BUBBLY ASSET PRICES HOLD A NASTY SURPRISE FOR CHINA By Richard McGregor in Beijing
Friday, August 24, 2007
China has been spared the turmoil convulsing global markets because of its strict capital controls, local economists say – but it will eventually be forced into a painful adjustment of bubbly asset prices driven by excess liquidity.
China has seemed a mirror image of the developed world in recent weeks, with a soaring local stock market attaining record highs and a central bank draining liquidity from the financial system while their offshore counterparts deliver emergency injections of cash.
The stock market has now risen fivefold in slightly more than two years. The Shanghai Composite index marked another record high point on the 22 Aug at 4,980.075. Residential property prices in large cities have increased in advance of the rate of growth in economic output for the best part of the last decade.
Shares and property have benefited from the wealth generated by China's economic boom and the privatisation of the housing market during the last 10 years. With few other investment options and only limited ability to place money offshore, both asset classes have also attracted speculators flush with cash trapped inside the country by capital controls.
“Excess liquidity creates imbalances in the economy, and sooner or later these imbalances would have to be addressed, and the process could be quite painful,” says Xu Xiaonian, of the China Europe International Business School in Shanghai.
China has gradually eased capital controls, announcing this week a plan to allow individuals to buy shares overseas, in Hong Kong, for the first time, through the Bank of China.
But even if this helps to drain some of the froth from the local market, the underlying credit conditions in China remain weak, says Yi Xianrong, of the Institute of Finance and Banking at the Chinese Academy of Social Sciences: “The quality of housing loans is much worse than the subprime loans in the US, because there is no real credit-check system in China. The bubble will burst sooner or later, and it is necessary for the bubble to burst as soon as possible.”
Dan Rosen, of China Strategic Advisory, in New York, says the country is “essentially all subprime; in terms of the technical quality of investments and the institutional structure around them.
“But the macroeconomic fundamentals surrounding those investments are very strong, and the ability of government to guarantee the medium-term functioning of the system is robust.”
China's state investment, however, does not have a substantial direct exposure to the sub-prime market in the US.
Apart from Chinese banks, the government's investment of its foreign exchange reserves in the subprime sector have been relatively small.
China has more than $250bn invested in mortgage and asset-backed securities in the US – but all apart from about $10bn of this money is in highly rated agency and agency-backed securities, says Wachovia, the US bank.
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