Beijing lets punters sink
By Wu Zhong, China Editor

HONG KONG - China's stock market last week suffered the largest weekly plunge in 12 years with the benchmark Shanghai Composite Index dropping below the 3,000-point mark, which has been widely seen by investors as a government defense line. Pessimistic sentiment now prevails as there is no sign that the government will take immediate measures to "rescue" the market.
Many analysts and investors are now beginning to blame Beijing's macro-economic control policy and measures to curb price increases for weakening profitability of heavyweight listed companies and thus shaking up market fundamentals.

On Friday, June 6, the Shanghai Composite Index, which covers yuan-denominated A shares and US dollar denominated B shares, closed at 3,329.67 points, down 21.98 points from the  previous close. The Shenzhen Component Index fell 126.30 points to 11,733.97 points.

During the long holiday weekend of June 7-9, the People's Bank of China (PBoC), the country's central bank, ordered commercial banks to raise their deposit reserve ratio by another one percentage point. This was the fifth such move this year to curb excessive liquidity and tame inflation. With the latest increase, the deposit reserve requirement for commercial banks is now 17.5%, a record high.

The news triggered a dark week for the stock market, with a continued plunge for four trading days of last week taking shares to a 15-month low. The Shanghai Composite shed 461 points, or 13.84% to 2,868.8. The Shenzhen index lost 1,797 points or 15.32% to close at 9,936.73.

The PBoC's move delivered a clean and sound message that, in order to curb inflation, Beijing would continue to tighten monetary policy, despite the expectation that Beijing might ease the policy after the Sichuan earthquake.

Last Thursday, the National Bureau of Statistics said China's consumer price index (CPI) dropped to 7.7% year-on-year in May, from 8.5% in April. Even so, the inflation indicator rose 8.1% in the first five months over the same period last year, still much higher than the 4.8% target for the whole of this year set by Premier Wen Jiabao in March.

Officials and economists are still worried that multiple factors, such as ample liquidity, may push up prices again in the coming months. In May, the country's money supply growth accelerated to 18.07% year-on-year from 16.94% in April. Now it is widely expected that the central bank may raise interest rates by at least 75 basis points and the deposit reserve ratio to 18.5% this year.

Bad for banks
Raising the deposit reserve requirement is bad news for banks' shares, as they have to put aside more funds received from depositors as reserves rather than lending them out. Of the top 20 heavyweight stocks in the Shanghai Composite, 12 are of financial companies whose capitalization accounts for more than 25% of the Shanghai bourse.

Last week, shares of Industrial and Commercial Bank of China shed 13.46% to close at 5.08 yuan, China Construction Bank lost 10.62% to 6.23 yuan and Bank of China dropped 10.85% to 4.19 yuan. These three are the largest of the "Big Four" state-owned commercial banks. The fourth, Agricultural Bank of China has yet to go public.

The A shares of Shenzhen-based China Merchants Bank, which is listed in Shanghai and Hong Kong, lost 17.07% in Shanghai to close at 23.32 yuan.

Beijing's control over energy prices has also increased fears that the profitability of leading energy enterprises such as PetroChina, Sinopec and China Shenhua, will be hit hard this year as the price of crude rises.

Last week, international crude oil prices exceeded US$130 per barrel with no sign that the government will soon allow oil companies to increase oil products' prices. As such losses at the refinery businesses of listed oil companies will deepen.

At the same time, the Sichuan earthquake last month has worsened China's electricity shortage. An electricity exporter before the earthquake, thanks to its numerous hydropower stations, Sichuan now has to import electricity from other regions due to damage to various parts of the province's power-supply network.

The nation faces a power shortage in June, July and August of up to 10 billion kilowatt-hours, according to the State Electricity Regulatory Commission, with the reversal of supply in Sichuan aggravating an already dire power crisis, brought about by an apparent shortage of thermal coal, the main fuel in China for electricity generation. The price of thermal coal is set by the market but the government controls the electricity price. With costs increasing, coal producers tend to increase coal prices, which increases pressure for power generators to seek higher electricity prices.

The Chinese government has resisted this, apparently in fear of further stimulating inflation and stirring public discontent, particularly in the aftermath of the Sichuan earthquake and ahead of the Olympics in August. Instead, it has intervened in the market.

Early this month, the State Council issued a circular demanding that all regions ensure sufficient supply of thermal coal so that there will be adequate power supply during the Olympics. Seeing this as a political task, at least at least three provinces - Shandong, Shaanxi and Hunan - have taken administrative measures to restrict thermal coal price increases.

Bad for power firms
No doubt, such intervention will hurt listed coal producers such as China Shenhua. Price control on electricity also hurts profitability of power companies.

Only three energy companies are among the top 20 companies in the Shanghai Composite - PetroChina, Sinopec and China Shenhua - although their capitalization accounts for more than 30% of the Shanghai bourse.

Last week, A shares of PetroChina shed 12.7% to close at 14.99 yuan, Sinopec lost 16.41% to 11.26 yuan. China Shenhua dropped only 6.98% to 39.43 yuan, but that was enough to bring its total decline over the past four weeks to 19.75%.

At a crude price of $130 a barrel, refineries would lose up to 3,000 yuan in producing one tonne of refined oil product, according to one estimate, giving total losses of the two oil giants, Sinopec (the country's largest refiner) and PetroChina of 220 billion yuan. So, unless the government sharply increases its subsidies to their refinery business from last year's 77 billion yuan, the duo's profitability will inevitably be hurt this year. And given their weight in the Shanghai Composite, their weak share prices would suppress the market - encouraging local punters to call them the "two big bears".

The two bourses in Shanghai and Shenzhen together have lost more than 12 trillion yuan in capitalization since last November, according to research by Lin Yixiang, board chairman and chief executive of Beijing-based TX Investment Consulting Co. PetroChina alone lost 4.3 trillion yuan, accounting for 35% of the total.

Power-consuming enterprises are feeling the crunch from the electricity shortage. China Aluminum, the country's largest aluminum producer, has had to suspend production of its factories in some regions such as southwest Guizhou province. The company's A shares dropped 20.83% last week to 14.48 yuan.

The decline in the stock market in neighboring Vietnam also had a psychological impact on investors in China on worry that the financial meltdown in Vietnam might trigger another Asian financial crisis similar to the one of 1997, according to some analysts. Economists on the mainland and in Hong Kong generally thought this was unlikely. The Vietnam stock market last week was down 63% over the same period last year.

Mainland China stocks have declined since October, when the Shanghai Composite hit a high just above 6,000. The latest slide comes after a recovery last month after the government in late April cut the stamp duty on stock transactions to 0.1% from 0.3% and placed restrictions to limit stock sales by a single shareholder. This helped to boost the Shanghai Composite from near 3,000 to above 3,500 in the following couple of weeks.

Bad for bears
But last week, Beijing showed no sign that it would take any similar measure to rescue the market. Instead, the Politburo, in a meeting last Friday chaired by President Hu Jintao, pledged to make greater efforts to tame inflation, though also saying it would promote the healthy development of the capital markets. On the same day, the PBoC reiterated in its annual financial stability report that it would take "forceful" measures to curb excessive price rises and enhance monitoring of cross-border capital flows.

To that point, small investors become totally disillusioned. According to a survey by Securities Times, over 70% of small investors say the market now is really dominated by the bear. More than 70% of respondents did not think the government would take immediate measures to rescue the market and thus they plan to sell their holdings despite losses.

Saturday editorials of major business newspapers in China were split over whether the government should rescue the market. A commentary on Shanghai Securities News said the government should take "disaster relief" measures to help the stock market. Others said that with the recent adjustment, the value of the market had became more reasonable.

The price-earnings ratio (based on 2007 results) is now 21.61 in Shanghai and 26.4 in Shenzhen, according to figures from the two exchanges. At their peaks last October, Shanghai's P/E ratio was 69.58 and Shenzhen's 73.51.

An editorial in the International Finance News, a sister publication of the Communist Party's flagship newspaper, the People's Daily said, "In fact, in a rational view of the current market, its value now comes to a reasonable level ... Even if our national economy slows down a bit, it would be a self-correction in the road of progress. This by no means the coming of an economic crisis. Our economy will sustain its growth at a relatively high speed of 7-8%. The long-term outlook is no doubt good."

Some fund managers, such as Harfor Funds, China Nature Asset Management and AIG-Huatai Fund, also said that after recent drops Chinese shares have become more reasonable in their values.

Many analysts now believe there is not much the government can do to rescue the market unless it wants to ease its price controls or directly intervene to buy shares with public funds. The possibility of either event transpiring seems almost zero at this stage.

"What the government could do is to suspend initial public offerings and refinancing plans by listed companies, and/or allow more funds from banks or insurance companies to enter the market,'' A Shenzhen-based stock analyst with Nanfang Securities said. "Thatís almost all. But such measures may not be as effective as before to restore investors' confidence under the current circumstances, as they now believe the fundamentals of the stock market are being shaken up by Beijingís intensified macro-economic controls.

"Apparently, the stock market seems to be truly becoming a barometer of the country's macro economy. So why should anyone complain?"

In fact, it would be abnormal if the stock market went up while the economy is expected to slow as Beijing strengthens credit tightening and price controls.

As the government is unlikely to give up its price controls on energy and food this year, the stock market is also unlikely to take a sharp upturn. It is now generally believed that the market will have an initial support at 2,800, with its bottom likely to be at 2,660.

(Copyright 2008 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)