China’s $1.8 Trillion Stock Surge: What More Gains Mean

By Alfred Liu

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China’s stock market swelled $1.8 trillion in value in six months as trading volumes hit records. The Shanghai Composite Index jumped 3.5 percent today for a gain of more than 60 percent since mid-July. Should the bull market be sustained, analysts see at least six implications for finance and the economy.

1. China’s Deleveraging Gets Easier

China’s been on a debt binge since 2008, adding to risks for the financial system. The fastest-growing and biggest part of the borrowing -- which rose to 251 percent of gross
domestic product by mid-2014, according to an estimate by Standard Chartered Plc -- is by companies.

If the rally continues, the appetite for shares would encourage equity sales that help companies to cut debt, said Rainy Yuan, a Shanghai-based analyst at Masterlink Securities Corp. See CHART

2. Broker Shake-Up Delayed

When the broking industry was mainly struggling after the bursting of a 2007 stock bubble, consolidation seemed more likely. Now, mergers and acquisitions could be smaller and slower if extra business makes even marginal firms profitable.

“Valuations are so high now that market-driven consolidation may slow,” said Judy Zhang, an analyst at BNP Paribas SA in Hong Kong. The nation had 115 brokerages in 2013, according to the most recent data from the Securities Association of China. See CHART

3. Extra Credit Risks

The money sucked into the share market may exacerbate competition for funding. Among those most vulnerable are the individuals, small businesses and unlisted property developers borrowing from the likes of pawn shops, online peer-to-peer financing sites and private lenders, Standard Chartered analysts in Hong Kong including Dorris Chen wrote in a report this month. If the bull market persists, the extra stress may increase defaults by such borrowers, the least creditworthy, they said.
Banks may find it more difficult to manage liquidity, an “important” concern, said Jim Antos, a Hong Kong-based analyst at Mizuho Securities Asia Ltd. See CHART

4. No Reserve-Ratio Cut

While analysts are split, some have argued that share gains could encourage the government to hold off from cutting the reserve requirements that dictate how much money lenders park at the central bank. Reductions aimed at fueling economic growth could lead to more money flowing into stocks, adding to the risk of a bubble. The central bank has been “reluctant” to move because of share-market concerns, Lu Ting, a Bank of America Corp. economist, said in Hong Kong this month. See CHART

5. Banks Fortify Capital

China’s banks may take the opportunity to sell equity to bolster capital, an option that is cheaper for lenders than raising money via issues of the subordinated securities called preferred shares.

“Distressed equity market valuations over the past few years made it extremely hard for banks to issue common equity,” the Standard Chartered analysts said. Underscoring how that has changed, shares of Industrial & Commercial Bank of China Ltd., the nation’s largest lender, climbed 29 percent in the past two months. See CHART

6. Volatile Money Markets

A protracted bull market could add to the potential for volatility in Chinese money markets. The interbank market’s seven-day repurchase rate had its biggest weekly jump of 2014 in the week ended Dec. 19 as initial public offerings and share-price gains drew more money to stocks.

“The risk-on mode will keep demand robust for new shares, so it’s almost inevitable to result in volatility in money markets,” said Liu Changjiang, a fixed-income analyst at Essence Securities Co. See CHART
To contact the reporter on this story: Alfred Liu in Hong Kong at aliu226@bloomberg.net
To contact the editors responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net Darren Boey