China stocks outperform on optimism over Beijing\'s fiscal policies

The Shanghai stock market is by far the best-performing market in the world this year and the Shanghai Composite index is the only leading equity market to have risen since Lehman Brothers went bankrupt in September.

Do Chinese investors know something the rest of the world does not?

Stock market analysts who follow the mainland market are divided over whether the gains for the Composite index – which has risen 33.2 per cent this year and 16.6 per cent since Lehman's failure – reflect a belief in a sustainable economic recovery or are merely another wild swing in a market ruled overwhelmingly by sentiment.

The Composite index closed yesterday at 2,425, a seven-month high, based mostly on speculation that the Chinese government will spend enough on stimulus measures to overcome a record drop in exports and help the local economy out of its current slowdown.

The index has risen 42 per cent since hitting a low of 1,706 on November 4 last year but is still well below the 6,092 closing high it reached in mid-October 2007.

Shanghai's recovery follows a Rmb4,000bn ($585bn) government stimulus package (announced in November), five interest rate cuts and a government-mandated year-on-year rise of nearly 25 per cent in bank lending in February.

The measures are aimed at achieving the government's target growth of 8 per cent in gross domestic product this year, partly by bringing forward several years' worth of infrastructure projects and ensuring that they are built in time to stimulate the domestic economy at a time when the global economic crisis has savaged China's exports.

“Mr Market is telling us that it's highly possible the regime can switch the economy from exporting Barbie dolls to America, to stimulating its own domestic economy” Robin Griffiths at Cazenove Capital in London told Bloomberg.

Real estate market analysts also point to a substantial recovery in property transactions in some of the major cities in the past few weeks, though they caution that it may be too soon to say that the property market has bottomed out.

Chris Peng, a Shanghai investment analyst, thinks Shanghai's market rebound is solid and “likely to continue as positive monetary and fiscal policies are gradually taking effect”.

“The reality has turned out to be much better than expected,” he says, noting that 2008 corporate earnings fell much less than forecast and electric power generation has begun to increase.

But Jerry Lou, Morgan Stanley China strategist, says Shanghai is in the grips of “a sentimental recovery, not a fundamental recovery”, powered largely by highly speculative retail investors. Lending has risen but exports have collapsed and retail sales growth has slowed considerably – “that sounds like something unpleasant developing underneath,” he says. “At some point things could unwind very unhappily.” The release of economic data for the first quarter could prove the precariousness of the rally, some analysts have cautioned.

In the crowded public trading hall of Shenyin Wanguo Securities in central Shanghai yesterday, retail investors – many of whom are still facing losses of more than 50 per cent, in spite of the current rally – are hoping that the government will find a way to ensure the rally continues. Huang Wen Xia, 61, a pensioner and regular user of Shenyin Wanguo's public trading terminals, says “90 per cent of the people here are trapped in the market [by their losses]”.

Qian Hui, a construction worker who says he has nearly all his savings invested in the market, says he has begun buying stocks again in the past few weeks, as the index has climbed – but his goal is only to recover losses that still exceed 50 per cent.

China's securities market regulators are also banking on a sustained recovery in the market. They announced this week that they hope to launch a much-awaited Nasdaq-style second board in Shenzhen in August to help istart-up companies to raise funding. But this plan could be delayed if the market rebound falters.

G20 GREENSHOOTERS

What moved the markets? Certainly not the way G20 leaders fawned over Barack Obama while announcing a welter of measures largely irrelevant to the immediate problem of the global recession, including a clampdown on tax havens, bonuses and big hedge funds. It was well before the summiteers released their communiqué that Hong Kong's Hang Seng index jumped nearly 7.5 per cent, with several European bourses notching up gains of about half that amount. In fact, stocks surged globally on hopes the worst of the crisis is past, hedged with relief that a relaxation of US mark-to-market accounting rules would provide a reprieve for banks harbouring toxic assets in case it was not.

Indeed, end-of-the-beginning theorists and green shoot-watchers are in clover: in the benighted UK, house prices registered a small upwards blip and the Bank of England's survey of loan officers suggested lenders intended to start loosening credit conditions. Industrial output in South Korea fell by a mere 10 per cent year on year in February, down from January's cataclysmic 26 per cent drop, amid claims by Lee Myung-bak, president, that export markets were “quickly stabilising”. Other foliage has appeared in the US, where durable goods orders and home sales rose in February.

The reality, of course, is that the world remains hostage to the health of the financial system. All the evidence from financial crises past makes clear that sustainable recovery is contingent on a purge of contaminated balance sheets. That process is far from complete. Whether the G20 claims a consensus on regulation is not going to create jobs in El Centro, California, where unemployment is running at close to 25 per cent, or anywhere else. That the G20 has said nothing worth hearing on fiscal stimulus is welcome. Given that many states, notably the UK, are close to their fiscal ceilings, any remaining borrowing capacity must be devoted to fixing banks.

China greets G20 results with caution

If Nicolas Sarkozy claimed credit for much of the progress at the G20 summit and Barack Obama won plaudits for his nimble diplomacy, China gave a more cautious welcome to the results of the meeting.

In the absence of the sort of presidential press briefing that many countries conducted, Chinese officials yesterday listed a number of their own achievements from the London summit, however they also acknowledged some of China's main priorities were not addressed.

Officials said they were pleased with the announced reforms of the International Monetary Fund, which include the end of the Europe-US monopoly on the leaders of the IMF and World Bank and the promised reform of the quota system to give China a larger say. While Gordon Brown, UK prime minister, said China would inject $40bn (€30bn) to the IMF's coffers, officials said the details of China's contribution were still under discussion.

More generally, if the headline numbers about funding for the IMF and the boost to trade finance materialise, economists said this could be very beneficial to China's export machine.

“Given that some 30 per cent of China's GDP growth in recent years has been driven by external demand, we believe that China will benefit significantly from these measures,” says Stephen Green at Standard Chartered.

Against that background, however, some of the most important issues for China saw little progress at the London summit. The commitment to avoid protectionism, one of China's biggest fears, was relatively vague, and having already announced a large fiscal stimulus plan for the next two years, China was hoping for more action on this front from other countries.

China signalled in the run-up to the summit that it wants to throw its weight around a lot more in international economic affairs, however the sorts of priorities that China will defend remain unclear. The London summit gave some clues.

The dispute over tax havens, which only ended after Mr Obama brokered a compromise between France and China, illustrated how strongly China will defend its sense of sovereignty in economic issues.

China has generally supported the G20 push to strengthen financial regulation – President Hu Jintao would have no problems with Mr Sarkozy's claim that the days of the “Anglo-Saxon mode” are over. However, China has mostly supported measures that would boost regulation in western countries, such as controls on hedge funds and ratings agencies. Mr Hu's opposition to publishing a list of tax havens that might include critcism of Hong Kong and Macao indicates China's reluctance to see a new international regulator that might influence its own financial system.

Diplomats say there was another factor. Both China and India, they claim, fear that any new international financial watchdog will be dominated by Europe and the US, in the way the IMF and World Bank has been.

HANDSHAKE BROKERED BY OBAMA SAVES DAY

Ultimately it boiled down to an Obama-brokered handshake between Hu Jintao and Nicolas Sarkozy, according to US officials. The reality may be more prosaic, and the agreement of a final summit text on Thursday was the culmination of weeks of work by officials from 20 countries. But Barack Obama's self-effacing approach to summitry – one that was on Thursday remarked upon by several non-US officials – certainly did no harm.

According to senior US officials, towards the end of the summit Mr Obama pulled Mr Sarkozy and Mr Hu aside in full view of the plenary session with several officials and translators in tow.

The US president then brokered a compromise between his Chinese and French counterparts on an issue so arcane and inconsequential that it is hard to believe failure to have done so would have led to a collapse of the summit.

According to the account, confirmed by non-US officials, Mr Obama got the two leaders to agree that the G20 would “take note” of the Organisation of Economic Co-operation and Development list of rogue offshore tax havens rather than “endorse” that list.

This allowed the Chinese to save face, since they do not belong to the 30-member Paris-based OECD. And it allowed Mr Sarkozy to claim back home that he had chalked up a blow against Anglo-Saxon capitalism.

In fact everybody, including Mr Obama and Gordon Brown, the UK prime minister, who on Thursday declared an end to the “Washington consensus”, has been reading the funeral rites of old-style unregulated financial markets and Thursday's nine-page communiqué spelt out some of the detail. More importantly for Mr Obama, he can now claim back home that he has led the global effort to tackle the global recession while staving off any attempt to pin the blame on the US.

IMF is clear victor in policy mêlée

One of the few clear victors in the policy mêlée around the G20 meeting is the International Monetary Fund, which is in the process of both acquiring a lot more money and making it easier to get it out of the door.

With Mexico's announcement, confirmed yesterday, that it would apply for a $47bn (35.5bn, £32.5bn) IMF precautionary credit line, the fund has finally overcome a decade of failure to get countries to take out IMF insurance in good times rather than simply being forced to go to it in bad.

Experts say the key issue now is how many countries follow Mexico's lead, and in particular whether countries in the middle of the spectrum, neither basket cases nor teachers' pets, are prepared to risk the stigma of going to the IMF.

The preliminary signs are that Mexico has been rewarded rather than punished for announcing its application for the IMF's new “flexible credit line”, which is available only to governments with a strong policy track record. Both the Mexican peso and local equity prices rose after the announcement was made.

Mexico has a history of being rewarded for sticking its neck out. In 2003, it was the first government to issue bonds in New York containing so-called “collective action clauses” that would have made them easier to restructure in a debt default. Such clauses might have been read by the markets as a preparation for default, but in fact Mexico did not find it harder to borrow.

Whether this experience will translate into a more general willingness to take IMF money remains to be seen. So far the countries that have gone to the fund are at the far ends of the spectrum. Mexico is at one extreme, and does not even intend to draw down on the credit line. At the other are crisis-racked governments such as Latvia and Hungary that have little alternative. Morris Goldstein, senior fellow at the Peterson Institute think-tank in Washington, says: “The real issue is all the countries in the middle. You can make the trough as big and wide as you want, but you can't force governments to drink from it.”

In Asia, a lingering stigma attaches to IMF lending as a result of the intrusive conditions it enforced during the financial crisis there a decade ago. But for some other countries, the reforms may help. Economists at Barclays Capital point out that Turkey, which has been in difficult negotiations with the fund, should find its path to an IMF deal smoothed by the easing of conditions. “Turkey would likely enjoy some sweetener from the IMF's newly found flexibility,” they said in a research note this week.

“The IMF wants to get as much business as it can, having been out of the game for a while,” said Mr Goldstein. “But countries who have had terrible experiences with the IMF, such as [during] the Asian crisis, will still do a lot to avoid going there.”

IMF is clear victor in policy mêlée

One of the few clear victors in the policy mêlée around the G20 meeting is the International Monetary Fund, which is in the process of both acquiring a lot more money and making it easier to get it out of the door.

With Mexico's announcement, confirmed yesterday, that it would apply for a $47bn (35.5bn, £32.5bn) IMF precautionary credit line, the fund has finally overcome a decade of failure to get countries to take out IMF insurance in good times rather than simply being forced to go to it in bad.

Experts say the key issue now is how many countries follow Mexico's lead, and in particular whether countries in the middle of the spectrum, neither basket cases nor teachers' pets, are prepared to risk the stigma of going to the IMF.

The preliminary signs are that Mexico has been rewarded rather than punished for announcing its application for the IMF's new “flexible credit line”, which is available only to governments with a strong policy track record. Both the Mexican peso and local equity prices rose after the announcement was made.

Mexico has a history of being rewarded for sticking its neck out. In 2003, it was the first government to issue bonds in New York containing so-called “collective action clauses” that would have made them easier to restructure in a debt default. Such clauses might have been read by the markets as a preparation for default, but in fact Mexico did not find it harder to borrow.

Whether this experience will translate into a more general willingness to take IMF money remains to be seen. So far the countries that have gone to the fund are at the far ends of the spectrum. Mexico is at one extreme, and does not even intend to draw down on the credit line. At the other are crisis-racked governments such as Latvia and Hungary that have little alternative. Morris Goldstein, senior fellow at the Peterson Institute think-tank in Washington, says: “The real issue is all the countries in the middle. You can make the trough as big and wide as you want, but you can't force governments to drink from it.”

In Asia, a lingering stigma attaches to IMF lending as a result of the intrusive conditions it enforced during the financial crisis there a decade ago. But for some other countries, the reforms may help. Economists at Barclays Capital point out that Turkey, which has been in difficult negotiations with the fund, should find its path to an IMF deal smoothed by the easing of conditions. “Turkey would likely enjoy some sweetener from the IMF's newly found flexibility,” they said in a research note this week.

“The IMF wants to get as much business as it can, having been out of the game for a while,” said Mr Goldstein. “But countries who have had terrible experiences with the IMF, such as [during] the Asian crisis, will still do a lot to avoid going there.”

SARKOZY CLAIMS CREDIT OVER REGULATION PLANS

Nicolas Sarkozy, French president, yesterday claimed credit for “immense” progress towards tighter financial regulation at the G20 summit, saying the agreed reforms “turned the page” on a dominant model of Anglo-Saxon capitalism.

The French leader refused to wait for Gordon Brown, the UK prime minister and summit host, to conclude his closing press conference and rushed to tell the French media that his objectives had been met and even surpassed.

“To tell the truth, it is more than we could have imagined,” he said.

Angela Merkel, the German chancellor, who joined her French counterpart on Wednesday in laying down demands for a regulatory clampdown, struck a more conciliatory note. The meeting had found “a very good, almost historic, compromise in a unique crisis,” Ms Merkel said. The outcome was a “victory for common sense”.

With the G20 agreeing to implement new rules on hedge funds, bank traders' pay, ratings agencies, bank capital requirements, securitisation, the blacklisting of tax havens and a review of accounting rules, both leaders can argue that their demands were largely met – although there will be long arguments over the detail in the months ahead.

The agreement to publish an OECD blacklist of tax havens within hours of the end of the summit was a last-minute bonus, officials said.

Mr Sarkozy argued yesterday that if he and Ms Merkel had not issued their utlimatums – backed up by the French president's apparent threat to walk away if not satisfied – their demands would not have been met “spontaneously”.

French officials privately admit this was pre-summit bluster because 95 per cent of the Franco-German demands had been met beforehand.

Nevertheless, Mr Sarkozy could expect congratulation on his return to France, with some French media outlets already commending his tactics.

Meanwhile, Ms Merkel's unusually pushy performance is likely to win her favour among German voters, many of whom are suspicious of Anglo-Saxon capitalism and who go to the polls in September in what is expected to be a tight race.