Chinese people like to invest their money more than any other people in the world. The latest consumer spending survey by ACNielsen says people in China with discretionary income are more willing to play the stock market more than in any other country.
This desire to invest has created a very liquid market that has generated a disproportionate amount of attention, which overlooks the fact that China’s stock markets have virtually no influence abroad.
Not even the Hong Kong bourse is significantly affected by the meteoric rises and temperamental drops of the Chinese stock market – which has increased in value by half this year alone and doubled in the last 12 months.
The A-share market is now worth just over US$2 trillion, less than half of the US$4.65 trillion Chinese people have in bank deposits and about equal to the country’s real GDP of just over US$2 trillion, according to research by investment bank JPMorgan. On top of that, a swelling balance of payment surplus adds even more cash to the market.
China’s bourses are simply not big or mature enough to handle that much money. The result is a bubble that continues to create unbalanced valuations.
Beijing’s continuing efforts to curb liquidity are doing little to stem the flow of funds.
Repeated hikes in banks’ reserve ratios, five so far this year, do very little. Each half a percentage point hike takes an amount of liquidity out of the market equal to the monthly surplus in the current account, noted JPMorgan.
At the end of May, authorities took stronger action, tripling the duty on stock transactions, which saw the Shanghai Composite Index (SCI) drop to around 3,700 points. But, fearing the market could melt down as quickly as it had heated up, officials stepped in with reassurances of strong prospects. They were also quick to quosh a resurgence in rumors of a capital gains tax.
The SCI was back around 4,100 by the middle of June.
With inflation topping 3% for three months in a row another interest rate hike is widely expected. This would suck some funds out of the market but not that much – rates have already gone up twice this year.
Outbound flows
In another effort to drain liquidity, China drastically expanded a program that allows domestic investors to channel their money abroad. The goal was to create an escape valve for extra cash but the Qualified Domestic Institutional Investor (QDII) scheme has failed to generate much interest.
If not a disaster, QDII has certainly been a disappointment. Beijing has allotted more than US$15 billion in quotas to various banks and investment houses but individual investors have been reluctant to step in because they could only invest in overseas fixed income products – often with returns too low to make up for the appreciation of the renminbi.
Changes in the program that took effect in May gave investors the go ahead to use up to half of their allotments in equity and equity-linked products but in a critique, JPMorgan economist Frank Gong noted that entry barriers remain too high. The minimum subscription by a single client is about US$39,000 (RMB300,000) – too rich for most individual investors.
Regardless of the lack of success it has had with QDII and the limited impact of other measures, Beijing knows that bubbles can only be inflated so much before they burst. The question is how much?
The uncertainty will probably continue, according to Deutsche Bank. An engineered correction is not likely before the October Communist Party Congress, but allowing the bubble to grow unchecked could create an untenable situation.
Worse, the bank believes even more streams of cash are flowing into the market. Stock market fund raising and corporate bonds could add another US$65 billion this year, about 30% of the total growth in loans.
In May, Beijing said it would increase the Qualified Foreign Institutional Investor (QFII) to US$30 billion, up from about US$10 billion.
Small footprint
The good news is that if, or when, the A-share bubble bursts, the impact will be limited, both within and without China.
Chinese investors may have opened more than 100 million investment accounts to date but 40 million of those are inactive and the remaining 60 million have to be divided between Shenzhen and Shanghai with many investors having separate accounts for each of the two.
“We probably have, at most, 30 million people trading,” said Glenn Maguire, chief Asia Pacific economist at Société Générale. Even if there is a major correction, he argued, “the real economy in China should be relatively immune.”
Markets outside of China would also not be affected by a major downturn. Mainland bourses account for about 6% of global market capitalization, not even close to the 30% NASDAQ represented at its peak.
The correction in late May in response to the stamp duty increase and rumors of a capital gains tax (Maguire said the latter was likely the more significant factor) is a case in point. Markets outside China were not moved at all.
In fact, during the first week of June, all other regional markets saw modest gains until poor economic data out of the US send them tumbling.
“The correction shouldn’t have an impact on economic growth,” said Maguire, who warned “not to put developed economy concerns on China.”
Ultimately, most watchers still expect a lot of Chinese bourses, even if most expect them to end the year a little lower.
“I think it will end the year slightly lower but in three to five years it will end up much higher,” Maguire said.