Temat: Frothy Chinese economy may deter investors

Frothy Chinese economy may deter investors
By Michael R. Sesit Bloomberg News
Published: December 24, 2007

PARIS: Investors in emerging Asian markets have various options. But unless you are the kind of individual who enjoys battling governments that hold most, if not all, of the cards, going for the markets outside China should prove a less risky and more profitable strategy - at least for the next several months.

Chinese stock markets are cooling. After soaring 188 percent in the year through Oct. 16, the benchmark CSI 300 index of Chinese shares has since fallen 13 percent. The Hang Seng China enterprises index, consisting of mainland Chinese companies that trade in Hong Kong, has slumped 18 percent since mid-October.

China, meanwhile, is beset with accelerating inflation and an overheated economy that expanded 11.5 percent in the first nine months of 2007 from a year earlier. Propelled by higher energy, labor and food costs, the rise in consumer prices jumped to an 11-year peak of 6.9 percent in November from a year earlier.

What's more, the fragile Chinese banking system is being starved of funds by savers turned off by its low deposit rates, while investors seek to send their money abroad. Total bank deposits are growing at a record-low 5 percent annual rate, while time deposits are actually contracting, according to BCA Research.

To cool economic growth, battle inflation and damp equity-market speculation, the People's Bank of China last week increased the one-year lending rate, raising it to a nine-year high of 7.47 percent. It was the sixth rate increase this year.
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Ten times this year, the Chinese authorities have increased the reserves that banks must deposit with the central bank, most recently on Dec. 8.

In a tactic specifically designed to rein in equity prices, the government has sought to mop up excess liquidity sloshing through the economy by increasing the supply of stock. Witness PetroChina's $8.9 billion initial public offering in November and the IPO by China Shenhua Energy, which raised a similar amount this autumn.

The Chinese market's small free float - those shares that are not controlled by the government and can be bought and sold by private investors - gives the state a powerful weapon in its efforts to restrain equity-price increases. While the market value of the CSI 300 index - comprising the 300 most representative stocks listed on the Shanghai and Shenzhen stock exchanges - is the equivalent of $3.06 trillion, the Chinese market's free float is just 18 percent of that, or $556 billion, according to Morgan Stanley Capital International.

Lawrence Brainard, chief economist at Trusted Sources UK, a London research firm specializing in the politics and economies of Brazil, Russia, India and China, said, "The future release of new shares into the market, either via IPOs or by increasing the free float of state-owned shares, should prove effective in damping the stock-price bubble."

While Chinese policy makers have slowed the equity-market rally, they have failed to bring inflation and the economy under control. In short, such so-called quantitative measures as raising banks' reserve requirements, imposing lending limits and prohibiting banks from making new loans have neither slowed growth nor significantly reduced liquidity. Interest rates remain too low, the yuan's exchange rate too weak and corporate coffers are flush with retained earnings from the profit boom of the past few years.

Liquidity is cascading into China through huge a trade surplus.

To help deflate the country's liquidity bubble, China is encouraging investment in foreign securities through its qualified domestic institutional investor, or QDII, program. As of Dec. 12, Chinese financial institutions had received approval to invest $42.2 billion overseas, of which about $27 billion had already been invested. Market estimates put the total at $80 billion to more than $100 billion by the end of 2008.

Now all you have to do is keep your fingers crossed that a U.S. recession doesn't take the global economy down with it.

http://www.iht.com/articles/2007/12/23/bloomberg/bxatm...