China Fights Stock Bubble, Shares Drop
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China instituted new financial reforms to battle a surging stock bubble that many analysts fear will burst at any minute.
The China Securities Regulatory Commission said last Friday that it would make more shares available for short selling while also restricting the ability of advantage from shadow financing. Historically, a limited number of shares were available in Chinese markets for short selling, which has left few options for investors looking to bet against the sharp rise in stocks.
China instituted new financial reforms to battle a surging stock bubble that many analysts fear will burst at any minute.
The China Securities Regulatory Commission said last Friday that it would make more shares available for short selling while also restricting the ability of advantage from shadow financing. Historically, a limited number of shares were available in Chinese markets for short selling, which has left few options for investors looking to bet against the sharp rise in stocks.
The Shanghai Composite Index (SCI) fell immediately on the news, but swiftly recovered to rise over 1% in early morning trading as demand for China shares continues to outstrip supply. The more conservative Hang Seng Index in Hong Kong was down 0.3% in early morning trading.
The SCI has more than doubled in the past year, with most of its gains coming in the last six months. Many investment banks in China have urged caution, indicating that unsophisticated investors are flooding the market with capital as real estate prices are falling and China’s notoriously aggressive savers have looked for an appreciating investment.
Additionally, recent easing restrictions on capital flows between the mainland and Hong Kong have driven the Hang Seng index markedly higher, leading to returns of over 23%, with most of those returns coming in the last two weeks. In many days of trading, they reach the full quota of capital going into the Hong Kong market from China; indicating mainland’s outbound capital flows have been driving the price increases, and not market fundamentals.
Swap Rate Boost
While fighting rising prices in equities, China’s regulators are also looking to fight falling prices in real estate and lower growth more broadly in the economy. To this end, the People’s Bank of China announced Sunday that it would lower its reserve-requirement ratio by 1%, effective today. That reduction is the biggest since 2007 and means that large lenders can have a debt to equity ratio of 18.5%. The ratio is even lower for smaller institutions serving rural areas.
Some analysts believe this move will counter contractionary headwinds in China’s economy, as real estate demand has fallen and once booming housing prices have reversed. In one note, an investment banker said that this is likely the beginning of an aggressive easing program that will conclude before the end of June. Further cuts to lending rates are likely, after one-year interest-rate swaps fell 20 basis points to 2.76% in early morning trading.
This is the second cut to benchmark interest rates in the last six months, indicating regulators’ aggressive efforts to meet the 7% GDP target that the Chinese government has set. Some economists remain doubtful it will be effective, but the move indicates China’s sharp pivot from an export-driven to a domestic demand-driven economy is in full force.
