From News, page 4, issue 373, June 23, 2008
Translated by Zuo Maohong
Original article: [Chinese]

The stock market tumbled. The real estate market stagnated. Capital retreated. Hot money vanished.

The above is only one side of the coin. The other side is climbing bank deposits and massive capital lurking in the banking system, and yet more and more companies are denied loans and resorting to costlier underground fundraising.  

For some economists, the scenario is not a bizarre one, but inevitable for China as it undergoes a long period of rapid growth.

Dampened Stock Markets
In the past two weeks, the Shanghai Composite Index slumped by 19.2% from 3459.04 points to 2794.

Back at the end of 2007, the A-share market was valued at 32.71 trillion yuan. On June 19, 2008, however, this number fell to 17.81 trillion yuan, indicating that within six months, 40% of its wealth had evaporated.

China Galaxy Securities (CGS) analyst Zhang Xinfa concluded: "The main reason lies in the panic over a slowdown of the economy."

The ideal growth model for the Chinese economy could have been broken in 2008. There would be risks of China's GDP slipping, as inflation would remain high, and unemployment likely to increase.

Other lurking problems include climbing global prices for oil and food. Meanwhile, the dollar's depreciation has led to fewer exports; overheated investment has caused excess liquidity, which has also been accumulating with rising trade surplus.

Moreover, the real interest rate remains negative while the exchange rate continues to pose challenges; profit outlook for the corporate sector appears grim and the Producer Price Index (PPI) keeps soaring.

The question is, if capital is retreating from the stock markets in view of a weaker macro economic outlook, where has the money gone to?

The Disappearing Seesaw Effect
According to the "seesaw effect" of investment between the stock and real estate, this money should have gone to the latter.

China International Capital Corporation (CICC) macroeconomic analyst Xing Ziqiang observed that investment in the real estate continued to go up despite tighter credit controls.

Since the end of 2006, China has tightened credit to real estate developers. Therefore, bank loans to these companies dropped from January 2007's 34% to the current 20%. In this same period, however, investment in real estate rose from 24% to 31.9%.

What's the source of such investment? Xing asked. He thus concluded that the money that had vanished from the stock market had gone to real estate.

However, the "seesaw effect" seems likely to disappear too; while the stock market is falling, the real estate market is also on the verge of a crash. By estimation of some industry watchers, a collapse of real estate prices may occur as early as August.

"In years when there's a lack of capital, there do exist a 'seesaw effect'. But since 2006, there has been plenty of money and bubbles evolved in the markets of stock, real estate, Pu'er tea, and art, amongst others.

"Now these bubbles are bursting," said a private equity fund manager, who wishes to remain anonymous.

Liu Yuhui, director of Institute of Chinese Economy Evaluation under the Chinese Academy of Social Sciences, said liquidity was draining not just from the Chinese market but also from the world's.

Where Has the Money Gone?
If the markets' liquidity is indeed ebbing, the main concern for Chinese would be that of hot money, or speculative short-term foreign investments. Where would it go? 

CICC analyst Xing believed to answer the question, one must first define "hot money".

"Many say 85.1 billion dollars of hot money has flowed into China in the first quarter of this year, but taking into consideration of the rise in non-dollar export prices, this number may drop to around 30 billion dollars," said Xing.

He also noted that capital from Hong Kong residents, who exchanged much of their Hong Kong dollars into yuan during the first four months of this year, wasn't pursuing any short-term interest and thus didn't belong to hot money.

Xing believed much more money had flowed back to banks. "After six raises last year, the interest rate is much higher than two years ago and therefore much more attractive," he explained.

Statistics have also shown a record high of deposit growth in May at 19.6%.

Xing pointed out between 2006 and May 2008, the growth rate of broad money (M2) was lower than that of narrow money (M1), the former covers current deposits only while the latter includes both fixed and current deposits.  

"If M1 grows faster than M2, it means more money is in current accounts, partly because of the vibrancy of the stock and capital markets," he said.

However, this trend was reverted in May 2008, when M2 grew at 18.01% and M1 at a lower speed of 17.8%. "This means the capital flow is against the stock market, and returning to banks, being deposited in fixed accounts," Xing added.

The trend was due to limited choices, he said. Given the current interest rate and inflation rate, depositing money in a bank meant a 3% lost (the gap between the two rates); keeping it at hand meant a 6% lost or more (based on the inflation rate). Yet, investment meant even higher risk of loss.

Companies Short of Money
As bank deposits mounted and monetary policy tightened, companies are actually facing acute shortage of money.

Some banking professionals were pessimistic about the outlook of loans. By May, commercial banks had already reached 59% of this year's loan quota of 3.6 trillion yuan.

While the central bank's data suggested strong demand for credit, there had been tighter policies on lending, which led to higher interest rates in underground markets, Xing said.  

The EO learned that bank loans involved 20% interest rate, of which 8% was meant for the loan itself, and 12% for consultation.

Credit controls had also boosted the pawn industry, which has recorded 50% more businesses than before tight controls, said president of Beijing Huaxia Pawnshop Yang Yongjiu.

In Wenzhou, the powerhouse of private business and capital in China, the yearly interest rate for loans in the black market has climbed to 120%, prompting comment that "only drug dealers could afford loans".

Many companies have shut down or ceased production due to higher financing cost and other factors. According to a report by the Council for Promotion of Medium and Small Companies in Wenzhou, of the 300,000 medium and small companies there, about 20% have stopped or cut production.

Some big state-owned companies have also felt the chill. "2008 will be the hardest year for the Chinese economy. State-owned companies should get ready for tightening their belts for at least two years," chairman of the State-owned Assets Supervision and Administration Commission (SASAC) Li Rongrong warned earlier in February.

"An overwhelming panic over inflation has created an atmosphere of capital shortage. A too tight monetary policy has suppressed corporate investments and therefore lessened profits. There could be a hard landing," CGS analyst Zhang said, adding his firm had adjusted its projected growth rate for China to below 10% this year.

The same worry was shared by Pan Xiangdong, chief macroeconomic analyst of Everbright Securities. "The chance for more tightening is increasing, so is that of a hard landing," he said.