The rally in the Shanghai Composite Index can only be sustained if PBOC takes a firm decision to stimulate the economy. Financial market participants having interest in China are expecting cut in the Reserve Requirement Ratio (RRR which is the share of deposits banks must set aside against financial trouble). The cut in RRR will enable banks to lend more to the public, which can revive the demand and boost the economy. The demand for further stimulus is coming at a time when China’s overall debt (public, private and financial) is at 258 per cent of GDP.
China’s equity benchmark, the Shanghai Stock Exchange Composite Index, in the last one month, rose by around 18% and in the last one year by 33%. The major part of the gain came after the Central Bank, People’s Bank of China (PBOC) cut benchmark interest rates by 40 bps to 5.6%, the first cut in two years. The interest rate cut has helped the equity index to jump by 18% in the last one month. In the last week turnover crossed one trillion yuan ((USD 163 billion) for the first time.
Clearly the rally in the stock market is not driven by any fundamental change as the country is expected to miss its annual growth target, set at about 7.5% for 2014, for the first time since the 1998 Asian financial crisis. China, the world’s second largest economy after the U.S., grew by 7.3% in the third quarter on yearly basis, its slowest pace in more than five years.
Almost all economic indicators, slowing industrial production, weak investment, subdued demand, and low inflation are indicating towards slowdown in the country. As per latest data released, China’s industrial production rose 7.2% in November 2014 on yearly basis, below expectations for a 7.5% growth and down from October 7.7% rise.
On Friday last week, China’s trade data showed that exports grew by 4.7% in the month of November on yearly basis against expectations of 8% growth. Imports declined by 6.7% against expectations of 3.9% growth leading to rise in trade surplus. Trade surplus rose by 61.4% to a record USD 54.47 billion. The sharp decline in exports and imports mean that there is a risk that country will miss its growth target of 7.5%, as both domestic and external demand are weak.
On the Inflation front, China has seen weak consumer price inflation, which is at a five year low level of 1.4%. Weak inflation data is hinting that demand is falling in relation to supply.
China is already suffering from weak investments due to mounting bad debt, which rose the most in about five years, up 72.5 billion yuan (USD 11.8 billion) to reach 766.9 billion yuan in the third quarter. Bad debt is at 1.16% of total lending, up from 1.08% seen in the previous quarter. Latest investment data shows that fixed-asset investment, an important driver of growth, expanded at its slowest rate in nearly 13 years. It grew 15.8% in the first 11 months compared to the same period year ago, in line with market expectations but slowing from a 15.9% rise in the first 10 months.
PBOC, was till recently, ignoring the voice raised by the government and financial markets and corporate sector to cut interest rates as it felt that easing credit driven by lower rates would worsen China’s debt problems and put the economy at greater risk.