The sharp fall in the Chinese stock market in recent days is mainly due to worries about the potential for imminent policy tightening in the mainland, according to Jing Ulrich, Hong Kong-based managing director and chairman of China equities and commodities at JP Morgan.
Although the closely watched CSI 300 Index was up 1% at 3,171.990 yesterday, it is still down around 16% from its recent peak of 3,787.033 on August 3. The index is cap-weighted and tracks the 300 most representative A-share stocks listed on the Shanghai and Shenzhen Stock Exchanges.
Making sense of the trading activity in recent days, Ulrich says China's economic data for July was reasonably strong, but a sharp fall in bank lending has stoked fears that liquidity could dry up in the second half.
To boost confidence, Chinese officials have repeatedly pledged that they will stick to a proactive fiscal policy and moderately loose monetary policy. Ulrich believes that the still-challenging outlook for exports and continued deflation suggest that these assurances are credible for the medium-term.
"Nevertheless, investors have grown jittery over potential scrutiny of asset price gains and bank lending to ensure that credit flows into the real economy," she notes.
Many market participants have been surprised by the magnitude of the recent sell-off, with domestic institutions offering the following feedback, according to Ulrich:
First, market players associate the surge in lending in the first half with strong liquidity and buoyant equity market performance. As discounted bills mature (discounted bills and short-term loans accounted for about one-third of new lending in the first half of 2009), Chinese banks are channelling the funds into medium- and long-term loans.
Second, domestic mutual funds have been heavily invested in equities. Some managers have been forced to sell-down their positions under enormous performance scrutiny and the absence of new fund launches has weighed on the recent demand for equities.
Third, insurers are close to their permissible investment limits in equities. The National Social Security Fund reduced its net exposure to Shenzhen-listed A-shares by Rmb664 million ($97.3 million) in July, but remains cash-rich.
Fourth, since April, the share of demand deposits as a proportion of total household deposits has edged higher -- a sign that investors are favouring liquid savings products. In July, the number of new trading accounts opened by individuals reached the highest level since late-2007.
Chinese bank lending will almost certainly moderate through the remainder of the year, Ulrich says, reflecting the seasonal tendency of banks to front-load new loans. However, she expects credit growth to remain adequate to support the government's fiscal policies and banks have already set aside a certain amount of capital for infrastructure loans in the second half of 2009.The Chinese government could steer the domestic equity market by influencing supply and demand, and stimulating confidence through market signals, she adds.
A stable domestic equity market is an important precondition for the successful resumption of IPOs and a number of ambitious capital market reforms planned in the near-term -- including the first red-chip listings in Shanghai, A-share listings of foreign companies and the launch of a Growth Enterprise Market, Ulrich notes.
Thus, she believes that, in the event of further correction, the Chinese authorities will be prepared to put a floor under stock prices by taking measures such as: temporarily limiting the central bank's issuance of short-term notes, which are designed to absorb excess liquidity; approving new mutual funds at an accelerated pace to boost liquidity (the CSRC recently approved the launch of three new funds after a two-week hiatus); and eliminating the stamp duty on equity transactions to send a positive market signal.