The growth rate of China’s gross domestic product eased to 7 percent in the first quarter.
Some market participants note the red-hot stock market has deviated from the economic fundamentals and say a bubble is building.
Momentum in the mainland market has been largely driven by government reforms and relaxed market liquidity.
In fact, the economic slowdown is partly a result of the ongoing economic restructuring.
It’s quite obvious that the Chinese central bank has to adopt a flexible monetary policy to help the economy bottom out.
In the middle of the first quarter, the People’s Bank of China adopted a set of monetary easing measures to help restore growth.
The PBoC reduced the reserve requirement ratio (RRR) for banks by 0.5 percentage point on February 4, the first cut since May 2012.
And the PBoC reduced the one-year benchmark interest rate by 0.25 percentage point to 5.35 percent and the deposit rate also by 0.25 percentage point to 2.5 percent on March 1.
So, the Chinese central bank has used cuts in interest rates and the RRR to try to stimulate economic growth amid huge capital outflows.
It’s possible a further interest rate cut will be made this month.
Apart from economic restructuring and capital market stimulus, the PBoC could apply bolder and more decisive interest rate and RRR tools.
In fact, the RRR once dropped to a low of 6 percent and was at 9.5 percent in early 2007.
Therefore, the RRR could be reduced to 10 percent in theory, which gives plenty of room for three RRR cuts of 1 percentage point each within this year.
These monetary easing measures could help reduce the financing costs and debt burden for companies.
And the expectation of reforms and loose market liquidity could support the mainland equity market and Hong Kong’s as well.
The correlation between the two markets has increased substantially after the launch of Shanghai-Hong Kong Stock Connect.
Beijing intends to buoy up the capital market to support the real economy and buy some time for economic reforms.
It hinted at further monetary easing to combat the slowdown in economic growth, as well as measures to stimulate investment and consumption, during a recent meeting of the Politburo.
The mainland stock market is dominated by individual investors, which is different from mature markets like the United States, which are dominated by institutional investors.
Therefore, the mainland market is more vulnerable to dramatic market volatility. Both investors and regulators have to take this into account.
The authorities are keen to turn the red-hot market into a healthy long-term bull market.
And they will support long-term growth with various reforms.
The monetary easing measures and wealth creation efforts should help companies wishing to issue shares to raise funds directly in the short and medium term.
The positive policy stance should pave the way for both markets to test new highs in the future.
This article appeared in the Hong Kong Economic Journal on May 5.
Translation by Julie Zhu
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