Zhou Xiaochuan, governor of the People’s Bank of China, has warned about China’s mounting debt levels over the weekend, telling the the China Development Forum in Beijing that corporate lending as a ratio to gross domestic product had become too high, ensuring the need for the country to foster more robust capital markets.
“Lending as a share of GDP, especially corporate lending as a share of GDP, is too high,” Zhou told the conference according to Bloomberg.
He suggested that one option available to the nation was to develop “robust capital markets”, suggesting that China should channel more savings into capital markets, helping to reduce corporate leverage and boost equity financing.
Zhou’s remarks came just two days after a statement from the China Securities Finance Corporation (CSFC), a state-backed agency that provides funding to Chinese brokerages for margin lending, that it was to restart loans for stock market investment, slashing lending rates to provide an added incentive for investors.
The timing of the two announcements — the first from the CSFC and then from Zhou — is hardly a coincidence.
In fact, they’re from exactly the same play book regulators used two years ago to whip up a speculative frenzy in the nation’s stock market.
In mid-2014, facing a hot housing market, increased corporate indebtedness and a reluctance from households to invest in anything outside of property, the government went on a PR blitz through its network of state-run media outlets, pushing the merits of stock market investment to the greater Chinese populace.
The reasons for doing so were simple.
Strong stock market gains would help to limit funds flowing to property, draw savings from households and allow firms to replace existing debt with equity, freeing up corporate balance sheets.
Initially the plan worked. Stocks ripped higher, more than doubling in less than 12 months, providing the environment for firms to swap debt for equity using household savings to purchase new stock issuance.
However, on the back of rampant speculation, a complete disregard for fundamentals and increased use of leverage, the market subsequently tanked, losing 50% from mid-2015 to early February this year.
Many firms missed the window to improve their balance sheet positions, ensuring the wild price action in stocks delivered little benefit to firms or investors alike. Indeed, some may even deem the government-led market experiment as an embarrassing and unequivocal failure.
Now, facing a similar scenario to what was seen in 2014, it appears that Chinese policymakers are going to have another crack at capital market reform.
The heat in some major housing markets is back, stocks are comparatively cheap compared to recent history and corporate debt levels are continuing to grow, drawing the warning from Zhou over the weekend about the need to develop robust capital markets.
Now, as was the case in 2014, the government is providing incentives to potential stock market investors. Margin lending — despite a less than impressive track record — is being actively encouraged, and Chinese stocks are heating up.
The benchmark Shanghai Composite has added 14% since the beginning of March, outpaced by gains of near 20% for small cap indices such as the CSI 500 and ChiNext indices.
The speculative frenzy is gaining momentum, fueled by the same factors that drove the boom-bust cycle seen in the past two years.
While is easy to see why Chinese policymakers want to see the stock market rally, one has to wonder why debt, and indeed short-term debt via margin financing, is being pushed by policymakers to exacerbate market returns.
That, along with valuations that were devoid of any fundamentals, were almost entirely behind the stock market crash that began on June 12 last year.
To think that now will be different, less than one year on, is highly debatable.
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