"Some of the recent policy moves on the stock and foreign- exchange markets are indicative of tension between the leadership’s desire for market-oriented reform and the apparent fundamental objective of control by the government and, ultimately, the Party," said Louis Kuijs, head of Asia economics at Oxford Economics Ltd in Hong Kong. "Indeed, the response of international markets may in part reflect rising worries about this tension."
The dilemma for the nation’s leadership is that they have highlighted the need for a more market-driven allocation of capital, which would stoke productivity gains and drive growth as the working-age population shrinks. Yet the turbulence that markets produce threaten to undermine confidence in the party that’s dominated government since 1949.
Markets Spooked
To be sure, it doesn’t take much to spook investors on China these days, and recent market ructions appear disconnected from signs of stabilization in the underlying economy. Evidence indicates consumers are still spending, house prices are steadying and export demand is recovering.
"The international reaction has probably been bigger than it should have been, given that China’s equity markets are not very related to the real economy nor yet very connected to international markets," said Tim Summers, senior consulting fellow on Asia at Chatham House.
There’s also been some progress on the reform front. Most interest rates are now at least influenced by market forces, and the PBOC scored a big win by qualifying for reserve currency status for the yuan from the International Monetary Fund late last year. All this while Xi’s drive to root out government corruption continues to roll ahead.
Still, given the ever-present debt overhang and muddled market policies, there’s been an erosion in confidence as to whether Xi and his policy makers are in control and have the ability to manage the scale of the tasks at hand.
"At the most basic level, we have no idea whether Xi understands what modern markets require," Arthur Kroeber, the Beijing-based founding partner and managing director at Gavekal Dragonomics, a research firm, wrote in a note. "China is unlikely to collapse. But it is losing its way. And it is this loss of direction, rather than a moment of confusion on foreign exchange markets, that should really worry investors."