Margin of error

Credit crackdown exposes flimsiness of China rally

Regulators are withdrawing some of the air from China's stock market bubble. A two-pronged crackdown on margin trading and shadow finance has temporarily reversed the near-vertical rise in mainland stocks. It's a reminder of how much the recent mania depends on borrowed money.

Chinese authorities have mostly remained on the sidelines as stocks soared in recent months. Now they are cracking down. The country's securities regulator announced on January 16 that it had caught some brokerages breaking the rules on providing margin finance to customers. Two of the largest, CITIC Securities and Haitong Securities, were among those banned from opening new margin accounts for three months. On the same day, China's banking watchdog published draft rules restricting entrusted loans - a popular technique for lending between non-financial companies.

On the face of it, neither measure looks excessive. Yet the stock market frenzy shows regulators have reason to be concerned. Chinese investors have borrowed heavily to finance their share-buying: margin loans against Shanghai-listed shares have soared by 80 per cent to 772 billion yuan ($124 billion) in the past three months. Inter-company loans may also be helping fuel speculation: new entrusted loans jumped to 458 billion yuan in December, according to central bank data - the highest level on record. Leverage could turn a sell-off into an economic blow.

Financial companies are the main victims. Shares in many mainland securities firms and banks fell by the maximum permitted 10 per cent on January 19. Haitong's Hong Kong-listed shares dropped below the price at which the company raised $3.9 billion from investors in December. CITIC Securities will face questions over its plans for a similar fundraising.

Whether the sell-off is a setback or a turning point remains to be seen: the benchmark CSI300 index is still up almost 40 per cent in the last three months, and the mainland shares of companies with listings in both Shanghai and Hong Kong are still trading at a hefty premium to their equivalents in the former British colony. Economic data and corporate performance, which never justified the rally in the first place, continue to deteriorate. Without a steady flow of fresh credit, there's a lot of air yet to come out of China's stock market.