August 28,2009

As Bank Credit Ebbs, Is the Stock Market Bull Doomed?

By CSC staff, Shanghai

The present bull round in China this year is almost completely driven by liquidity instead of any real improvement in the real economy. The recent market "correction" stems from the exit of credit funds with which to speculate. With the gradual reduction of the stimulus policies and the increasingly serious threat to the sustainability of economic recovery from the vast production surpluses they brought on, the stock market may well "correct" downward even further if the bank lending continues to ebb.


Shi Lei, a Bank of China analyst, finds in his research that the huge surge in credit has been one of the most important reasons for the domestic asset and commodities price rebound in the first half of the year. Middle and long-term credit capital of 1.2 trillion yuan, he says, has entered the secondary equity and real estate markets instead of into fixed investment, not counting the short-term credit and bill financing that may also have entered the markets.


According to Shi's study, acquired by Caijing magazine, 1.2 trillion yuan is equivalent to 26% of the turnover during the first six months in the Shanghai and Shenzhen stock markets this year, and 76% of the total turnover in the national real estate market, not including short-term loans and paper financing into the asset market.

Shi calculated the proportion of fixed-asset investment against middle and long-term loans. Since 2006, this proportion has fluctuated within a range from 1.3-1.7, but during the first half of this year, it dropped to 0.9-0.7, down 40%. It is on this basis he claims that the 1.2 trillion yuan of middle and long-term loans in non-financial enterprises has not entered fixed-asset investment.


New bank lending reached 7.3 trillion yuan in the year to July. It is a market consensus that much of that has gone into the capital market, but nobody before has been able to calculate the scale. Companies, the bulk of them state-owned, took the loans, whether they need them for survival or not.  


Shi's study shows that when an entrepreneur has a firm with operating capital of 100 million yuan, normal short-term credit of 100 million can create the demand of 200 million to one billion in assets and commodity markets, even with no illegal use of the money.


21st Century Business Herald reports an anecdotal case. At the end of February, just after Spring Festival (the Chinese New Year), a loan officer from a large state-owned bank offered loans with a nice interest rate discount to Wu Hua, owner of a textile company in Hangzhou. Private enterprises, especially private enterprises in the textile industry, seldom enjoy such preferential treatment, but the loose monetary policy this year allows banks to relax lending standards, and banks have been busy looking for potential clients. Wu took the money.


In March, Wu received the first loan of 20 to 30 million yuan. (He has refused to disclose the total amount he has received.) How to spend the money was a problem. Because of shrinking export orders and an inadequate rate of operations, purchasing equipment would merely have resulted in greater losses. Wu took 30% of the loan to invest in stocks. "I dared not invest it all. If the loss reached 10%, I would withdraw immediately to ensure repayment to the bank."


On July 29, the Shanghai market dropped 5%, surprising Wu. He saw sharp adjustment and increasing risk in the market. He also received a call from the bank officer, asking about the progress of the loan. On August 7, he withdrew all the money from the market. In less than five months, he had earned about 30% on his borrowed investment.

His loan period is one year at a rate of 4.779%, the floor limit required by the central bank. Suppose Wu borrowed 30 million yuan. The one-year interest is 1.4337 million yuan. Suppose he invested about nine million yuan in the stock market, and earned 2.7 million yuan. After repayment of interest, he would still have earned 1.26 million yuan.


Individual investors can also use loans to get into the stock market. Last October, the central bank introduced policies to stimulate the housing market, setting the down payment for a first home at 20%, with a 30% mortgage interest discount. After the discount, the five-year lending rate is only 4.158%. Such low interest rates provide huge room to move for those buying houses.


Speculators in Shenzhen have borrowed money from banks with their new houses as collateral, and then bought structured products from equity funds. The annual return rate is at least 10%. This means under normal circumstances these customers can obtain 5.852% low-risk returns.


Many loans to state-owned enterprises are rumored to have gone to the capital market, because these SOEs have their own internal financial management company, though no firms have advertised such dealings thus far.


The market has reached consensus that in the second half bank lending will tighten, and the gush of liquidity almost single-handedly driving the stock market boom may be a thing of the past.


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