.”
The provision of compensation may serve to ease the frayed nerves of investors, and ensure that China is able to step up the quality of its share market without incident.
An excess of such measures from regulators could also have an effect which is contrary to their desired outcome of enhancing the functionality of China’s capital markets.
It could instead undermine market efficiency, by warping expectations or creating odd forms of moral hazard.
Why Xi Jinping wants to supercharge China’s economy by creating the world’s largest national market
China has signalled it will step up its campaign to create a “grand unified national market” (全国统一大市场) in 2025.
In March last year, Beijing called for “accelerating the establishment of a grand unified national market” at China’s anual Two Sessions’ congressional event.
Since the start of this year, Beijing has reiterated its commitment to this policy, with the State Council releasing it trial guidelines for the undertaking on 7 January.
Xi Jinping hopes to reap the rewards from vast economies of scale, and overcome the “involuted competition” blamed for industrial overcapacity.
Enhanced economies of scale
The explicit goal is to enhance China’s growth by creating massive economies of scale via
Speaking in December 2021, Xi Jinping called for the formation of a“fair, competitive, and fully open grand national market which is unified.”
By overcoming regional barriers to economic transactions, Beijing hopes to “drive the smooth circulation of goods, factors of production and resources on an even greater scale.”
This is particularly the case when it comes to factors of production - the inputs of the economic process that are employed in the creation of goods and services.
While China long ago liberalised the market for most end commercial products as part of its transformational reform process, some observers argue that reform of factor markets has long lagged behind, leading to entrenched inefficiencies.
Involuted competition and industrial overcapacity
Another key goal is to overcome the problem of “involuted competition” between China’s local governments, who continue to vie against each other as economic rivals.
China’s regional leaders have long been assessed on the basis of their economic performance, pitting parts of the country against each other in a competition to raise output.
This is a characteristic feature of China’s post-reform economy that has long been viewed as a key driver of its remarkable growth trajectory since the late 1970s.
Competition incentivises regional governments in China to grow their economies by attracting investment and business, as well as raising productivity and efficiency.
More recently, however, it’s drawn increasing criticism from domestic economists for being the chief cause of overcapacity in certain sectors.
This damaging form of economic rivalry is considered to be a form of “involuted competition” (内卷式竞争) that increasingly does more harm than good.
An example of this is the Chinese auto sector - now considered the envy of the world for the international success of its EVs. China’s initial forays into the auto sector floundered, however.
A key problem was the proliferation of an excessive number of smaller auto companies in China’s many provinces, all enjoying the support and protection of local governments that were competing against each other.
Beijing consider overcapacity to be key macroeconomic priority, given both inadequate aggregate demand at home and worsening trade relations abroad.
"For a long time, China's macroeconomic policy has stressed the removal of overcapacity, avoiding the adoption of short-term stimulus measures, avoiding deficit expansion , and avoiding excess money supply growth," wrote Yu Yongding (余永定), a researcher at the Chinese Academy of Social Sciences (CASS) and head of the China World Economy Association, in an opinion piece from October last year.
The overcapacity created by involuted competition creates major dilemmas for the Chinese economy.
It makes China vulnerable to accusations of unfair trade practices from other leading economies, giving them ammunition for protectionist measures that can harm Chinese exports, such as tariff hikes.
It could also cause problems for the financial system, if enterprises in overcapacity sectors struggle to remain profitable and are unable to pay off their loans, generating a wave of bad debt for commercial banks.
