The Operational Mechanism Of China’s ‘Equity Finance’ Has Become Apparent – Analysis

By Chen Naijia

With major global economies entering a rate-cutting cycle and external pressure on the Chinese currency renminbi (RMB) stability easing, the People's Bank of China (PBoC) has gained more room for monetary policy. On September 24, the State Council Information Office (SCIO) held a press conference featuring PBoC Governor Pan Gongsheng, National Financial Regulatory Administration (NFRA) head Li Yunzhe, and China Securities Regulatory Commission (CSRC) chairman Wu Qing, who discussed financial support for high-quality economic development.

During this conference, several key policy measures were announced, including a reduction in the reserve requirement ratio and policy interest rates, which will lead to lower market benchmark rates. Additionally, existing mortgage rates will decrease, and the minimum down payment ratio for housing loans will be unified. New monetary policy tools were also introduced to support the stable development of the stock market. Specifically, a swap facility for securities, funds, and insurance companies will enable qualified entities to obtain liquidity from the central bank through asset pledges, while special re-lending for stock repurchases and increases will guide banks to lend to listed companies and their major shareholders for buybacks and stock increases.

After the press conference, both Chinese and international capital markets reacted strongly to the news, with the Shanghai Composite Index rising by 4.16% in a single day and the Nasdaq Golden Dragon China Index climbing nearly 4% that evening. Many believe these reform policies are effective in reversing market expectations, but they still fall short of addressing the long-term structural issues in the economy, indicating a need for more sustained fiscal policies. However, researchers at ANBOUND observed that among this series of new regulations, a mechanism guiding local governments to improve "equity finance" through listed companies has quietly begun to take shape, a point that has received little attention so far.

The so-called "equity finance" refers to the increasing attempts by local governments in recent years to promote industrial development and regional economic growth through capital operations and equity investments, driven by the advancement of state-owned enterprise (SOEs) reforms and the continued maturation of capital markets. The returns from these equity investments, including gains from capital markets and corporate dividends, also form a new incremental revenue stream in the form of non-tax income, thereby creating potential space for local fiscal construction. ANBOUND has repeatedly mentioned policies like "fiscal entry of markets" and "equity finance", suggesting that the integration of local economies with financial capital is an inevitable direction as China's economy moves beyond the phase of land-based finance. Against this backdrop, local state-owned asset supervision and administration commissions should expedite their transition from "asset management" to "capital management". Additionally, "equity finance" presents a relatively stable and reliable source of revenue for local governments, especially as the "land finance" model begins to collapse.

While "equity finance" has been a long-term trend for local governments, its operational mechanisms remain underdeveloped. Local authorities have primarily focused on early stages like "equity investment attraction" and mid-stage activities such as "equity investment" and "equity operation", yet they still rely on central authorities to enhance the overall capital market mechanisms for the effective realization of value. The central government has hesitated in this area, only committing to deeper reforms after the collapse of the "land finance" model this year. In January 2024, the State-owned Assets Supervision and Administration Commission (SASAC) announced it would implement assessments of listed companies' market value management. In April, the State Council issued guidelines emphasizing the importance of dividend arrangements for listed companies and encouraging them to increase and multiply dividends. These measures may seem like efforts to stabilize the capital market, but they also reflect deeper considerations about the fiscal system.

On September 24, a new policy tool was introduced to support stock buybacks and increases through special re-lending, enabling banks to provide loans to listed companies and their major shareholders. This tool enhances capital operations and market value management for SOEs. Local governments can now establish investment groups to facilitate mergers and equity swaps with state-held companies, manage their market value through buybacks and dividends, and borrow from banks for these operations. As market values rise, they can pledge equity to secure funding for reinvestment, boosting profits. Increased profits lead to higher dividends, generating non-tax revenue for local budgets and addressing debt issues. For instance, a local government with RMB 1 trillion in debt can leverage these operations to grow market value, ensuring dividends exceed loan interest rates to repay debts, provided the company is well-managed and dividends are reasonably distributed.

In this approach, the key requirement for local governments (or SASAC) is their capability in enterprise operations and market value management. During the press conference held by the SCIO, specific methods were outlined, including the CSRC's "Guidelines for the Management of Listed Companies' Market Value". Additionally, further measures were clarified to promote corporate mergers and restructurings, which can be seen as guiding the capital operations and market value management of SOEs. It is essential for local governments to understand macroeconomic trends and the reform intentions of higher authorities, working together to achieve structural reform in the Chinese economy.

ANBOUND's founder Kung Chan noted that the current decline in China's economy is a culmination of long-standing structural issues, resulting in a form of entrapment shrinkage. Traditional economic fixes and stimulus measures are ineffective in this regard, as addressing structural deficiencies will take time. The most practical approach now is to seek alternatives to the outdated models that have reached their limits, so as to stabilize the economy while fostering progress. The shift from "land finance" to "equity finance" exemplifies this transition. In modern society, capital markets have become central to economic operation and distribution. By effectively managing these markets and implementing capital operations like buybacks and dividends, rather than exploitative financing, the government can ensure that both corporate capital and ordinary investors receive equal resource benefits. This strategy can alleviate debt burdens, increase nominal income, and even reactivate consumption potential. Traditionally, China's asset structure has been centered on land and real estate. Now, it will increasingly shift towards capital and equity. This transformation offers significant flexibility for China's economy, government revenues, and private capital returns.

Final analysis conclusion:

As the land-real estate economic development model in China reaches its limits, local fiscal shrinkage along with heavy government debt burdens are becoming increasingly unsustainable. In this context, it is crucial for the country to restructure the economy by transitioning from "land finance" to "equity finance" to create space for economic maneuvering. This year, the Chinese central bank and the CSRC have implemented a series of reforms that effectively address the institutional gaps in "equity finance", providing clear operational pathways for local state-owned asset supervision and administration commissions.

• Chen Naijia is a Research Fellow at ANBOUND, an independent think tank.