July 13, 2015 / 9:20 PM / 2 years ago

Stock market rout another blow to fading 'Chinese Dream'

Workers make metal parts at a factory of the Changzhou Wujin Zhengda Vehicle Industry Co. Ltd in Changzhou, Jiangsu province, China, July 9, 2015.John Ruwitch

CHANGZHOU/WENZHOU, China (Reuters) - About a week after Shanghai's main stock index broke above 4,000 points in April, the leading newspaper of China's ruling Communist Party weighed in with patriotic glee.

Not only was the bull run just beginning, said a widely-read, and later ridiculed, editorial from the People's Daily.

In the longer term, it continued, the "Chinese Dream" of rising prosperity and security championed by President Xi Jinping would be reflected in capital markets, creating "huge" investment opportunities.

The stock market turmoil in the last month has shattered that particular dream for many small-time players, though the risk of contagion from a relatively narrow class of retail investors who dominate Chinese equities appears small for now.

Beijing had earlier stepped in to address the property boom and mounting bad debts, two potential danger zones in the economy, helping to bring down house prices and shift local government debt to longer term maturities to avert a crisis.

Now it must find ways to change economic gear from massive stimulus to consumer-led growth, and the slump in stocks has not helped.

Zhou Sujuan, a 44-year-old manager at a private medical device company in Wenzhou, a coastal city 450 km (280 miles) south of Shanghai known for its entrepreneurial spirit, lost 2 million yuan ($322,186) in the selloff.

"This has caused me a lot of heartache. It will take some time to recover," she said.

The scope of Xi's vision of the future goes well beyond a few million people investing in shares, and is key to maintaining stability among the population of 1.3 billion.

A volley of government policies and edicts has turned the stock market around, at least for now. Despite recent sharp falls, values are roughly double what they were a year ago.

Delivering on the broader promise is likely to prove harder, as a series of interviews with Chinese people from a range of backgrounds underlines.

Recent data show the scale of the challenge.

Sluggish property, weak consumer spending, factory gate prices falling for over three years and local governments laden with $3 trillion in debt mean the economy is expected to grow at its slowest pace in a quarter of a century this year.

China's success or otherwise in reviving growth is one of the biggest factors hanging over the global economy, with implications for companies across continents and industries, from automakers and luxury goods makers to miners and farmers.

"PROFOUND AND PERMANENT" DAMAGE?

The measures the government enacted to halt the stock market's slide have raised questions about the Communist Party's commitment to reforms needed to achieve a more open and dynamic economy, driven by domestic demand.

"The massive state intervention, especially preventing major shareholders from selling shares and going after short sellers, has damaged financial sector reform in profound and permanent ways," said Victor Shih, associate professor at the University of California San Diego, who studies China's finance policy.

By halting initial public offerings, for example, Beijing has closed off one funding option for non-state-owned businesses that are expected to eventually lead the economy.

One such company belongs to Ren Zhengming, a 54-year-old who has run his manufacturing business in Changzhou, an hour northwest of Shanghai by bullet train, for more than 20 years.

Changzhou Wujin Zhengda Vehicle Industry Co Ltd makes machined metal parts for measuring instruments, and serves major sectors of the economy from cars to homebuilding.

Like many in Chinese manufacturing, Ren has seen costs rise steadily, exports soften and domestic demand growth stall. He has about 100 employees, from up to 200 a few years ago, and profit margins are down from around 25 percent five years ago.

"If we can guarantee 10 percent now that would be pretty good," he said. "These last few months, it's been just enough to pay for our workforce."

Ren's experience is typical of thousands of small manufacturers, who have become less competitive as a stronger yuan currency hit exports and rising labor and other input costs eroded profit margins.

Growth in private sector investment has been slowing in recent years.

Xi and Premier Li Keqiang have set out to tackle the effects of years of growth-at-all-costs development in the decade or so before they took office, reforming the foreign exchange regime, liberalizing other prices and trying to rein in soaring debt.

But that brings with it short-term pain, both for Chinese firms like Ren's and multinationals that have invested heavily in China as a growth market.

"With this set of leaders in office it's fairly hard to be optimistic about our business," Ren told Reuters.

FOREIGN COMPANIES FEEL PINCH

Optimism about the Chinese economy has slipped significantly among U.S. businesses operating here, according to a March survey by the American Chamber of Commerce in Shanghai.

Some European firms are preparing for lay-offs amid weaker economic growth and slow reforms, the European Union Chamber of Commerce in China said in June.

Prices of commodities from copper to crude oil, key elements in construction and other industries, are down, in part because Chinese appetite for raw materials has weakened.

Economies like Australia and Brazil are feeling the effects.

Ren says he's too old to do anything radical to reshape his business. The future of the company will depend on his son-in-law, who is gradually taking charge.

"All we can do is build a platform for younger people."

Many of China's brightest young people, however, are struggling to find work.

The number of college graduates in China reached a record high of 7.49 million this year, an increase of 220,000 from 2014. Hu Xiao is one of them.

A 21-year-old from the southern province of Yunnan, Hu majored in accounting at Dongbei University of Finance and Economics in the northeastern port city of Dalian.

This year's job hunting season, from April to June, was "one of the toughest in history", Xinhua said, and Hu joined the growing mass of educated youth who don't have work, despite applying for more than 150 positions.

"I think I should be able to find a job, it's just that it may not be a very good job," she said.

While work for graduates is hard to find, unemployment, a key benchmark of social stability, remains low at around 4 percent, although some officials doubt the reliability of that figure. The labor ministry has warned that authorities cannot be "blindly optimistic" as the pace of job creation slows.

Wage and income growth have also been flagging.

SERVICES BOOST?

Xiao Peng, a tech entrepreneur in Shanghai who goes by the name XP, concedes exports and the type of investment that powered the economy in the 2000s are slowing, but he sees cause for optimism.

XP's latest venture, Xish International, runs an app that promotes weekend activities, riding rapid changes in consumer behavior in China.

"You know what Chinese did on weekends during the last decade; they played mahjong, watched TV and maybe went to eat at a restaurant, and that's it," he said. "This younger generation, they want to spend money more on experiences."

XP's one-man startup has grown into a 120-employee company in under two years.

"This government wants people to consume to drive the economy," XP said. "I'm pretty optimistic."

His rosier outlook is based partly on forecasts that in the next 15 years, 400 million Chinese will move into cities.

But there is also evidence that Chinese consumers are cautious, in part because of debt.

Zhang Yingyi, a 30-year-old administrative assistant and mother of a three-year-old daughter, works full time at an international exchange program in Shanghai.

She and her husband earn reasonable salaries that put them in China's emerging middle class. They live in a 2.5 million yuan ($400,000) apartment and recently bought a Mercedes-Benz B180 to shorten his commute.

But the couple's spending power is hobbled by debt for the flat and car, and Shanghai's high living costs eat away at their monthly income. Zhang says her husband does not drink or smoke and they hardly buy any clothes.

"I don't feel like I spend that much but there's never money left," she said.

Like many Chinese whose investment opportunities have been limited, what equity they do have is tied up in their apartment.

PROPERTY, DEBT WEIGH ON CHINA

China's real estate market has been softening for around two years, as Beijing enacted restrictive measures to take the steam out of what many thought was becoming a dangerous bubble.

Sales have slowed, new construction has dropped off sharply and banks have become increasingly cautious about lending to developers and home-buyers. Housing prices fell in June for the second month in a row, two surveys showed earlier this month.

That slowdown impacts not just developers, but other industries from home appliance firms to steel makers. Some economists estimate housing and housing-related sectors account for about 30 percent of gross domestic product.

There are signs activity is starting to pick up, and ironically, stock market volatility could support property by encouraging people to avoid equities and invest in real estate.

Beside housing, Chinese debt is also choking off growth.

Worries about a potential crisis sparked by local government debt have largely subsided as a result of a swap deal this year that enabled localities to convert short-term loans into longer-term bonds, but the arrears are still constraining investment.

Much local debt dates back to a massive stimulus package that pulled China out of a growth slowdown in 2009, and makes it harder for Beijing to spark activity in this way again.

NOT ALL DOOM AND GLOOM

Few predict Armageddon for the Chinese economy, even after the stock market rout.

While annual growth is relatively sedate, the $10 trillion economy is several times its size when it last grew slower, in 1990, and producing far more by virtue of scale.

In the first quarter China ran a current account surplus of $75.6 billion, while the government is sitting on a war chest of well over $3 trillion in foreign exchange reserves.

So far the government remains sanguine about prospects for re-shaping the economy, and sources close to the leadership told Reuters that top leaders do not see the stock market's troubles as a crisis.

But its handling of the market turmoil has been openly criticized by some Chinese in a rare expression of dissatisfaction at the Communist Party's economic stewardship.

Zhou from Wenzhou, who lost her bet on shares, had hoped to buy a house in a different district to get her daughter into a better school. That dream will have to wait.

Zhou concedes she was greedy, but also blames state-run entities for heavy-handed tactics in the market.

"The government is unreasonable," she said. "It is forever a planned market, a planned economy."

Additional reporting by Alexandra Harney, Sue-Lin Wong and the Shanghai Newsroom, and Jason Subler, Jake Spring and Sui-Lee Wee in Beijing; Editing by Mike Collett-White

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