China's stock market rise is an illusion, propped up by state interventions that distort natural economic dynamics and undermine investor confidence.
Investors
in China’s stock market have recently enjoyed significant gains, with the
Shanghai Composite Index rising by 12% from a multi-year low in February. This
upward trend, however, belies the underlying distortions caused by the Chinese
government's efforts to prop up the market. While state purchases of shares
have provided short-term relief, more destructive measures have been employed,
casting a shadow over the long-term health of the market and the broader
economy.
Central
to China’s strategy is the role of the "national team," a group of
state-owned institutions that buy shares to prevent market declines. This
direct intervention, while boosting share prices temporarily, undermines the
market's natural dynamics. The artificial support provided by these
institutions distorts price signals, leading to a market that is less
reflective of actual economic conditions and more dependent on state actions.
This method, employed during previous market turmoils like the 2015 crash,
raises concerns about the sustainability and transparency of China's stock
markets.
A
more insidious aspect of China's market manipulation is the curtailment of
initial public offerings (IPOs). By restricting IPOs, the government aims to
concentrate liquidity in existing shares, thereby supporting their prices. This
policy, however, has detrimental effects on private investment and innovation.
In 2022, China led the world in IPOs, with companies raising a staggering 587
billion yuan ($81 billion). This vibrant IPO market facilitated capital flow to
innovative startups and provided exit opportunities for venture capital (VC)
and private equity investors. However, the sharp decline in IPO activity in
2024, with only five companies listing on domestic bourses in April compared to
35 in the same month the previous year, signals a significant shift.
The
reduced IPO activity has a cascading effect on the entire capital allocation
chain. Private equity investors, who previously relied on IPOs as exit
strategies, now face limited options. This has led to a dramatic drop in
private equity sales, from $89 billion in 2022 to just $46 billion in 2023.
Consequently, valuations have plummeted, making fundraising more challenging
and discouraging investors from deploying capital. As private capital retreats,
state-backed funds have become increasingly dominant. These funds, initially
intended to merge market efficiency with government policy, now overshadow
private investment. The objectives of state capital often diverge from those of
private investors. While private investors seek returns, state capital may prioritize
employment, regional development, or other political goals. This misalignment
can hinder the growth of innovative firms, as startups become entangled in
bureaucratic requirements and lose the entrepreneurial freedom that drives
innovation.
Robert
Wu, a Chinese investor, highlighted this issue in a recent blog post, noting
that venture capital funds now must rely on local governments for financing.
The heavy involvement of state capital has "completely subverted" the
industry's logic, shifting the focus from serving startups to meeting the
demands of state investors. China's increased focus on state-favored industries
further exacerbates these issues. Restrictions on IPOs have led investors to
concentrate on sectors that align with government priorities, such as flying
taxis, near-space industries, and machine-brain interfaces. This focus narrows
the scope of innovation, as capital flows predominantly to areas deemed
favorable by the state, potentially neglecting other promising sectors.
The
case of Hefei, a city that has emerged as a fast-growing startup ecosystem,
illustrates this trend. Despite significant investment in industries like
biotech and artificial intelligence, Hefei ranks last in successful investor
exits. Between 2017 and 2023, VC firms made 735 investments in Hefei, but only
23 exits were achieved. This pattern is not unique to Hefei; eight of the ten
cities with the lowest exit rates in PitchBook's ranking are Chinese. The
broader implications of these policies are concerning. By stifling the natural
exit mechanisms of the market and favoring state-backed investments, China
risks creating a stagnant economic environment where innovation is hampered,
and entrepreneurial activities are discouraged. As economic growth decelerates
and IPOs become increasingly difficult, the valuations of companies,
particularly in emerging industries, appear vulnerable. This vulnerability
could lead to a significant funding crunch, further exacerbating economic
slowdowns.
Moreover,
the distortion of the stock market undermines investor confidence. Retail
investors, who own a significant portion of the market, may initially benefit
from state interventions. However, the long-term effects of these distortions
could lead to increased market volatility and reduced investment returns,
ultimately harming the very investors these policies aim to protect. China’s
attempts to prop up its stock market through state purchases and restrictive
IPO policies are short-sighted measures that distort the market and stifle
innovation. While these strategies may provide temporary relief, they create an
environment where private capital is sidelined, and state priorities dominate.
This misalignment hampers the growth of innovative firms and undermines the
natural dynamics of the market. For sustainable economic growth and a vibrant,
innovative economy, China must allow its markets to function freely, guided by
price signals and entrepreneurial spirit rather than state intervention. The
path to a robust and resilient economy lies in reducing state interference and
fostering an environment where private enterprise can thrive.
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