Market nerves over China reflect wider policy angst

By Mike Dolan – Analysis

LONDON (BestGrowthStock) – This week’s outsize jolt to world markets from China’s widely flagged credit tightening has puzzled many analysts, but global investors say it has served to stir some of their deepest fears for 2010.

The world economy’s emergence from recession — which the International Monetary Fund forecasts will flip it to brisk growth of 3.9 percent this year from a contraction of 0.8 percent in 2009 — has being achieved largely on the back of extraordinary monetary and fiscal policy boosters everywhere.

The central concern then for most investors — who have already bet on that rebound via a 70 percent rise in global stock prices in the nine months to December — is one of policy error in normalizing money and fiscal policies.

Will governments and central banks will step on the brake too soon and push the world back into recession? Or will they delay so long in removing the stimulus that inflation takes root and requires an even harsher policy clampdown at a later date?

“The fact that central banks in emerging economies will be hiking interest rates in the coming months really disturbs the markets,” said Franz Wenzel, senior investment strategist at Axa Investment Managers in Paris.

Investors have been unnerved about the speed and extent to which China moved to limit runaway credit growth this year since it announced on January 12 that it was raising domestic banks’ reserve requirement ratios by 0.5 percent point.

On Wednesday, China’s largest bank, ICBC, said it had stopped rolling over some loans to slow credit growth after a surge at the start of the year — a surge that appears to have alarmed the authorities.

What is more, some analysts fear the suspension has caught importers and other companies by surprise and will lead to delays or cancellations to China’s imports — causing possible ripples beyond its borders and likely statistical dents to January business surveys, investment and trade data.

To be sure, it’s hard to completely isolate the China effect. Market risk aversion has risen over the past two weeks for a variety of reasons — from Greek debt worries to U.S. regulatory proposals to tame mega banks.

Yet since January 12 Shanghai stocks (.SSEC: ) have lost almost 9 percent; global emerging markets (.MSCIEF: ) have lost 7 percent; and world stocks at large (.MIWD00000PUS: ) have lost 6 percent. Emerging market sovereign debt spreads have widened about 30 basis points, or about 10 percent.

WHERE’S THE WORRY?

China’s stimulus-driven rebound to more than 10 percent growth has been central to the global economic recovery over the past six months — anything that limits or dampens that will cause a pullback elsewhere too.

And the fact China started the credit squeeze quicker than many had bet on has raised fears that seeds of inflation have already been sown and may tempt other central banks to exit loose money policies sooner than markets assume.

“The surprise has been that the tightening has started so shortly after the start of the year and that it has been instigated by the country whose growth has done the most to underpin expectations of recovery,” said Sean Shepley, economist at Credit Suisse.

The latest IMF forecasts for China’s economy (Read more about the fastest growing economy.) — which now accounts for almost 10 percent of the world’s $60 trillion gross domestic product — is for growth of 10 percent this year. That is five times its forecast for all advanced economies together.

While Shepley said global credit markets would likely recover through the year, he added the policy change shows “the increase in macro risks demands respect.”

Many argue China’s move to tighten early and act aggressively on bank lending should even be seen as a help in sustaining growth, and any serious risk to China’s own target growth rates would stop authorities there going too far.

“It is really, really healthy for the sustainability of this bull market. The market was overbought,” said Charlie Morris, head of Absolute Returns at HSBC Global Asset Management.

“They have a very real V-shaped correction and the normal thing to do is put the brakes on.”

And vice governor of the People’s Bank of China, Zhu Min — speaking at the World Economic Forum in Davos on Wednesday — sounded far from hawkish in his assessment of the world economy at large. “The current economic mood is very weak,” he said.

However, Morgan Stanley strategists said that while the adverse world markets reaction to China’s tightening may not be warranted, the inflation concern that it reflects is sobering.

“China’s moves must be seen in broader context as a symptom of inflationary trends taking hold, particularly in Asia,” they said in a note to clients.

“We continue to sense a considerable level of complacency in the market with respect to the upside risks to emerging markets inflation from here,” they added.

Global banking group the Institute for International Finance said on Tuesday that it expects emerging market inflation to accelerate to 5.4 percent this year — more than four times the 1.2 percent forecast rate for mature economies.

Investment Research

(Additional reporting by Jeremy Gaunt, Sujata Rao and Seb Tong; Editing by Ruth Pitchford)

Market nerves over China reflect wider policy angst