Shanghai/Hong Kong: Deng Yijun, a cargo-freight agency manager in Shanghai, faced a dilemma last December. “I needed a car, but I didn’t want to use up my savings as the stock market was booming,” she says. “So I used credit cards.”
Deng, 32, was eyeing a Ford Focus that cost about 200,000 yuan ($25,815), roughly equal to her savings. Maxing out three cards, she put 140,000 yuan on plastic and gained 56 days of interest-free credit. She paid the rest herself. Most of her remaining cash went into stocks, including Sichuan Swellfun Co., a distiller whose share price more than tripled in the past year.
Deng is typical of Chinese who are using easy credit to fuel a stock boom, only briefly deflated last month by government threats to crack down on illegal lending. The willingness of banks to break the law to finance stock trades shows the blunt tools regulators wield as they try to manage China’s markets.
“Banks have no incentive nor means to track loans that flow into the stock market so long as borrowers make timely payment,” says Yuan Lin, a Beijing-based analyst at BOC International Holdings, the investment banking arm of Bank of China Ltd. “Banks are more concerned about the repayment of the loan than its whereabouts.”
The Shanghai and Shenzhen 300 Index rose 121% last year, fuelled by as much as 20 billion yuan of personal bank loans illicitly used to buy stocks, Yuan estimates.
The government last month announced the creation of a task force to clamp down on illegal lending, triggering a 9.2% plunge in the index on 27 February. That sparked a 6.7% drop in the MSCI World Index over the next five days.
Deng says she was able to buy the car for three times her annual salary and purchase stocks after card issuers Bank of Shanghai, China Merchants Bank Co. and China Construction Bank Corp. gave her credit over the phone. While Deng broke no law, many investors illegally buy stocks with loans.
Investors put the borrowed money in stock markets and some use it in ways that are different from what they claim in loan applications, says Liu Mingkang, chairman of the China Banking Regulatory Commission.
Mortgage applicants often conspire with real-estate agents to secure bogus home loans before shifting funds to a third-party bank account, says Zhao Jie, a loan officer at Industrial & Commercial Bank of China Ltd, the nation’s biggest.
Shanghai-based Zhao says banks are countering the scams by sharing information to track down funds that are used illegally.
Such counter-measures have not been aggressively implemented because banks have little incentive to rein in lending, says Yin Jianfeng, a researcher at the Chinese Academy of Social Sciences’ Institute of Finance & Banking.
“Banks are lending for profit,” he says. “They have collateral on hand, they have payment on time and they have lucrative interest income, so what’s the incentive to work with regulators?”
Some 300-500 billion yuan of bank loans, almost all refinanced mortgages and revolving consumer loans, may have gone into the stock market in the past year, Yin estimates.
The Shanghai and Shenzhen index has gained 8.8% since 28 February, as the government failed to announce measures to curb speculation during the annual meeting of the National People’s Congress from 5 to 16 March.
There was concern that regulators would impose a capital-gains tax or increase the stamp duty on stock sales. “Within the government, people have divergent views on whether the bubble is big enough to burst,” Yin says.
For now, policymakers are relying on persuasion, warning investors about risks of stock buys. “Investors should have a reasonable assessment and judgement of the stock market,” says Ma Kai, director of China’s highest economic-planning agency, the National Development and Reform Commission. “The responsibility of the government is to provide transparency and equality.”
China’s last stock boom ended in the second half of 2001, when regulators shut brokerages that used client money for their own trades and the government announced plans to make state-owned shares fully tradable. With its economy growing more than 10% a year, this boom has been driven by restrictions on overseas investment that leave people with few options but to invest in domestic stocks, says Qin Xiao, chairman of China Merchants Group, which controls China Merchants Bank and China Merchants Securities.
“China has more than 30 trillion yuan of bank deposits, but stock market capitalization is only 10 trillion yuan, of which about 30% is freely tradable,” Qin says.
China’s underdeveloped capital markets have forced the government to try to control investment with administrative levers such as increasing deposit reserve requirements for banks and restricting loans to specified industries.
Concerned about fast-rising property prices, the People’s Bank of China, the central bank, in July 2003 limited lending to developers and home buyers. A year later, loans to rapidly expanding industries such as steel, cement and construction were restricted to curb investment.
US treasury secretary Henry Paulson on 8 March challenged China to ease controls on its financial markets and remove caps on bank interest rates.
“An open, competitive and liberalized financial market can effectively allocate scarcer resources in a manner that promotes stability and prosperity far better than government intervention,” Paulson said at the Shanghai Futures Exchange.
China on 18 March raised interest rates for the third time in 11 months to cool investment. The central bank increased the benchmark one-year lending rate to 6.39% from 6.12% and the one-year deposit rate to 2.79% from 2.52%.
Even in developed markets, central bankers and economists debate whether interest rates can be used to influence asset prices. US federal reserve chairman Alan Greenspan’s 1996 warning about “irrational exuberance” in the US stock market was ignored until the technology bubble burst in 2000.
The worldwide stocks boom leading up to the 27 February sell- off was the result of capital inflows from growing Asian economies and pension funds in Europe and North America that no regulatory agency could control, says China Merchants Group’s Qin.w
“Excess liquidity is a global issue, not a China issue alone,” he says.
The challenge for China is to slow the rising stock market without triggering a collapse.
“The Chinese government is the chief engineer of the A- share market; it can make or break it,” says Chris Leung, a senior economist at DBS Bank Hong Kong Ltd. “It has a range of policy tools at its disposal, from mild tightening of monetary policy to direct intervention.”
Investors can take comfort from the knowledge that their interests are aligned with those of the government, which controls 70% of the Shanghai stock market and needs high returns to fund social welfare programs, says Isaac Meng, an economist BNP Paribas Peregrine Asia in Beijing.