After an impressive 30-per-cent run in the second half of last year, the Chinese stock market took a tumble again at the beginning of 2014.
The Hang Seng China Enterprise Index, a gauge for mainland stocks traded in Hong Kong, declined 10 per cent year-to-date amid concerns over its expanding shadow-banking system.
The rapid rise of Chinese shadow-banking activities is a consequence of the government’s effort to reign in credit growth and transform the economy from investment-led growth toward a more sustainable consumption-driven economy by setting up loan quotas for banks to limit financing to investment projects. The shadow-bank system was created to circumvent the rule. Specifically, Chinese banks sold new “wealth management products” (WMPs) which promise higher interest rates to their depositors. These products are backed by cash flows from investment projects and are typically issued by high-risk borrowers such as local governments (and their financing vehicles) and real estate developers. They are neither on banks’ loan books nor insured by the government.
In late January, local newspapers reported that a 3-billion-renminbi (Bt15.975 billion) investment product called Credit Equals Gold No 1 might default on January 31, when it was due. The hard default scenario has been averted, as China Credit Trust and other parties involved have reached a resolution to restructure the underlying trust loan, which limits investor losses to a minor haircut. Nevertheless, the news has fuelled concerns over the unsustainable credit growth in China and sent ripples through the stock market.
It is true that Chinese debt levels are rising too fast but, in my view, the risks should be manageable because:
lDespite the rapid rise of credit, the total debt level is still low in comparison. China’s total debt-to-GDP ratio (including both public and private debt) rose from 130 per cent in 2008 to 210 per cent, but the overall debt level is still low compared to 300 per cent in the US and 500 per cent in Japan;
lChinese WMPs are relatively simple and involve no leverage or derivatives. Cross-holdings of assets between institutions is low which helps limit contagion risks among banking sector;
lBuyers of WMPs are mostly high-net-worth individuals who have high tolerance for loss;
lThe share of risky borrowers such as infrastructure, mining and real estate projects has been declining in the past few years.
lChinese equities have already priced in extreme pessimism. The H-shares banking sector is trading at a crisis level, with price-to-book ratio at 0.9 and price-to-earning ratio of 4.5.
The reform package announced late last year by the Central Committee of China’s Communist Party, if imple?mented effectively, could help alleviate credit bubble fears and shift investors’ focus from risks to long-term growth potential, of which China has plenty to offer.
Komsorn Prakobphol is a Senior Investment Strategist at TISCO Economic Strategy Unit (ESU). He can be reached via www.tiscowealth.com or firstname.lastname@example.org.