Beijing props up the yuan and vows to promote trade, but the spark may have died

(Originally published Feb. 28 in “What in the World“) Beijing is struggling to prop up China’s currency as its economy falters.

That explains why the People’s Bank of China cut mortgage rates last week but not its short-term prime rate. The central bank is trying to arrest a weakening yuan ahead of the “two sessions” gathering of top Communist party leaders next week. The annual plenary sessions of the National People’s Congress and the Chinese People’s Political Consultative Conference are due to start March 4.

As explained in this space last August, China’s problem is that cutting rates to revive growth makes it more attractive to sell yuan to buy dollars. Dollar bonds and dollar deposits pay higher interest, and so the rising gap only encourages more Chinese companies, households, and foreign investors to pull their money out of China. That can perversely reduce the amount of liquidity available to lend and borrow, which is the opposite effect that lowering interest rates is supposed to have.

Beijing is promising to pull out all the stops to re-start China’s growth engine. Premier Li Qiang vowed Monday following a study session with his cabinet to clear more barriers to growth at home and abroad. That includes getting provincial governments to lift trade barriers that inhibit domestic trade and doing more to protect intellectual property rights.

But it isn’t just interest-rate spreads that have investors heading for the exits. The government’s solutions so far may have unwittingly killed something vital to growth: its animal spirits. While cracking down on rampant property speculation, runaway credit, corruption and inequity, Beijing appears to have sapped the nation’s entrepreneurial spark. That’s another reason why investors, both foreign and domestic, have been using their innovative energy to find ways to get their money out of China.

A crackdown on corruption has created a paralysis in officialdom, a common by-product of imposing greater accountability and the threat of prosecution on a bureaucracy. But added layers of red tape are also creating what one Chinese sociologist decries as a “crisis of social stagnation” as the bureaucratic engine grinds to a halt.

The paralysis has also jumped into the entrepreneurial class. Beijing’s crackdown on high-flying billionaires like Alibaba’s Jack Ma sent a chill through the ranks of corporate innovators. While that crackdown has largely been lifted, the effects linger. More recent rules on data privacy and prevent espionage, have left foreign companies and consulting firms fearful and uncertain about what is and isn’t allowed.

The same goes for domestic startups. Uncertain legal risks, combined with a growing briar-patch of regulation, bureaucracy, and legal risk, are lengthening the odds against their survival. Foreign venture capital trends reflect the chill: according to data quoted by The New York Times, deals to fund Chinese start-ups involving U.S. investors dropped 88% in the last two years.