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In-Depth Report 17 May

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In-Depth Report 17 May In-depth report 17 May. 10 Financial Services Sector Policy Liquidity is King The Chinese government is, again, trying to implement mutually contradictory economic policies. It is in the process of tightening money supply in order to prevent inflation and housing price bubbles, which has had a knock-on effect of causing the slump in the stock market. At the same time, it needs the stock market to remain buoyant in order to support the potential 287bn yuan of bank capital raisings and the 150-200bn yuan IPO of Agricultural Bank of China. Without these, the banks cannot continue to lend sufficient amounts to support economic growth. This means the government is searching for other sources of non-inflationary liquidity to support the market, including directing banks to the H share market, and expanding margin trading and index futures to both domestic institutional investors and QFII. In tandem with investors switching out of property investments into stocks, Central Huijin buying bank shares and NSSF pledging support for index futures, this potentially puts a floor under the market at current levels. Financials Sectors To ebb… In response to the April economic data showing increased bank lending, higher property prices and rising inflation, the government is likely to continue to increase credit Banks controls, enhance the implementation of property policies, and resume RMB Policy: Negative appreciation in the near future to head off inflation. Outlook: Negative However, before adjusting the exchange rate, PBOC will continue to control the pace Insurance and direction of bank lending and use open market operations and adjustments to the Policy: Neutral reserve requirement ratio to remove liquidity from the banking system. These efforts, Outlook: Neutral combined with a switch in investment from stocks to property market, have contributed to the 20% drop in the CSI 300 in the year-to-date. Securities Policy: Positive While this in itself would not be a major issue, and possibly even beneficial in the long Outlook: Positive term, the problem is that the government needs to pump the market back up again in order to complete the bank’s capital raisings. … and flow There is the potential that some of the money being forced out of the property market may feed its way back into stocks, as there are few other avenues for investment, particularly against the current environment of negative real interest rates on deposit accounts. On the policy side, however, the two responses appear to be: a) To increase liquidity at the domestic stock market through margin trading and stock index futures. Extending the market from retail investors to funds, QFII and securities houses in the near future should boost the market. b) To tell the banks to raise cash through the H share, rather than A share market. While in the short term, this is likely to push shares down further, the result of all this is that H share investors are effectively buying Chinese government debt through equities. Published by FCI for A307, Guanghua ChangAn Plaza, No.7 Jianguomennei Avenue, 100005, Beijing distribution by North Square Blue Oak outside PRC China Tel: 86 10 59111088 Fax: 86 10 59111089 www.firstchinainvest.com China Policy In-depth Further tightening to come April economic data painted a negative picture for inflation, with CPI and PPI rising faster than expected, bank lending increasing ahead of expectations and property prices continuing to rise, so continued monetary tightening is firmly on the cards. With increased liquidity withdrawals through open market operations since the Spring Festival (removing 1.1trn yuan from the banking system through last week – see chart 2) and the recent 50bp hike to the reserve requirement ratio, PBOC has brought M2 growth down from a high of 29.6% yoy in November to 21.5% yoy in April (see chart 1). PBOC has targeted 17% growth for the full year, so further tightening is likely to come in order to meet this target and head off inflation expectations. Chart 1: Money supply growth (% chg yoy) 45% M2 40% M1 35% M0 30% 25% 20% 15% 10% 5% 0% -5% Jun-09 Jun-08 Jun-07 Jun-06 Jun-05 Mar-10 Mar-09 Mar-08 Mar-07 Mar-06 Mar-05 Sep-09 Dec-09 Sep-08 Dec-08 Sep-07 Dec-07 Sep-06 Dec-06 Sep-05 Dec-05 -10% Dec-04 Source: PBOC Chart 2: PBOC weekly net injections/withdrawals from the banking system 400 300 200 100 RMBbn 0 -100 -200 -300 03/09/2009 17/09/2009 30/09/2009 15/10/2009 29/10/2009 12/11/2009 26/11/2009 10/12/2009 24/12/2009 07/01/2010 21/01/2010 04/02/2010 25/02/2010 11/03/2010 25/03/2010 08/04/2010 22/04/2010 06/05/2010 Another 50bp hike to the As part of the general tightening of monetary policy, it is likely that the reserve RRR likely requirement ratio will be raised again by another 50bps in the near future, bringing the RRR to 17.5%, the same as the peak level in H2 08. PBOC is also likely to continue to withdraw money from the banking system using open market operations. Since the beginning of the year, PBOC has removed 679bn 2 Financial Services Sector Policy yuan from the banking system, and this is likely to continue in order to slow the growth in M2. If the three reserve requirement ratio hikes are factored in, PBOC has removed roughly 1.6trn yuan from the banking system in 2010. Bank lending to be tightened In addition to general tightening of monetary policy, the implementation of credit controls will become stricter, particularly where it relates to lending for second and third-home mortgages. This is likely to take the form of stricter implementation of previously announced policies, as opposed to new policies. In April, new long-term household lending reached 230bn yuan, up 134% yoy, contributing to the 12.8% yoy increase in house prices in April across 70 major cities, which in turn made housing costs in the CPI figure increase to 4.3%. Chart 3: Long-term household lending and % of total lending 400 80% 350 70% LT Household lending 300 % of total lending 60% 250 50% 200 40% RMBbn 150 30% 100 20% 50 10% 0 0% Jul-2009 Apr-2009 Apr-2010 Oct-2009 Jan-2009 Jun-2009 Jan-2010 Mar-2009 Mar-2010 Feb-2009 Feb-2010 Aug-2009 Sep-2009 Nov-2009 Dec-2009 May-2009 Source: PBOC At the beginning of H2 09 banks significantly increased long-term lending to the household sector, the vast majority of which is mortgage lending, with long-term household lending accounting for 50% of total lending in H2. While the share of long- term household lending has fallen to around 30% in Q1 10, it is still much higher than the 8% of total lending seen in H1 09. Mortgage lending likely to As the government wants to see house prices growth slow to below 10% from the decrease from current current 12.8% growth, the current high level is unlikely to be maintained as the levels implementation of the current restrictions on mortgage lending is expected to become stricter. Liquidity and the stock market The tightening of liquidity will be a necessary step for the Chinese government to reduce inflation expectations and cool property price growth. The problem with the tightening is its effect on the stock market, as stock market movements in China can be roughly correlated with the growth of the money supply (see chart 4), meaning monetary policy tightening may continue to have a negative effect on the stock market. Switch between property The correlation is not perfect, with other factors such as QFII funds and investor’s and stock investment preference from property investment over stock investment playing a factor. Chart 5 shows ‘other deposits’ in H2, which are essentially stock market accounts, and property deposits. At end-08, the increase in ‘other deposits’ drove the stock market higher, while starting in H2 09 when ‘other deposits’ began to fall, property deposits increased. This also means that the current round of tightening in the property sector could increase stock market liquidity, given the lack of other investment channels in China. 3 China Policy In-depth Chart 4: The stock market and money supply growth 45% 7,000 M2 40% M1 6,000 35% CSI300 (RHS) 5,000 30% 4,000 25% 3,000 Index 20% 2,000 15% 10% 1,000 5% 0 Feb-05 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 Aug-05 Nov-05 Aug-06 Nov-06 Aug-07 Nov-07 Aug-08 Nov-08 Aug-09 Nov-09 May-05 May-06 May-07 May-08 May-09 May-10 Source: PBOC Chart 5: Deposits and the stock market 1200 M2: Quasi money: Other deposits 5000 1000 Property deposits 4500 CSI300 (RHS) 800 4000 600 3500 400 3000 200 2500 Index RMBbn 0 2000 -200 1500 -400 1000 -600 500 -800 0 Jul-08 Jul-09 Jan-08 Jan-09 Jan-10 Mar-08 Mar-09 Mar-10 Sep-08 Nov-08 Sep-09 Nov-09 May-08 May-09 May-10 Source: PBOC From 2005 to 2008, new increased property deposits averaged 76bn yuan per month, while new monthly inflows into ‘other deposits’ averaged 37bn yuan. In H1 09, when money was being directed towards the stock market ‘other deposits’ increased by an average of 328bn yuan per month, partly reflecting the use of bill financing for stock market investment, as highlighted in our report, Chinese A-Shares, The Liquidity is Repaid 11/08/10.
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