SinoInsight 1
According to mainland media reports, the chairman or actual controller of 13 A-share listed Chinese companies were either arrested or investigated this year on a range of criminal charges, including insider trading, market manipulation, bribery, illegal disclosures, illegal absorption of public funds, embezzlement, and the issuance of fake invoices. Their arrest caused shareholders to sustain heavy losses.
OUR TAKE
1. It is an open secret that there are many problems with China’s stock market. The Sino-U.S. trade war has caused many hidden problems to bubble up to the surface. We previously issued several warnings on China’s stock market this year; China’s stock market has a reputation of being a “casino,” and investors are taking very large speculative risks by entering the A-shares market.
2. We wrote on a number of occasions that China’s economy will continue to deteriorate in the second half of 2019. Recent official economic data for July supports our analysis, and we expect to see more signs of economic and financial weakness. We have a pessimistic outlook on China’s stock market, and anticipate more negative news to surface in the coming weeks and months. In particular, pledged shares in China are in danger of meltdown and are a dangerous time bomb.
The problem of pledged shares can be seen from the recent devaluation of the renminbi. After the RMB fell below the 7 mark on Aug. 8, over 85 A-share stocks fell to record lows during the week. And as of Aug. 6, a total of 3,573 public companies had pledged shares worth a total market capitalization of 4.5 trillion yuan. Haitong Securities estimated that 1.2 trillion yuan worth of pledged shares, or 27.5 percent of all pledged shares on the A-shares market, have fallen below the designated threshold that would force a sell-off. A large-scale pledged shares meltdown will have a significant impact on China’s financial system.
3. Recently, both China and the United States have signaled that they will continue to negotiate until a trade agreement is reached. If international investors are optimistic about the prospects of a Sino-U.S. trade deal and China accelerates the opening up of its financial markets, then foreign investments could pour into China’s A-shares market. This phenomenon, if it does occur, will lower and delay the risks of a mainland market meltdown.
4. Given our long-term research into the Chinese Communist Party, we are not optimistic about the prospect of a Sino-U.S. trade deal or improved relations between both countries. Even if both sides reach a compromise, all signs of goodwill are only temporary and a sharp collision is unavoidable.
SinoInsight 2
On Aug. 16, Chinese premier Li Keqiang presided over a State Council executive meeting to discuss the lowering of real interest rates through market-based reform measures and the easing “financing difficulties.” The State Council decided that existing benchmark interest rates will be replaced with a new Loan Prime Rate (LPR). The meeting also decided to “realize” the cutting of financing costs of small and micro enterprises by 1 percentage point within the year.
On Aug. 17, the People’s Bank of China announced that it would implement the LPR mechanism on Aug. 20. Commercial lenders are required to set the price for new loans to businesses and households with reference to the LPR, and must adopt the LPR as a pricing benchmark in floating-rate loan contracts.
OUR TAKE
1. We believe that the PRC government introduced the LPR reform to resolve the issue of financing the real economy and curb the phenomenon of enterprises profiting from arbitrage that resulted from central bank stimulus measures.
In China’s economic environment, central and state-owned enterprises naturally enjoy an advantage in borrowing from the banks. However, the central and state-owned enterprises often abuse their easy access to funding to profit from lending to others or investment in wealth management products instead of using the funds to grow their main business and the real economy.
In December 2015, Xiang Songzuo, then chief economist at the Agricultural Bank of China, observed that “virtually all SOE main businesses are operating at a loss. How are they making money? Through side businesses, of which one is financing or financial arbitrage. This is a scary phenomenon, my friends.”
2. The PRC government’s problems with funding and growing China’s real economy is a reflection of institutional issues brought about by the CCP’s authoritarian system. The problems will unlikely disappear so long as the Party remains in command.
While small and micro enterprises will see their financing costs cut by 1 percentage point, we believe that this change is too small to mitigate the impact of the Sino-U.S. trade war.
3. Li Keqiang stated in his March 2018 government work report that the central government will cut taxes for enterprises. However, the State Council has been harping on the issue of tax cuts for a year and a half, a sign that the central government is finding it hard to achieve progress on this issue in the provinces. Thus, we remain deeply pessimistic about China’s economic prospects under the CCP. An interest rate reform will not be enough to save China’s economy.
