Booming China stocks test government's will

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.


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”.

This time, authorities are unlikely to resort to such measures, partly because they have become more committed to free markets and more sensitive to public opinion.

But a continued rise in stocks could accelerate further hikes in interest rates and bank reserve ratios that are already expected by the end of this year, as asset prices join inflation as an important factor for central bank policy.

After deciding this month to let institutions buy stocks overseas, China could take more steps to divert investment funds out of the country -- though this would likely have little impact, since with the yuan appreciating, few individual Chinese investors are interested in sending money abroad.

Instead, authorities may tighten the noose on funds entering the stock market by slowing regulatory approvals for new mutual funds. Regulators cooperate much more closely with central government policymakers in China than they do abroad.

A determined crackdown on banks could deter the illicit use of loans for stock investment, while central government authorities could press state-owned firms and local officials around the country to stop investing surplus funds in equities.

A crackdown on corruption linked to the real estate market in Shanghai last year prompted money to be pulled out of the city’s red-hot property market. A similar effort could conceivably cool speculation in stocks.

Authorities may also move toward introducing a capital gains tax for stocks. Even a hint at such a tax by a senior official in Beijing might send the market down steeply.

“China’s capital markets have never seen such a tax, so any hints about this would have a major impact -- investors would be hurt psychologically,” said Yan Zhenghua, chief strategist at China Asset Management Co.

“Investors putting new money to work in China’s stock markets ignore the adage ‘Don’t fight the central bank’,” global investment bank ING said in a report on Monday, warning that future pull-backs could unsettle risky markets globally.