Inflation in China surges to two year high

Chinese inflation rose to its highest level in more than two years, raising renewed concerns about potential fallout of the sizzling growth in the economy. The surge in inflation is mainly driven by soaring prices for pork and other food items. According to government figures released Tuesday, consumer prices rose by 3.4 percent in May, while food prices jumped 8.3 percent from a year ago.

A rise in food prices is politically sensitive, as it will affect the common masses who have not benefited from the prosperity generated by the country's two-decade-old boom. Beijing has adopted a series of monetary measures aimed at cooling the economy and the latest inflation figure may induce further tightening.

Chinese Stocks : Rebound from Free Fall

China's stocks have been in a virtual free fall since the government tripled the tax on securities trading on May 30. The slide has wiped out more than $500 billion of market value - more than the combined GDP of Taiwan and Singapore.

The benchmark Shanghai index closed more than 8% lower on Monday on concerns that the government is set to launch further measures to cool the gravity-defying rise, including a capital gains tax. On Tuesday, a late rally saw the market rebound to finish more than 2.5% higher after a volatile day of trading that saw a 7% decline earlier in the day.

In an apparent bid to reassure investors, editorials in official newspapers have said that the market's medium- and long-term outlook was still positive, and that the tax hike was merely aimed at speculators. Terming the fall as a healthy short-term correction that won’t hurt the “bull run”, the newspapers have advised investors to take a long-term view of the development of the Chinese capital markets and the importance of the financial reforms.

The meteoric rise of the Chinese stock market has led to widespread fears of a bubble-in-making and warnings of dramatic corrections. Significantly, global markets, which were shaken by a heavy Chinese market sell-off in late February, appear relatively calm to the latest meltdown.

Will the Bubble Burst?
Chinese Stocks Plunge as Transaction Tax Trebled

China's main share index has fallen 6.5% in Wednesday trading following the government’s decision to triple the tax on stock transactions. The move is seen as an effort to cool the overheated market that has led to fears of a possible bubble.

The Shanghai Composite Index had risen 62% this year to Tuesday's record close and has quadrupled in value since the start of 2006. Last week former Federal Reserve chairman Alan Greenspan warned of a looming correction in the Chinese stock market.

It’s the unprecedented demand from domestic investors that has fueled the rally. There is a flood of fresh money from millions of new investors – including students and pensioners - sinking their savings into the stock market in the hope of super returns as there is a scarcity of other investment options.

The number of stock trading accounts has risen to about 100 million, with tens of thousands being opened every day. It is reported that 300,000 people a day opened brokerage accounts last week. The finance ministry is tripling the stamp tax on stock trading to 0.3 percent, from 0.1 percent, effective Wednesday. Although investors are sanguine about growth prospects and many feel that the correction may be short-lived, there are fears that the government will follow with more steps to curb speculation and excessive flow of money into the stock market.

China Continues Credit Tightening, Raises Reserve Ratio Again

China’s central bank announced another increase of 0.5 percentage point in the reserve ratio effective May 15. Big banks will now be required to hold 11 percent of their deposits in reserve at the central bank. This is the latest in the series of measures the People’s Bank of China has been taking to cool down credit and investment growth - fourth increase in reserve requirements this year and seventh in past one year. Over the past year, the central bank has also raised interest rates three times - most recently on March 17.

The central bank of the word’s fourth largets economy has been struggling to sterilize a surfeit of liquidity largely flowing in from the burgeoning trade surplus and capital inflows. The excessive liquidity has given rise to worries of potential asset price bubbles. In particular, the easy money has been fueling rally in the domestic stock market which is being considered unsustainable. Chinese stocks have risen 40 percent this year on top of a 130 percent leap in 2006.

China raises reserve ratio

In a move to temper the staggering pace of economic growth and curb inflationary pressures, China's central bank has raised the reserve ratio by 50 basis points. Commercial banks will now be required to set aside 10% of their deposits in cash reserves. This is the second hike in 2007 and fifth since last July.

The People's Bank of China is concerned that continued growth will stoke consumer prices as the economy marks a record trade surplus. Mounting trade surplus along with strong FDI inflows are adding to the excessive liquidity in the banking system and the central bank has taken a slew of measures to slow the pace of lending.

"Since 2006, the People's Bank of China has used a combination of monetary tools to soak up liquidity in the banking system and has achieved some results," the central bank said in a statement posted on its web site. "But the surplus in international payments remains large and the pressure on loan expansion is still relatively big so it is necessary to again increase the reserve ratio," it said.

China's economy, the world's fourth-largest, expanded 10.7% in 2006. And consumer prices returned a rise of 2.2% for the month of January - lower than the previous month's 2.8%, still high enough to call for continued tightening bias.

China hikes reserve ratio to cool liquidity growth

In a bid to rein in bank lending and cool liquidity surge in the booming economy, China's central bank has announced another increase in the reserve requirements. The 50 bps hike will be effective from 15th January, bringing the effective rate to 9.5% and follows a series of tightening measures last year - three 50 bps hikes in the reserve ratio and two 27 basis-point hikes in lending rates.

Chinese monetary authorities are worried about the prospects of an overheating in the economy and surging liquidity leading to asset price bubbles. Controlling liquidity has, therefore, been a high priority. The central bank has expressed concerns on various ocassions about the surfeit of liquidity in the system and is expected to follow-on with more rounds of hikes. The "excessive" liquidity in the world's fastest growing economy is building up from large trade surpluses and capital inflows.

An update on ICBC IPO

After raising US$21.9 billion in the world's largest IPO, the Industrial & Commercial Bank of China (ICBC) has made its debut in China's first simultaneous listing on Shanghai and Hong Kong markets. While the Shanghai debut was a bit uninspiring with a modest gain of just 5 percent, the Hong Kong listing was along the expected lines marking a gain of 15%.

The IPO was oversubscribed 26 times. Four of China's banks have come out with initial public offers in the past one year and have seen strong demand particularly from overseas investors. China's surging economy, which is set to grow by more than 10% this year, has created strong demand for these banks’ shares. However, there are fears that banks have been overvalued, with questions raised over levels of bad debt.

Here's a list of the world's 10 largest IPOs till date (source: Reuters). It can be seen that 3 Chinese banks figure in the list.

Date Company Size (Billion USD)
Oct. 20, 2006 Industrial & Commercial Bank of China 21.9
Oct. 12, 1998 NTT Mobile Communications 18.4
Oct. 31, 1999 Enel 17.4
Nov. 17, 1996 Deutsche Telekom A.G. 13.0
May 24, 2006 Bank of China 11.2
Apr. 26, 2000 AT&T Wireless Services Inc. 10.6
July 14, 2006 Rosneft 10.4
Nov. 15, 1997 Telstra Corp Ltd. 10.0
Oct. 20, 2005 China Construction Bank 9.2
Nov. 18, 2005 EDF 9.0

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What makes Chinese banks hot?

The world's biggest initial public offering coming from the largest bank of the world’s fastest growing economy has seen huge demand from institutional investors from across the world. The Industrial and Commercial Bank of China (ICBC) plans to debut in Hong Kong and Shanghai on Oct. 27. This will be the first IPO to be simultaneously listed on both stock exchanges.

If priced near the top of the range (which is almost certain), the issue will garner US$22 billion, beating the record of $18.4 billion set in 1998 by a Japanese mobile-telecoms operator NTT Mobile Communications Network Inc. The sale will also place ICBC among the ten most highly valued banks in the world, with a market capitalisation close to $130 billion.

ICBC is the latest in a series of massive IPOs launched by Chinese banks during the past year. Bank of China, the country’s second largest lender, raised US$11.2 billion with an IPO that was the fourth-largest on record. China Construction Bank, the mainland's no. 3 bank, raised US$8 billion in October 2005.

What makes Chinese banks ‘hot’? It’s the strong growth recorded by these banks in the sizzling economy that is luring the institutional investors. There is a scramble among the financial powerhouses of the world like Goldman Sachs, Morgan Stanley and Citigroup to gain a foothold into the Chinese banking system. For them, these banks are a sort of a proxy for China itself: vast, diverse, growing fast, and with extraordinary scope for internal restructuring. Economist terms the ICBC IPO as a single transaction that could sum up the knowns and unknowns surrounding China's red-hot economy. According to an Economist article, “…ICBC, however valuable, also reflects the murkier side of life in the Chinese economy. Political considerations often come first, information is unreliable, and openness in the banking system is questionable, despite conditions tied to China's entry into the World Trade Organisation.”

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