Two stock investors talk to each other in front of a share prices board at a security firm in Fuyang. China’s monetary easing at the weekend was aimed at stopping a stock market stampede, but has some economists worried that policy is being used to prop up an equity rally that was not based on fundamentals and has not done much economic good.

Reuters/Shanghai


China’s monetary easing at the weekend was aimed at stopping a stock market stampede, but has some economists worried that policy is being used to prop up an equity rally that was not based on fundamentals and has not done much economic good.
Yet, they have also warned that not taking action could have major impact on investor sentiment and do disproportionate damage to the wider economy.
The decision to cut both lending rates and reserve requirements at some banks on Saturday was seen as almost entirely driven by the need to stabilise Chinese bourses after they lost 20% over the course of just a few weeks.
“The government appears eager to maintain a bull market to expand the capital market and reduce reliance on bank lending,” wrote Standard Chartered economists in reaction to the cuts.
“Although the use of monetary policy for that purpose is questionable.”
Part of the problem is that even by giving investors the impression that the central bank will use monetary easing to stem losses could be seen as encouraging further one-way speculation.
In addition, there’s the problem that the rally isn’t helping with China’s slowing growth. In most economies a bull market is welcomed for its “wealth effect,” stimulating investment and spending in other parts of the economy.
The Chinese rally has had no such effect. Even as stock markets saw their net capitalisation increase by $7.6tn in 12 months to $11.5tn – larger that the country’s entire gross domestic product in 2014 – retail sales figures have declined steadily, and business investment has stayed weak.
Even a private survey that suggested a tentative recovery had begun among Chinese firms in the second quarter took care to discount the impact of the stocks rally.
“Of all of our indicators, it is capex that should respond most positively to the boom in equities prices - yet capex saw only a minor uptick, as did loan demand,” wrote the authors of the China Beige Book quarterly report.
But just because the rally hasn’t done much good doesn’t mean the crash can’t do much damage.
“A ‘best case’ scenario is that a continued equity collapse would knock a percentage point off China’s GDP growth simply by cooling currently overheated financial sector activity,” wrote Mark Williams of Capital Economics in a research note.
“But the rapid expansion of leverage over the past year means that a sharper economic slowdown is possible...the major downside risk to China’s economy is that a wave of defaults linked to stock market losses leads to a surge in counterparty risk and a freezing of credit markets.”
Analysts point out that the rally really got started after a surprise interest rate cut in November, and has remained almost entirely focused on liquidity moves by the central bank ever since.
That could pose a problem because it means that mildly positive economic news – like the recent recovery in housing prices – could be read by investors as the beginning of the end of the easing cycle, and lead to a sharp selloff.
For its part, the People’s Bank of China did not attribute its decision on Saturday to the stock market directly; while it mentioned the need to stabilise equity markets in its announcement, it also discussed the desire to ease funding burdens at state-owned enterprises and increase lending to agriculture and small businesses.
But the timing of the decision has led many to conclude that it was the stock market alone that drove the decision.
The announcement came just days after the State Council, China’s cabinet, proposed eliminating the loan-to-deposit ratio at commercial banks, a move seen by some as a step away from blunter easing measures toward an emphasis on investment quality.
A June 25 article in a newspaper run by the central bank quoted an expert as saying China would not cut rates this month, which some domestic media interpreted as reflecting a tacitly endorsed view from the central bank.
“May inflation data was released in early June, and PBoC should not have waited until now if it considers real rates excessively high,” the Standard Chartered economists wrote.
A banker at one of China’s “big five” state owned banks said he believed the easing was “more like a bailout for the falling stock market.”
While he allowed this might not be the actual intention of the central bank, the effect would be the same, given ultimate demand for bank loans has stayed weak.
“The fact is, cash will be flowing to the stock market by way of wealth management and structured products,” he said.