By Wayne Arnold
Reliance on credit means policymakers face tough choices in
addressing imbalances in Asia's largest economy.
Welcome back to the giant Jenga game that is China's
economy.
Whenever Beijing slides out another block of dangerous credit
from its towering pile of overinvestment and excessive lending,
China's yield-starved investors figure out a new way to perch
another on top of the teetering structure. With every turn of play,
China's economic edifice grows ever more precarious.
In the latest move, stocks in Shanghai fell 7.7% Monday, their
biggest drop in six years, after the country's securities regulator
announced that - while opening more than half a million margin
trading accounts last month to feed a craze for stocks - brokers
had played fast and loose with the rules. Their punishment: no new
retail accounts for three months.
Perhaps more significantly, China's banking regulator the same
day cracked down on so-called entrusted loans, in which companies
pay banks a fee to lend their money to each other to avoid
restrictions on intra-company lending. The new rules appear to stop
asset management companies using entrusted loans to funnel investor
funds into wealth management products or the stock market.
Predictably, the big brokerages under suspension -- Citic
Securities (6030.HK ), Haitong Securities (6837.HK ) and Guotai
Junan Securities (1788.HK) -- faced the biggest hit Monday, as my
colleague Isabella Zhong discusses in her latest piece. But
blue-chip banks were also trounced, with Industrial &
Commercial Bank of China (601398.SH), Agricultural Bank of China
(601288.SH) and Bank of China (601988.SH)all down by roughly the
daily limit of 10%.
Breathtaking as it may be, the drop is no big deal: it comes
after the index soared 64% in just six months to its highest level
in over five years. Monday's fall only takes it back to where it
was at Christmas.
But the stumble illustrates the dangers Beijing faces as it
tries to reform and restructure its economy. China's government is
trying to pull the world's second-largest economy into a more
sustainable path. Allowing it to slow to a safer speed, though,
raises the risk that heavily indebted borrowers go bust and trigger
a wave of defaults and a credit crisis that hobbles growth and
raises unemployment.
Contending against Beijing are natural impulses: China's aging
savers are desperate to build up nest eggs for retirement and yearn
for better returns that they can get in China's heavily regulated
interest-rate environment. They're risk junkies. China's heavily
indebted companies and local governments, meanwhile, don't want to
go bust. They'll try anything to stay afloat. And Beijing doesn't
want to see them to go under. Every time it looks like they might,
it throws them another block to keep them afloat and the Jenga game
going.
The stock market rally has therefore never been about the
economy. Its health is fading: Economic data due today is expected
to show that China's GDP growth rate fell last year to 7.3%, its
slowest pace since 1990.
On the contrary, the rally is as a reaction to the slump in
property prices after government measures to prevent
over-speculation that finally succeeded in exposing vast
over-supply. Average home prices dropped 4.3% on year in December,
deepening the 3.6% drop in November and the 2.5% decline they
posted in October.
As property succumbs, investors have turned to a market they
long ago dismissed as a casino where only the connected can win.
Regulations lowering the threshold for opening brokerage accounts,
combined with improved governance, helped lure them back in.
But Shanghai's rally has also been driven by a massive increase
in credit. Margin trading - buying stocks with borrowed money --
rose to 1.08 trillion yuan ($176 billion) Jan. 13, according to
Bloomberg, up from 400 billion yuan at the end of June. Entrusted
loans are even larger. Morgan Stanley estimates they rose to 2.5
trillion yuan last year, representing 15% of all new credit and
double the level in 2012.
At that pace, you have to wonder what took regulators so long to
step in. In fact, they did. A little over a month ago, regular
readers will recall, this column discussed a move to raise the bar
on using bonds as collateral for bond repurchase agreements. The
crackdown was designed to eliminate an avenue local governments
were taking to rack up more debt. But by tightening up on the bond
market, regulators also eliminated a key source of collateral for
margin lending on stocks. Shanghai's stock market dropped 5.4% in
response.
The question now is whether stocks bounce back again. With the
economy slowing and corporate profit growth ebbing, Shanghai stocks
are now wildly overvalued, trading at a 27% premium to their Hong
Kong-listed counterparts, according to Gavekal Dragonomics. Without
new funds to support the margin craze, the rally could be
kaput.
But others, like Gavekal's Joyce Poon, say savers will likely
keep piling in, particularly as China responds to the slowing
growth and pain its regulatory crackdowns cause with its usual
schizophrenic response - cutting rates to pour fuel on the fire. If
it does, the tottering Jenga tower over Shanghai - and China's
economy -- may rise ever higher.
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Comments? E-mail us at wayne.arnold@barrons.com
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