viernes, 12 de junio de 2015

viernes, junio 12, 2015
Markets Insight

June 9, 2015 4:33 am

Why China is blowing an equity bubble

John Plender

High valuations will make it easier and cheaper to recapitalise state-owned groups 
 
 
Bubbles come in different shapes and forms, but it is striking how often they are the byproduct of attempts to make difficult economic transitions. This was true of the US stock market in the late 1920s as Americans reluctantly stumbled towards the hegemonic global role previously played by the British.
 
It was true of the property and equity markets in Japan in the 1980s, when an export-led growth model that had worked well in the catch-up phase ceased to be viable in a country that had turned into an economic giant. So, too, with China today, where first a property bubble and now an incipient stock market bubble have a great deal to do with imbalances in an economy that needs to shift from investment-led growth to increased consumption.

Such transitions are difficult because of the clash of vested interests. Chinese local government officials have been big beneficiaries of easy financing of infrastructure investment and the accompanying land grab. State-owned enterprises have lived handsomely off the same gravy train. At every level of the public sector there are people for whom the status quo is a cornucopia. Equally to the point, liberalisation, which is the key to an effective transition, can only erode the power of the Communist party.

For those officials who see that change is essential, a further difficulty arises from the new sluggishness of the Chinese economy. Since their legitimacy derives from delivering high economic growth they are under pressure. It is all too easy to solve the problem by throwing more money at infrastructure and at industries that suffer from surplus capacity. Yet this can only be done at the cost of creating bubbles, running up more debt and misallocating resources on a grandiose scale in what economists of the Austrian school call malinvestment.
 
There is one sense, though, in which euphoria in mainland Chinese equities is unusual. Far from being an unintended consequence of policy, the authorities are egging investors on with articles in the state-run press seeking to justify extreme valuations. The People’s Bank of China has been busy cutting interest rates. And to good effect. The Institute of International Finance, a club of global banks, says Chinese retail investors have increased their equity investment via margin borrowing by almost 85 per cent this year to a record $400bn.

Why, you might ask, would those charming officials in Beijing wish to encourage a bubble? A consequence of the investment boom is that many state-owned enterprises are lossmaking, while state-owned banks have lent excessively to these companies and to local governments. The authorities are urging them to lend more despite the fact that they will never be repaid in full.

The obvious way to de-risk this dangerous game of extend and pretend is to recapitalise the state-owned corporate sector. Bubble valuations will make this easier and cheaper. Foreign investors, meantime, are set to be granted better access to China’s domestic A shares. While Chinese capital is pouring out of the country foreigners are clamouring to move in. EPFR, the data provider, detects a thaw in sentiment towards a market that foreign institutional investors have recently shunned.

The debate on whether Chinese A shares should be included in the MSCI Emerging Market Index suggests that, whatever decision the MSCI makes on the issue this week, there will soon be more forced investors in this market. How convenient for the authorities in Beijing. That also illustrates how passive investing can reward bad behaviour. China, after all, has the world’s biggest crisis of corporate governance.
 
Recent scandals have highlighted failure to enforce securities laws to ensure the integrity of accounts, abuse of conflicts of interest in state-owned enterprises, abusive related party transactions and seriously deficient property rights. In other words, any investor in an indexed fund that includes A shares will be exposed to serious corporate dross. When companies in the index raise capital that exposure will increase. The game will change from extend and pretend to pass the toxic parcel.
 
Until now the possibility of a Chinese bubble deflating was of little concern in the west. Bubbles were financed by domestic saving. That is now beginning to change. As the incremental process of liberalisation continues the scope for contagion outside China will multiply. In short, China and the developed world are set to become more uncomfortable financial bedfellows.


The writer is an FT columnist

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