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Doubts about China’s leaders sap confidence

THE fear that gripped financial markets this month is a stark one: That China’s economy might be slipping into a decline that could persist for years.

But the world’s second-largest economy isn’t collapsing—certainly not yet, anyway. What’s really in freefall is confidence in its leaders, once seen as wielding near-mythic power to keep their economy growing at a propulsive pace.

Global stock markets have sunk —and gyrated—as investors have wrestled with their doubts. The Dow Jones industrial average has lost nearly 1,000 points since China’s surprise move to devalue its currency on  August 11. That step, in part an effort to align the yuan with market forces, was also seen by investors as a desperate bid to fuel exports in a faltering economy.

“The incredible faith in the Chinese policy-makers has been shaken,” says Ruchir Sharma, head of Morgan Stanley’s emerging markets equity team.

For all its woes, China still outruns every other major economy. For 2015 while the nearly healthy US economy will expand, perhaps, 2.5 percent, even most pessimistic analysts predict that China’s will grow at least 5 percent. Yet, its growth has decelerated for four straight years.

And a series of bungled decisions have escalated doubts about Beijing’s economic stewardship. The skepticism is rising just as China is pursuing one of the most daunting transitions in modern economic history—from overheated growth, driven by exports and often-wasteful investment, toward slower and sturdier growth fueled by spending from an emerging middle class.

The leadership’s miscues have multiplied, starting with its handling of the stock market. To try to cushion the pain from a slower economy, the government deployed state-run media to promote stocks for inexperienced individual investors. The hope was that Chinese companies could issue shares into a rising market and use the proceeds to finance growth and shrink their heavy debt levels. Untethered from economic reality, Chinese stocks took wing. The Shanghai Composite Index rocketed 150 percent in the year through mid-June, propelled in part by individuals who poured money in, often on borrowed funds, confident that their government wouldn’t steer them wrong.

On June 12 the bubble burst: Shanghai stocks have since tumbled 37 percent, though they remain 47 percent above where they were a year ago.

Beijing, abandoning a pledge to let market forces play a bigger role in the economy, tried futilely to stop the freefall. It suspended trading in many companies, restricted the use of borrowed money for some trades and banned big investors from selling their stakes for six months. “The bubble pops, and they intervene and it doesn’t work,” says Derek Scissors, resident scholar at the conservative American Enterprise Institute. Beijing suddenly looked like something less than omnipotent.

Then, on August 11, China devalued the yuan. The government said the move was a nod to reality: Investors were signaling that the currency was overvalued. And the United States and the International Monetary Fund had long urged China to let market forces play a bigger role in the yuan’s exchange rate.

Yet ,the decision surprised investors and aroused suspicions that it was a bid to drive up exports, which tumbled more than 8 percent in July from a year earlier. (A lower-valued yuan gives Chinese goods a competitive edge overseas.) And Beijing has since sent confusing signals, sometimes intervening to keep the yuan from falling too fast.

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