China's asset bubbles may just grow bigger
BEIJING: China is running the risk of inflating new asset bubbles, as the price for keeping monetary policy super-loose until its economic recovery
That is the consensus among analysts after China became the first major economy to pull decisively out of the global downturn with surprisingly strong annual growth in the second quarter of 7.9%.
The robust growth is down to the government’s 4-trillion yuan ($585 billion) fiscal package and to outsized lending by the state-dominated banking system, which extended 7.37 trillion yuan in loans in the first half, about a quarter of annual GDP.
The question for investors is when China’s leaders will judge it safe to abandon this “proactive” fiscal policy and “appropriately” loose monetary stance.
The answer, economists say, is not until private sector investment, household consumption and net exports are strong enough to fill the hole in the economy that would be left, if the government scaled back its spending or cracked down on credit.
In practice, said Qing Wang, Morgan Stanley’s chief China economist, that is unlikely to happen before next year.
“Since the strong recovery has been largely policy-stimulus driven, it makes little sense to us for the authorities to make a major policy shift toward outright tightening in the absence of robust autonomous organic growth, especially when inflation does not pose a risk,” Wang said in a note to clients. To be sure, policymakers are showing signs of stirring.
The People’s Bank of China has pushed up money market rates and is conducting more vigorous open market operations; the banking regulator has ordered banks to cease lending frenzies that dress up their balance sheets at the end of every month; and some cities have tightened mortgage rules for second homes. But this is finger-wagging, not a slap across the face. As a result, many economists say conditions are ripe for a continued run-up in stock and property prices less than two years since the bursting of the last bubble in both markets.
Dong Xian’an, chief macro economist at Industrial Securities in Shanghai, was reluctant to talk about an asset bubble because that implied a mismatch between price and value.
“The real determination of price is supply and demand. With demand rising, so should price. That is healthy. But it would be dangerous, if they overshot and that could trigger a policy response,” he said.
Some fear the authorities may already have left it too late.
The Shanghai stock market is already up 75% this year, while the national average price of residential properties jumped more than 20% in the first half, Mingchun Sun, Nomura’s chief China economist, noted in a report.
Liquidity conditions were at their loosest in two decades and Shanghai’s price/earnings ratio was well below its historic peak.
“In other words, we believe a bubble is inevitable and will only grow bigger, possibly exceeding that of 2007,” Sun said.
All bubbles burst, messily, so why don’t policymakers act now?
One reason, Sun said, is that many investment projects launched by the state will take three to five years to complete, requiring additional bank financing in 2010 and 2011.
“Therefore, a sudden and aggressive tightening would not only face substantial resistance from local governments, but may also delay the completion of some of the projects and bring immediate and unnecessary non-performing loan problems to banks,” he wrote.
So monetary conditions are likely to stay loose until 2012 or even later, he said.
One conspicuous source of liquidity is a renewed surge in China’s foreign exchange reserves, which jumped $177.9 billion in the second quarter to $2.13 trillion, the PBOC said on Wednesday.
The rise furnished evidence of a resumption of hot money inflows as foreign investors, lured by great big bubbles in the making, found ways of getting around China’s capital controls.
If a cash tide washes into China as the economy goes off to the races, Beijing’s hand could be forced on the yuan’s exchange rate, which it effectively repegged to the dollar a year ago as a defence against the global financial crisis.
Dong Tao, Credit Suisse’s chief China economist, said gradual appreciation, of 5-7 percent, could resume next year. The trigger for serious tightening will be growing asset bubbles. Panicking, Beijing could raise interest rates by up to 600 basis points.
But that is also a story for next year. For now, many firms and investors have missed out on the stock and property markets’ run-up so far this year. With their bank accounts bulging with cash, they are poised to make up for lost time.
“The measures taken by Beijing and local governments are probably not enough to hold back asset speculation,” Tao said.