China's Private Investment Crash May Be Mirage, but Pain Is Still Real

China’s drop in private investment may look worse than it is because of the distorting effects of last year’s stock market bailout.

It may seem like good news that China’s private investment spending isn’t completely falling off a cliff. The bad news is, it’s because “private” companies aren’t private anymore—and maybe never were.

To the great worry of China economy watchers, private fixed-asset investment in things such as buildings and factories looked like it took a steep fall this year. Since the private sector contributes two-thirds of all investment, this is a major concern. So much so that China’s State Council ordered an investigation into the situation. In June, Premier Li Keqiang spoke out against local officials blocking private investment projects.

But there’s another explanation for why the data showed the private-sector crunch. It has to do with the after effects of last year’s government stock-market bailout, which still reverberate. Beijing’s one trillion yuan ($150 billion) stock-buying exercise caused many companies previously classified as “private” to now be classified as state owned, because state investment funds now own significant parts of those companies, suggests analysis by Nicholas Lardy and Zixuan Huang of the Peterson Institute.

Spending that would have last year been classified as private is now considered state spending, by virtue of the classification change. Worryingly, that could indicate a backtracking on years in which more and more economic activity was supposedly generated from the private sector, which tends to be more efficient and offer higher returns on equity.

It is also possible these companies weren’t all that private in the first place, says Andrew Coflan of the Rhodium Group. It could be that so-called mixed-ownership companies were previously classified as private, even if the state held, say, a 49% stake. The bailout caused them to go above 50%. This might have been done to show, falsely, that the economy was making progress in leaning away from state support.

One takeaway for investors is that China’s government has been spending less than it seems this year. The fall in private investment, according to the numbers, had been counteracted somewhat with fresh government spending. Since government spending tends to be infrastructure focused, the rally in iron ore, steel, coal and other commodities this year might have been driven by what turned out to be a false wind.

The reinterpretation of the numbers doesn’t mean China’s private sector is all of a sudden in fine shape. Investment spending overall, government and private, is at its lowest point in years, and took another leg down in July. Like like the data itself, China’s economy remains something of a murky mess.

Write to Alex Frangos at alex.frangos@wsj.com

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