Tech and tuition crackdowns: how to understand China’s growing pains as it fine-tunes its economy

The regulatory changes are meant to balance between short- and long-term growth objectives as Beijing seeks better social outcomes
Given China’s enormous economic growth potential, it should remain an integral part of any investor’s portfolio in the long run, both in equities and fixed income

Chaoping Zhu

Published: 4:30pm, 6 Aug 2021

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The recent sharp correction in Chinese equities, on the back of tighter internet regulations and private education reforms, has left investors worried about China’s economic and market prospects.

This recent market volatility signals inevitable pains in a drastic policy transition necessary to achieve China’s long-term objectives. To sustain economic growth, policymakers need to cultivate competitiveness in strategically important sectors such as the technology and new energy sectors. While these actions should serve as a tailwind for some sectors, they disrupt others.

Given China’s enormous economic growth potential, it should remain an integral part of any investor’s portfolio in the long run, both in equities and fixed income. However, navigating the short-term volatility in this policy transition implies great challenges for investors.

The same challenges are felt by policymakers as well. The recent Politburo meeting chaired by President Xi Jinping provided some clarity on the challenges that officials face in balancing the short-term economic growth trajectory with the longer-run policy objectives.

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Admittedly, the abrupt changes in regulations relating to the technology and education sectors could continue to dampen global investor sentiment towards Chinese assets. Regulatory reforms are still on the cards for some “new economy” industries where the authorities see the need to achieve better social outcomes, such as in youth protection and social benefit coverage for workers, or in improving the competitive environment by allowing smaller players to compete with industry leaders.

Investors should also recognise that the regulatory changes are not all market negatives. For example, ambitions in self-sufficiency in semiconductor manufacturing and software development, or in achieving greenhouse gas reduction targets, mean certain industries stand to benefit from policy tailwinds in the medium to long term.

Meanwhile, the Chinese securities regulator has called for closer communication with its United States counterpart when it comes to the role of international capital markets for Chinese companies.

The regulator has stressed that it is open to companies choosing where to list, as long as it is in compliance with relevant laws and regulations. This is consistent with the authorities’ narrative that the capital market rule changes for education providers will be an isolated incident.

China’s recent Politburo meeting provided greater insight into the economic and regulatory policy direction for the rest of the year.

On the economic outlook, the Chinese government recognises the imbalances in economic recovery. Small and medium-sized enterprises and low-income households have lagged in the rebound. The purchasing managers’ index (PMI), which fell to 50.4 in July from 50.9 in June, and is at its lowest point since February 2020, illustrates the broader slowdown in China’s manufacturing base.

This implies that fiscal policy could do more of the heavy lifting in supporting growth for the rest of this year, especially as government bond issuance is running below this year’s quota and can be stepped up.

Monetary policy has shifted to a neutral stance after some modest tightening in the first half. However, this position could shift if growth momentum eases further.

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On social policy, labour rights improvements and incentives to encourage families to have children could affect the business sector. After all, the reforms to after-school tuition were aimed at reducing parents’ financial burden.

On industrial policy, electric vehicles, greenhouse gas reductions. and the nurturing of self-sufficiency in scientific and technological innovation remain the key focus. This should not be surprising and will remain priorities.

The recent regulatory changes in China should be viewed in the context of finding the balance between short- and long-term growth objectives. Chinese officials have the tools to do both by using fiscal and monetary policies to stabilise the near-term growth outlook, which creates room for measures to address longer-term economic and market reform.

China should remain an essential part of investors’ global equity allocations, and technology continues to play a critical role in the country’s economic development. Beijing is still looking to open its capital markets to international investors in the long run.

Hence, we view the latest episode as a temporary setback, albeit one that underscores the need for investors to understand Beijing’s policy objectives around social equality and to actively manage their positions.

Chaoping Zhu is a Shanghai-based global market strategist at JP Morgan Asset Management