A New Economic Era for China Goes Off the Rails

An investor uses his cellphone to check stock prices at a brokerage house in Chengdu, China, after a so-called circuit breaker measure halted trading on Thursday. Credit Color China Photo, via Associated Press

HONG KONG — When President Xi Jinping of China convened a group of top officials to discuss the economy last month, the highly publicized meeting was seen as a moment of triumph.

A stock market plunge last summer, and a messy currency devaluation that followed, had faded from global view. In the relative calm, he seemed to usher in a new era of economic management, promising policy coordination at the highest levels to prevent another bout of turmoil.

Less than three weeks later, his plans have been derailed as China’s stock market and currency once again rattle investors around the world. The latest rout sets up a challenge for Mr. Xi, who has positioned himself as the master of the country’s economy.

At every turn, the president’s efforts to manage the economy, market and currency have been undercut by global headwinds and haphazard policy making. Three initiatives this week, involving currency depreciation and two sets of stock market rules, have been particularly discordant. All three were hastily suspended after China’s stock market plunged on Thursday morning.

He also cannot move forward on the bolder actions needed to head off a more serious economic slump, such as forcing hopelessly indebted state-owned enterprises to stop borrowing money and shut down. Otherwise, he risks further eroding short-term confidence and growth, which have depended heavily on this borrow-and-spend mentality, and mass layoffs could follow.

Mr. Xi’s options are also more limited than in the past. He and his aides engineered the elevation of the renminbi to the ranks of the world’s leading currencies, a status bestowed by the International Monetary Fund in November. But in doing so, he gave up some control, allowing market forces to play a bigger role.

In the last couple of years, China had begun allowing, even encouraging, companies and people to invest more of their wealth overseas. Doing so helped reduce deflationary pressures at home from chronic overinvestment and overcapacity, and increased China’s influence around the world.

But a trickle of money leaving China to buy houses and other overseas investments has become a flood this winter. The central bank has responded by trying for the last three weeks to slowly guide the currency down as a way to help bolster exports and also make overseas investments seem more expensive and less appealing.

The result has been chaotic. With the renminbi worth less by the day in the international markets, Chinese families and companies worry that their renminbi wealth will buy less tomorrow, spurring faster capital flight and worsening the currency turmoil.

This week, regulators also put in place a so-called circuit breaker for the stock market, a mechanism that halts trading when shares fall too steeply. The new measure, which followed last summer’s market slide, was aimed at stabilizing stocks. But in practice, it has amplified anxiety.

Another measure, which banned large shareholders from selling stock, was supposed to expire on Friday. The looming deadline prompted smaller investors to dump shares.

“These very high-level bodies were supposed to coordinate policy, and in this case there really was a failure of coordination,” said Victor Shih, a specialist in Chinese financial policy at the University of California, San Diego.

The resulting stress has driven share prices in China down 12 percent so far this week. The fall would have been even steeper if the new rules had not shut down the market repeatedly.

In a stark about-face, the Chinese stock market regulator said Thursday night it would suspend the new measure, “in order to preserve market stability.” It is also extending the selling ban for another three months.

With circuit breakers repealed on Thursday night and large shareholders told that they would have to wait another three months before they would be allowed to resume selling shares, the Shanghai Composite Index rebounded 1.5 percent on Friday morning.

The combination — a troubled stock market and currency — has proved worrisome for global investors. The Standard & Poor’s 500-stock index, the main benchmark in the United States, was off 2 percent on Thursday, and European and Asian shares were down broadly.

Few analysts had expected such a quick retreat. “Removing the circuit breakers now means they have to admit they made a mistake,” Hao Hong, the chief strategist at Bank of Communications International, the overseas arm of a big Chinese bank, said earlier in the day.

For years, the response to economic weakness has been the same in China: spend, spend, spend.

When the global financial crisis hit in 2008, the Chinese authorities developed a $585 billion stimulus package. The money, funneled into infrastructure, high-speed rail lines and intercity highways, helped protect China against the problems plaguing the United States and much of the world.

In some way, China is reverting to its old tactics.

Over the last few months, the government has cut interest rates and introduced numerous measures to help stimulate growth. The central bank’s response to the latest stock market fall has been to inject more money into the financial system, so that banks can keep lending.

In the face of Monday’s tumult, Prime Minister Li Keqiang visited one of the country’s largest and most troubled state-owned steel companies, Taiyuan Iron and Steel Group. There, Mr. Li reassured workers, urging them to “revive your strength and power.”

The strategy, though, risks deeper problems down the road.

By not shutting down struggling companies, China is putting off a much-needed shakeout. The country is also piling on debt to keep such businesses on life support.

That makes it difficult to discern the underlying health of the economy, and runs counter to Mr. Xi’s tough promise that China will clean up its corporate mess.

Investors gather near darkened stock-price display boards after trading was halted at a brokerage in Beijing. Credit Ng Han Guan/Associated Press

Mr. Xi also cannot easily ask the central bank to print huge sums of money to bail out the stock market and struggling companies. Doing so now would risk flooding the economy with cash, causing a further decline in China’s currency against the dollar.

Some economists see ominous signs of a broader slowing.

A quarterly survey of 2,000 Chinese manufacturers and other industrial companies shows that almost none are currently investing in new equipment and factories. “In the past four quarters, it’s only 2 to 3 percent that are making expansionary investments,” said Gan Jie, the director of the Center on Finance and Economic Growth at the Cheung Kong Graduate School of Business in Beijing, who oversees the quarterly survey.

Controlling the currency is already a problem. China has found itself in the difficult position of setting the value of the renminbi lower and lower each day, culminating in a fall of 0.51 percent Thursday morning alone. But the central bank tried to halt the renminbi’s slide on Friday morning by fixing it 0.015 percent higher than the day before in mainland trading.

China faces a similar steady drip of stock declines.

China’s stock markets have tended to be less correlated with the local economy than most countries’ markets. That is because trading tends to be a speculative activity in China, mainly undertaken by retail investors who frequently have a herd instinct.
The problem was on full display this week, as the new circuit breaker mechanism kicked in. The rule imposed a cooling-off period, halting trading for 15 minutes when losses reached 5 percent. After trading resumed, the steep slide continued, prompting the markets to close early twice this week when they reached a second circuit breaker of 7 percent.

To some analysts, it was unnecessary. China already has a rule that each stock cannot drop more than 10 percent in a day.

Even China tacitly admitted it had made a mistake. When the country’s regulator abandoned the policy on Thursday night, it noted in a statement that it had imposed the policy despite having “no experience” in using a circuit breaker.