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In the first two weeks of July, the Chinese stock market soared in a massive rally that experts worry may have been led by retail investors who are now leaning into leverage-fueled risky trading. This same phenomena is what triggered a devastating China’s yuan crash in 2015.
The numbers recorded earlier this month skyrocketed, with the Shanghai composite jumping 14 percent. The CSI 300 index also saw a spike of over 20 percent, and the Shenzhen composite climbed 17 percent. In response, the China Securities Regulatory Commission quickly released a warning to investors. They urged them to steer clear of lenders that illegally provide financing for margin trading, a practice that comes with significant risks since investors are playing with borrowed money. That means any losses incurred will hit the traders particularly hard, since they need to pay back the original sum as well as any interest.
Experts continue to keep an eye on levels of margin trading occurring with China. Among them is William Ma, the chief investment officer at Chinese asset management firm Noah Holdings. He noted in a recent interview that his firm has seen trend levels currently at about half of the peak, an indicator that the present rally has some legs. However, he also cautioned that they are “only 20 percent away from peak valuations in recent years.” For policymakers in China, the recent rally has both its advantages and some serious drawbacks. On the positive side, the inflows have been useful in slowing down the buildup of corporate debt, which has seen a spike in 2020. As far as the negatives, the pandemic has caused the Chinese government to pour billions of yuan into the struggling banking system in order to push lenders to extend credit and lower interest rates. While this practice is useful in the short term, it will eventually lead to long term consequences as the number of bad loans in China skyrockets.
This will further put a strain of banks in the country by pushing margins closer together and cutting down on profits. Of course, smaller local banks will feel the strain much more acutely, while large, state-owned institutions are able to get by.
Overall, China is expecting a serious economic slowdown nationwide. The International Monetary Fund revised pre-pandemic predictions that the Chinese economy would grow 6.1 percent this year. Now, they anticipate a mere 1 percent growth.
If that worst case scenario comes to bear, the ratio of bad loans among city commercial banks would jump by 3.44 percentage points, according to analysis by Fitch Bohua. Meanwhile, the ratio of bad loans would rise 2.62 percentage points in joint-stock banks and 1.92 percentage points among state-owned lenders.
The country remains unprepared to handle the widespread potential for loan losses, and the China Banking and Insurance Regulatory Commission warned that many banks have not yet acquired adequate provisions to guard against these losses.
To set aside the bare minimum cushion, profits in the banking industry would have to decline by over 350 billion yuan–that’s $50.08 billion.
Meanwhile, the tension that has been building between two of the world’s superpowers is making matters all the more complicated. As China and the United States continue to butt heads rather than collaborate, the global economy sinks deeper into its suffering. As a result, investors have become increasingly skeptical of putting their money into riskier assets. After all, if ties between the countries deteriorate further, the rewards no longer outweigh the vulnerabilities.
Some experts no longer see a world in which China and the United States can re-enter a symbiotic relationship, especially after having played a blame game with the pandemic and squabbled extensively over Hong Kong. In the months ahead, the decoupling will likely move ahead on a more and more condensed timeline, barring significant policy shifts on one side or the other, which is a near impossibility.”