Market plunge makes Beijing’s exit harder
The Chinese leaders have a dream. The banks pump trillions of yuan into the market, which props up asset prices, creates new demand, and gets the economic engine roaring again. Then, just before inflation starts to surge, the money is drained out of the system.
Others, from U.S. Federal Reserve Chairman Ben Bernanke to Bank of England Governor Mervyn King, share the dream but the Chinese economy, still largely driven by the state, should make it easier to realise. Unfortunately, investors in Shanghai’s stock market have their own ideas — the mere suggestion of credit tightening caused the index to plunge 20 percent in just two weeks to Wednesday’s close before bouncing slightly.
The Chinese policymakers are left between a rock and hard place. At some stage, they must stop pumping money into the system, and prepare to mop it up instead, but timing this to avoid another stock market slump looks close to impossible.
Investors can remember what happened the last time. The central bank’s resumption of sales of one-year bills in July looks similar to the tightening action which began in May 2003. That prompted a six-month fall in stock prices.
That time, Beijing was slow to show it meant business. A couple of reserve rate hikes were largely symbolic, and it was not until late 2004 that interest rates were raised, 18 months after the first move. The market had lost half its value about a year later.
Beijing might not be very effective at controlling wild swings in the market, but it is effective at jump-starting the economy. While Japan had to pump free liquidity into the system for seven years before economic growth returned, it’s taken just half a year for China’s astonishing GDP growth to resume.
This increased economic activity has done little to improve corporate earnings. Take banks as an example, they are the biggest beneficiaries of the loans surge, as new lending tripled the amount on the first six months of last year. But net interest income at China’s largest bank ICBC fell 12 percent during the first half, because lending was less profitable — the interest spread was almost a third less than last year.
The authorities’ hope that rising property prices and investment would increase domestic demand, and hence corporate sales and earnings, has not been realised so far. Urban dwellers feel less well off than at any point since 1999, according to a survey by the central bank conducted in late May.
Chinese policymakers hoped the stimulus would buy China some time before demand from developed markets recovered, but the process of unwinding the West’s huge consumer debt total built up in the past two decades will be slow. Net exports, which contributed about 10 percent to China’s economy, have kept falling, and only recovered slightly in July.
Perhaps the latest market sell-off might prompt the Chinese authorities to maintain loose money policy a little longer, to encourage the buyers back in to share and property markets.
Unfortunately, even if the ploy works, it just sets them up for more difficult times next year.
— At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund —