The divergence between China’s economy and its equity market has widened.
Since late last year, the Shanghai Composite Index has more than doubled to 4,500 points from 2,100 points.
Some people question whether the nation’s economic conditions justify the whopping gains in the stock market given weak manufacturing and economic data.
Is Beijing deliberately driving up the stock market to mask the outflow of capital and talent?
In fact, China is going through the biggest capital outflow in its history.
That, coupled, with a brain drain, has triggered widespread concerns about the nation’s economic outlook.
The central bank has been forced to slash interest rates three times and cut the reserve requirement ratio for commercial banks by 1.5 percent to ease pressure on the economy.
China has a current account deficit of US$80 billion and an export surplus of US$7.9 billion during the past 30 months. The actual capital outflow is about US$160 billion in that period.
Some of this money has flowed overseas legally but some left the country via secret channels.
Over the past six months, the central bank has undertaken massive monetary easing to shore up the property and stock markets.
But is the move sufficient to stem capital outflow?
As we’ve seen, the government is working on structural reform.
However, liquidity from monetary easing has yet to seep into the real economy and the investment and consumption sectors.
Over the past six months, both the property and stock markets have shown a remarkable upturn.
Housing prices in first-tier cities have surged nearly 10 percent in the past four to five months.
However, a large number of small companies are still struggling with poor demand and rising labor and raw materials costs.
The economic situation is worrying. Can we reasonably expect things to sharply improve in the next few years?
As the government presses ahead with its reform agenda, vested interests push back against reform.
The massive capital outflow is a side-effect of structural reform.
At present, China’s banking system has total deposits of 150 trillion yuan. A 1 percent cut in RRR will unleash 1.5 trillion yuan into the system.
RRR is still high at 18.5 percent after two rounds of cuts. There is room for another another 5 percent reduction.
However, Beijing might need to figure out other ways to stimulate the economy if the additional liquidity released by RRR cuts has not flowed into the real economy but instead streamed out of the country.
A massive capital outflow will cause considerable damage to the economy.
There are divergent views over the nation’s economic growth.
The most pessimistic view is that China could suffer a hard landing and that the economic downturn will last for a while.
I believe economic growth remains healthy and investors should capture opportunities from the economic restructuring.
China’s industry upgrade and technology innovation continue to lag expectations.
Big Chinese companies should establish R&D centers overseas.
Lenovo, Alibaba, Baidu and Tencent have set up R&D centers overseas as part of their externalization strategy.
Also, the Chinese government should consider establishing a technology innovation special zone which will offer intellectual property rights protection in line with global standards and encourage domestic and global players to establish R&D centers in the zone.
This article appeared in the Hong Kong Economic Journal on May 26.
Translation by Julie Zhu
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