Booming China stocks test government's will

By Lu Jianxin - Analysis

SHANGHAI (Reuters) - Rising to a record high immediately after the central bank hiked interest rates, China's booming stock market has entered a battle of wills with the government -- a battle that it may well lose.

Millions of Chinese investors, trading on mobile phones or in brokerage halls around the country, shrugged off the central bank's monetary tightening, which was partly designed to prevent the market from overheating.

Instead, investors pushed up stocks in massive turnover that was about 10 times year-ago levels.

"The market seems to have largely ignored the signal that the central bank has sent about a soft landing," said analyst Zhao Wuling at Everbright Securities. "But underestimating the central bank may prove dangerous."

The Shanghai Composite Index .SSEC opened down 3 percent but quickly rebounded to climb as much as 1.3 percent, hitting a record intra-day high of 4,083.416 points. It ended the day up 1 percent at 4,072.225.

That means authorities are likely to take stronger steps in coming weeks to restrain the market and drive out speculative money, analysts and fund managers believe.

They think the government may want stocks to pull back 10 or 20 percent in the next few months to let air out of the bubble -- and that a further rise of 10 percent would almost certainly produce harsh official action.

The monetary tightening was the latest in a series of efforts this month to restrain the market, which is up over 50 percent this year after a 130 percent leap in 2006.

Central bank governor Zhou Xiaochuan said he was concerned by a stock bubble and would monitor asset prices.

"The problem with the stock market is not only valuations. People are leaving their jobs, using their pensions, selling their houses to speculate in stocks. That's really dangerous," said Zheng Weigang, analyst at Shanghai Securities.

DON'T FIGHT THE CENTRAL BANK

Investors' refusal to heed the government's warnings so far has some logic. They know authorities will hesitate to end a bull run that has had many positive results, such as the listing of China's biggest firms and the development of the market into a viable corporate fund-raising source.

But by brushing aside the central bank's tightening, the market has sent policy makers a challenge that they cannot afford to ignore if they want to maintain credibility, analysts said.

"The failure of the market to respond properly today will no doubt lead to direct and stronger steps," Zheng said.

In 1996, when the index jumped as much as 145 percent, the government halted the bull run and sent stocks into a tailspin by using the People's Daily, the Communist Party's mouthpiece, to warn in an editorial against "excessive speculation".