Boom and Bust

May 19, 2007

The stock market frenzy in mainland China has reached a historical high in the last few weeks. Both Shanghai and Shenzhen stock markets are experiencing an unprecedented boom, as more than 50% of the urban working population is engaged in stock trading. From various press reports, a great majority of these investors are novice and are punting for quick profit. However, the current pricing of stocks has gone way beyond that which fundamentals can support. From past experience. a bust is looming large on the horizon.

The South China Morning Post reports that The People’s Bank of China yesterday raised the key one year lending rate by 0.18 percentage point to 6.57 per cent and the one-year deposit rate by 0.27 percentage point to 3.06 per cent. Bank reserve requirements, which have been raised several times in a row recently, will rise to 0.5 percentage point to 11.5 per cent from June 5. Meanwhile, the central bank has also widened the Yuan’s trading band against the US dollar to 0.5% either side, up from 0.3%. Such moves are unusual in that they are taken simultaneously, and showcase a strong determination by the central government to cool down the overheated economy. Last week, the government relaxed certain rules in the Qualified Domestic Institutional Investor scheme (QDII) to allow funds to be invested in overseas stocks. This will ease the growth in China’s foreign reserves and relieve pressure for the Yuan to appreciate faster. It could also help absorb excess liquidity in the mainland’s financial system, which is accountable for the recent stock market frenzy.

The news of QDII relaxation has boosted Hong Kong’s stock market, with daily turnover on May 14 reaching a historical high of close to HK$100 billion. However, local stock investors are relatively rational and the Hang Seng Index has had only narrow fluctuations compared to its mainland counterparts.

History has revealed that the wealth effect from a booming stock market will certainly help boost local property market. The current buoyant stock market will of course benefit the property investment market. But there are imminent concerns. Despite many previous dampening measures adopted by the central government on the mainland’s iron hot economy, Shanghai and Shenzhen stock markets seem to have ignored all the warnings. Whether the measures announced yesterday will be manifested remains to be seen. But one can be certain that if the markets defy the cooling policies, the central government will inevitably introduce more stringent measures. There will come a time when the last straw will break the camel’s back. When that happens, it could mean a disaster not only for the mainland stock market but also for Hong Kong’s stock and property markets, as the wealth effect works in reverse. To the local Hong Kong economy, memories of the market collapse from 1997 to 2003 are still fresh. It is time to wake up.

By K S Koh