Date
15 December 2017
The People's Bank of China is now more open to cutting interest rates. Photo: Bloomberg
The People's Bank of China is now more open to cutting interest rates. Photo: Bloomberg

China likely to inject liquidity to boost capital markets

China’s A share market posted a whopping gain last year after enduring several years of setbacks.

We believe the authorities have a strong incentive to boost the capital markets by injecting liquidity this year.

The market rally since late November was closely linked to the cut in interest rates on Nov. 21.

And whether the market will sustain its rally has much to do with the future direction of monetary policy. 

We believe the central bank is poised to inject liquidity this year.

The surprise rate cut in November indicated the central bank has dropped its approach of targeted reductions in the required reserve ratio at banks and switched to a more active rate cut strategy.

The strategy shift has come against the backdrop of stubbornly tight liquidity and flagging economic growth.

In fact, the latest reading of the Hong Kong Economic Journal’s Li Keqiang index (a composite indicator of economic growth in China) has dipped below the levels of early 2009 and close to mid-2013, when a major credit crunch occurred.

That shows mainland economic growth is on shaky ground.

We believe the central bank will continue to pump more money into the financial system, which will benefit the A share market this year.

Beijing has a strong incentive to push up the A share market.

The mainland property market has reached a fairly high level, and the last thing the central bank would wish is for the property market to crash, flooding the economy with liquidity.

The capital markets offer another means to absorb excessive liquidity.

A booming equity market would help create wealth and stimulate economic growth. 

Also, it offers another financing channel for listed companies experiencing tight liquidity.

The Shanghai Composite Index may enjoy a potential further gain of 60 percent and hit 4,900 points within the year, if we compare the cumulative gains of India’s stock market since the 2008 financial crisis.

The earnings per share of the constituents of the Shanghai Composite Index have fared better than those of their counterparts in the Indian market.

Therefore, the index may have a good chance of hitting 5,000 points if external markets do not perform too badly.

However, how long the market can sustain its rally depends on economic recovery and the existence of idle capital.

If company earnings fail to catch up with the sharp market rally, profit-taking might take place after the interim results.

It looks set to be a bumpy journey down the road.

This article appeared in the Hong Kong Economic Journal on Jan. 5.

Translation by Julie Zhu

– Contact us at [email protected]

MY/JP/FL

Department of Investment Analysis at HKEJ

EJI Weekly Newsletter

Please click here to unsubscribe