China stock feeding frenzy: Don't get bitten
By Zhou Jiangong
SHANGHAI - It seems everything is ready for China's stock markets to embrace a
"golden decade": the country's robust economic growth, the anticipated
appreciation of the yuan, a strong rebound in the Shanghai and Shenzhen bourses
last year after successful reform to dispose of non-tradable state holdings,
and plenty of money still flooding in.
But recent market performance has government officials and some analysts
concerned that a bubble is forming that could burst at any moment. In their
view, investors and speculators alike are so keen to make staggering profits
that the "golden decade" for growth potential could simply come to an end in
just a couple
of years.
The roller-coaster ride the Shanghai stock exchange saw on January 4, the first
trading day this year, has further worried the decision-makers in Beijing.
Within 10 minutes after the index temporarily surpassed the all-time high of
2,800 points, the Shanghai Stock Composite Index fell by 100 points. The day
also experienced the biggest swing between its high and low in nearly five
years, driven by a volume that dwarfed the highest peak volume in the Hong Kong
Stock Exchange's history.
Now the whole country senses that share prices are just defying the law of
gravity. Analysts and investors believe that Chinese authorities had hoped the
bullish sentiments would last long enough for new market surges
to be seen as "celebrations" for the 17th National Conference of the
Communist Party in the autumn and at the Beijing Summer Olympics next year, but
will now be frowning on the irrational market performance and will begin to
take action to cool things down a bit.
The People's Bank of China (PBoC), the country's central bank, announced on the
second trading day of 2007 a rise of the reserve ratio on bank deposits by
another 0.5 percentage point for the fourth time in seven months to curb a
rebound in lending and investment. By lifting the reserve ratio, the central
bank can reduce the commercial banks' lending capacity by 160 billion yuan
(US$20 billion). The action can deter money from entering the stock market and
limit listed banks' lending capacity, which is the major source of profit for
banks.
Analysts have interpreted the move as an effort to cool down the
overheated market.
The central bank has kept an eye on increasing asset prices for a while. At a
conference in Beijing in mid-December, Zhou Xiaochuan, governor of PBoC, told
China Business News, a leading business newspaper based in Shanghai, that
although inflation is low, "the change of prices could substitute each other
among goods, services and assets, so we have to pay attention to the prices of
other aspects. We have to tell if the change is from the monetary effect."
Excess liquidity is still the chief concern of the central bank in 2007,
according to Zhou's remark recently at a conference of the Bank of
International Settlement in Basel, Switzerland. He hinted that the PBoC is
considering "further measures" to deal with it.
Excess liquidity has been blamed for China's economic overheating in recent
years. China's excess liquidity - what economists call too much money in the
market - can be attributed to the country's huge trade surplus and
its thinly floating exchange-rate regime. The central bank's $1 trillion
reserve in fact was bought from China's exporters by issuing base money to
safeguard the present currency regime. Therefore "excess money" is circulating
in China's economy and contributes to the white-hot investment and real-estate
bubbles that have emerged in the past couple of years.
Now it's the stock market that is characterized by excess liquidity. Some
analysts are simply measuring how many points the market indices have gained in
the past year from the currency-appreciation factor. By the end of 2006,
the market value of both Shanghai and Shenzhen stock exchanges totaled 8
trillion yuan. Now the market value is standing at over 10 trillion yuan -
largely due to the A-share initial public offering (IPO) of China Insurance -
of which 1.8 trillion yuan can be counted as the "appreciation premium".
Investment, speculation, and even gambling on the stock market are hugely
popular activities. With its residents having savings of 16 trillion yuan
sitting in their bank accounts, China is seeing money being invested in the
stock markets as never before. Although thrifty Chinese don't consume much,
they love investing and even "gambling".
According to a sample survey conducted by the Shenyin Wanguo Securities
Research Institute, the total capital of individual and institutional investors
investing in China's A-share market exceeded 677.88 billion yuan by the end of
2006, 3.02 times that at the beginning of the year. The money flowing into the
stock market increased in late 2006, with the net inflow hitting 113 billion
yuan in December, 10 billion yuan more than that in November. In December
alone, funds flowing into IPOs amounted to 15.9 billion yuan.
Rumors are also circulating that the authorities will impose limits on
fundraising for stock investment. Money illegally channeled from the banking
system into the stock market has been traced and could be taken back. Stories
are also going around that houses are sold by individual investors to bankroll
stock speculation.
So far, the authorities' preemptive measures do not seem to have had the
desired cooling effect on the market. An "asset revaluation" theory now
prevails in the investment community. It states that because of the growing
trade surplus and the expectation of further yuan appreciation, more base money
will pour into asset markets. As for the financial assets, the decline of the
risk-free interest rates and risk premium, on the grounds of excess liquidity,
lifts the baseline of such valuation tools as the price-earnings ratio.
Therefore, the market and investors can accommodate higher share prices even if
company profits don't keep pace. Proponents of the "non-bubble" or "solid
bubble" school assert that the stock market is now being ushered into a "golden
decade".
Regulators in Beijing are cautiously setting the pace of broadening and
widening the capital market. Usually stock-market and real-estate booms
accompany the appreciation of the host country's currency. But the lesson of
Japan's appreciation-generated boom-bust in the 1980s and 1990s is also well
known in China's financial decision-making circles.
Furthermore, the rocketing indices do not tell the true story of China's stock
markets. The Shanghai Stock Composite Index, widely used by media to measure
market performance, has been criticized by many analysts who say it is
distorted.
The index consists of the weight of total shares including tradable and
non-tradable stocks. Such big blue chips as Industrial and Commercial Bank of
China (ICBC) have a strong leverage effect on the index. In fact, a single ICBC
transaction put hundreds of points on the index in the last week of 2006, while
other high-quality shares gained few points. The market boom becomes a play
based on a couple of big blue chips' performance. In this sense, a few fund
managers can easily manipulate the index by leveraging a small portion of
tradable shares of a few big blue chips. That's why the Shanghai Stock Exchange
has just announced that the performance of IPO shares in the first 10 trading
days will not be factored into the index.
Despite all the bullish sentiments, concerns are growing that the
government will not sit idle as the market bubble, if there is one, continues
to grow. Therefore, fear of government intervention is now likely to make
investors and speculators behave more cautiously.
Zhou Jiangong is a Shanghai-based analyst on China's political, economic
affairs and international relations.
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