Few stock markets this year have seen a greater reversal of fortune than China's. In June, 2007, retail investors were flocking to China's equity markets in search of triple-digit returns. Fast-forward to today and the CSI Index, the benchmark that measures the 300 most important listed companies on the Shanghai and Shenzhen exchanges, is down 39.9% so far this year.
Chinese stocks took a further hammering on June 10, seeing their biggest drop since February, 2007. The CSI plunged 8.1% in the wake of a surprise central bank decision to cool the economy by raising reserve requirements for Chinese banks. Unlike the 9.1% one-day decline 16 months ago, which barely broke the market's stride as it continued its upward march, today's fall is the latest evidence that shares are headed south. "Sentiment is very bad," says Nicholas Yeo, a fund manager at Aberdeen Asset Management in Hong Kong.
The 100-basis-point hike in the reserve requirement, the percentage of loans a commercial bank must hold in reserves with the People's Bank of China, the central bank, caught investors unprepared. It is the fifth adjustment to the ratio this year, though previous increases were done in 50-basis-point increments. As has often been the case, the announced increase came in advance of monthly inflation figures, which are expected later this week. "The magnitude of the latest hike took many by surprise and is fueling further cautiousness," Jing Ulrich, chairman of Chinese Equities at JPMorgan (JPM) said in an e-mail note.
Fears for Corporate Profits
China has been battling to tame inflation stoked by rising fuel, food, and commodity prices (BusinessWeek, 3/11/08). Price rises accelerated to 8.5% in April, though they are expected to slow in May to 7.7%, when official figures for the month are released on June 12.
Higher prices have spooked investors who fear that inflation will eat into corporate profits, especially at banks. Industrial & Commercial Bank of China, the nation's largest lender, fell 8.4% and Shanghai Pudong Development Bank, in which Citigroup (C) holds a stake, fell 10%, the maximum daily limit. Air China, the country's flag carrier, also fell by the daily limit in the face of soaring oil prices.
Cost pressures are particularly acute for the manufacturing sector, which has been a pillar of China's growth for decades. Aberdeen's Yeo says that soaring fuel, raw material, and labor costs have forced many factories in Guangdong province to shut their doors. Yeo says costs have increased by as much as 20% for these firms in the past 12 months. Guangdong, home to much of China's export manufacturing, is feeling the squeeze from the global slowdown and a strengthening Chinese currency. The yuan has appreciated nearly 6% this year against the dollar.