My Blog

April 24, 2008

Last night the Ministry of Finance and the State Administration of Taxation announced that the stamp tax on the purchase and sale of stocks would be cut from 0.3% to 0.1%.  Today, in response, the Shanghai Composite Index surged 9.3%.  According to an email earlier today from my teaching assistant Shang Ning, “the index opened up 7.98% today, and closed 9.29% higher.  A fucking crazy day, volume more than doubled over yesterday. At 1:30, the index reached its lowest level, roughly 5.6% up, and then it turned, shooting up.”  He’s been speculating on warrants and from the excited email message I think he may have made a couple of bucks today.  I should see if I can get him to pay for dinner tonight.

The cutting of the stamp tax was a widely-anticipated reversal of the move last year, on May 30, when in order to cool what seemed like a vastly overheated market, the stamp tax was raised from 0.1% to 0.3%.  The market fell 6.5% the next day, and lost another 6.5% that week, if I remember correctly, but not for long.  It quickly turned around and returned to its dramatic rise, surging another 75% or so to reach 6124 on October 16.  Government attempts to manage stock market prices in China do work, for a while at least.

Since its peak in October, however, the market has plummeted to just below 3000 on Tuesday, losing over half its value, and creating a great deal of concern for the government – China’s is the world’s worst performing stock market year to date.  The government is afraid both that the continued market slump may anger the newly-emerging urban middle classes and that it may translate into reduced consumption as savings are eroded (although according to Andy Rothman at CLSA at its peak the total market cap of traded shares was only about 36% of GDP, and is much less today). 

This was not the government’s first move to try to kick-start a rally.  On Sunday night, as I discussed in my Monday entry, the CSRC announced restrictions on the ability of owners of previously locked-up shares to sell their shares in the market.  This was designed to address fears of a selling overhang, and although it couldn’t have had much fundamental effect as far as I can see, it was transparently a signal that the government wanted the market to trade up.  Sure enough the market shot up nearly 7% in the morning before giving away nearly 90% of the gains over the rest of the day.

Since that announcement was not enough, the government made its next big signaling effort last night and reduced the stamp tax.  I have discussed in earlier entries that this was much-rumored during the past few months.  Because of the big negative impact of raising the tax last May, there was a very widely held assumption that lowering the tax would have an equally large but positive impact.  Actually, and evidence if any was needed that insider information is a main determinant of profitability here, the market was up 4.2% yesterday before the announcement was made.  Perhaps just a lucky guess.

No one doubted that this tax move represents fairly blatant signaling by the government.  Today’s Bloomberg quotes Wei Wei, an analyst at West China Securities Co, saying “It's a clear signal from the government that it thinks of the decline as overdone.”  And according to today’s South China Morning Post “internet chat rooms carried messages praising government officials believed to be responsible for the tax cut.” 

This is pretty typical of how most investors view the change in the stamp tax.  It has no real fundamental effect but it signals government intentions, and in China the main driver of the stock market is still perceptions of government intentions.  This is definitely not a good thing.  My friend Mark Williams of Capital international is quoted in today’s Financial Times as saying “The government’s continued efforts to manage the level of prices condemns the equity markets to further volatility.”  I am afraid he is right.

But how effective will this move be in keeping the market from sagging further?  Sunday’s move created a real frisson of excitement Monday morning, but it quickly fizzled out.  Last night’s move has already been far more effective, but the reported doubling of stock trading volume today doesn’t indicate to me that people were excited about holding onto these newly-valuable stocks.  I would almost read it as professionals taking advantage of higher prices to shift shares into the hands of retail speculators.  Let’s see how firm the rally is over this week and next.  If it too fizzles out, government intervention is going to lose even more credibility – something that will surely happen soon enough anyway.

At any rate given how far it has come off since October is the market finally fairly valued?  According to Bloomberg the market is priced at roughly 21 times earnings.  This is not cheap, but with real interest rates negative (and declining in real terms), and with GDP growth still very high, this might suggest that certainly for ordinary Chinese stocks are a pretty good alternative to bank deposits, and for the rest of us they are a reasonable play on Chinese long-term growth.   

Still, we might need a period of stability and rising prices before Chinese or foreign investors jump back in.  It is worth noting, by the way, that B-shares, which have all the rights and dividends of A-shares but trade in foreign currency and can be purchased by foreigners, are trading at discounts to A-shares of 35-45%.  One can make a very plausible argument that they are a great medium-term buy, especially if, as is widely expected, the distinction between the two is eventually eliminated and B-shares are converted into A-shares.

Of course before jumping in it is worth noting that the government is still signaling that it is concerned about the need to tighten the economy further.  According to today’s South China Morning Post:

People’s Bank of China governor Zhou Xiaochuan has called for further monetary tightening and said the central bank would step up measures to cope with economic uncertainties at home and abroad.  In a speech to an internal meeting of central bankers, Mr. Zhou said further tightening was needed despite the current austerity policy already having an impact.

The PBoC’s website, which published the speech, had Zhou saying that the PBoC should make greater efforts to slow overly fast growth in the money supply, although he also called for increased lending to support the agriculture, services and consumers sectors.

Most people believe that attempts at monetary tightening and lending controls will continue, although in my lunch with a senior Chinese banker yesterday I was told that it is mostly the small- and medium-sized companies that are taking the full brunt of loan growth constraints.  According to him, many of these companies seem to be turning to the informal banking sector for working capital loans.  Loan growth, in other words, may be higher than the PBoC thinks because of non-regulated loan growth in the informal banking sector.

How much more tightening do the authorities want?  Although I am skeptical that they have the tools to mange monetary policy, I had suggested in earlier entries that the minimum growth they would accept would probably be determined by the amount of growth needed to keep unemployment for accelerating.  I speculated that this might be around 10%.  Today’s Bloomberg has an interesting variant on this.

China should stick with its tight monetary policy unless the economy's expansion slows to below 9 percent, a National Bureau of Statistics official said. “Below 9 percent, it means the tightening is overdone and needs to be loosened,” Zheng Jinping, the bureau's chief engineer, said at a seminar in Beijing today.  

…China can't afford a sharp slowdown because it needs to create jobs, reduce poverty and continue with urbanization, he added.

Zheng then said “A reasonable combination for this year is 4.8 percent inflation and 9.7 percent GDP growth,” adding that inflation might come in between 4.5% and 5.5%.  At the same seminar Fan Jianpang, the State Information Center's economic forecast chief, said “As long as inflation can be kept below 6 percent, there's no need for further tightening measures and economic growth should be able to stay strong.”

I don’t know if they are saying this because they believe it or because they are simply observing the official line, but inflation is not going to come in below 6% in 2008.  I am pretty sure of that.  So apparently are others.  According to the same Bloomberg article, and in reference to a 5.5% inflation forecast for 2008 by the Chinese Academy of Social Sciences, “The central bank’s forecast is ‘more pessimistic’ Wang Yi, an official with the central bank's research and statistics department, said today, without giving a number.”  I’ll bet it is.

Comments (6) for "Stock market rises 9.3%"

Thanks for yet another information-packed & insightful post, Prof. Pettis. Your blog has become a daily read for me. Keep up the great work. By David Geise - 4/24/2008 1:42 AM

I remember seeing it somewhere that the amount of stamp duty tax the government collected last year was more than the total dividends paid out of the entire stock market. This seems to me as if 1) the government is competing for profits with its people; 2) the stock market therefore is left with no fundamental investment values but but pure gambling. What is the point of imposing this stamp tax in the first place? By Megatone - 4/24/2008 9:40 AM

Back in the spring of 2007 the Chinese government wanted people to spend more. I think they had cut the interest rates or something so that it would not be profitable to save in banks. But instead of spending more people just tranferred their savings to the stock market. This led to a huge bubble and the government decided to premptively burst the bubble, which was probably wise. As long as Chinese people feel insecure about the future, as long as the don't have adequate protection, such as social security and insurance, they will probably continue to save, although they might By orgulous - 4/24/2008 9:19 PM

Since the 1996 Boskin Commison report, the official CPI bear little resemblance to real cost increases on main streets, through its recommended substitutional (if pork price rises to the sky, but chicken is not, then chicken cost is disprotionately inputed into the calculator) and hedonic adjustments (if a new car model comes with two extra airbags, the perceived 'economic' value of those extra airbags is inputed to negate the price increase of the new model). I can only presume all central banks and govt agencies assigned with compilation of CPI numbers are dancing to the same tune of CPI suppression. To understand more on how CPI calculation has transforned since the Boskin Commission, try http://www.financialsense.com/stormwatch/2005/0624.html By Kheng Giam - 4/25/2008 7:08 AM

Megatone, I think the justification for a stamp tax, besides the revenue generation, is the same as that for the so-called "Tobin tax", in which a small increase in the frictional cost of trading is supposed to reduce the benefits for traders that turn over positions very rapidly – largely speculators. The goal of the Tobin tax is to create disincentives for speculation. One problem, as I see it, is that in a market that can easily move up or down by 5% in a day, like the Shanghai and Shenzhen markets, a tax of 0.1-0.3% doesn't seem like much of a disincentive to speculate. Orgulous, I think you are right that the lack of a safety net creates strong incentives for households to save, and holding large amounts of liquidity in negative-real-rate bank accounts may create incentives for speculative bubbles. By the way, much of the recent increase in savings seems to have come from the corporate sector. There may be ways – i.e. by requiring higher dividend payments – to reduce savings, and incidentally this might also help address the agency problem among Chinese SOEs. Kheng Giam, the CPI measurements are problematic everywhere. There is an additional problem in China that you don't have in the US or Europe. For all their imperfections the CPI baskets in developed countries can present reasonable proxies for consumption because the real consumption baskets are quite stable. The CPI basket might not be totally accurate but at least the inaccuracy is “random” and not likely to be biased. In an economy like China's that is changing so rapidly and undergoing massive rural-urban migration and social transformation, even if it were possible to construct an ideal CPI basket the basket would be hopelessly out of date within a very short time. By Michael Pettis - 4/25/2008 5:19 PM

It seems we are spending so much time and energy tracking these CPI numbers which sound more slippery than an eel. Those in charge of signing off on each CPI release want the numbers to be low, or lower. The outcome is we either due to powerless ignorance or lack of a better choice, started to accept those artificial numbers. It is like slowly boiling a frog in a big pot of water from cold. The frog doesnt know the temperature is rising, until it is too late. The 'lower' CPI enabled artificially lower rate across the spectrum. It also directly fosters strings of asset inflation which are not captured in CPI measurements. A good example is how 'owners equivalent rent' (govt's estimate of how much rent an owner is likely to charge him/herself) tends to drop when house prices go up! Back in the mid 80's, fresh out of college, I remember mortgage rate as high as 16%. That eventually ushered in a 'severe' recession, but nowadays, a 5.25% FedFund Rate is enough to tip the economy in a 'depression'? Official CPI numbers around the world are now coherently trending higher. Sooner rather than later, our frog in the pot will begin to wonder why the water is feeling hotter than what the thermometer reads. By Kheng - 4/25/2008 8:15 PM