Great Wall of Worry for China Stock Investors

The market melodrama over Greece’s fiscal crisis has overshadowed the growing global investor disenchantment with Chinese stocks. The Shanghai composite index fell 1.9 percent on May 11 after a higher-than-expected jump in consumer prices and is now off more than 20 percent from a November peak, a downturn usually defined as a bear market.

Investors are jumpy about the frothy state of the Chinese economy and fear it could signal big problems. Consumer prices advanced 2.8 percent in April from a year earlier, and property prices rose a record 12.8 percent, according to the latest official numbers from Beijing. Chinese President Hu Jintao’s government is trying to contain full-year inflation at a 3 percent rate in an economy that clocked astounding 11.9 percent growth in the first quarter and shows no sign of slowing down.

The property price spike suggests that stronger measures might be needed to curb the runaway real estate speculation in Chinese cities such as Shanghai and Shenzhen. Three times this year the central bank, the People’s Bank of China, has ordered lenders to increase their capital reserve levels, effectively lowering the amount of money available to lend. At the same time Beijing also raised mortgage rates and down payment requirements for second home purchases—and imposed an outright ban on loans for third-home purchases. (That’s right, third-home purchases.)

Emerging-markets investor Marc Faber didn’t help sentiment with his prediction on May 3 that China’s economy may “crash” within a year. The price declines of Chinese stocks and commodities may signal the country’s property bubble is set to burst, Faber said. True, that’s a minority view, but other investors are worried about slower growth if Beijing tightens monetary policy to cool the economy. “If inflation isn’t contained, the central bank will have to raise interest rates,” says Zhao Zifeng, who helps oversee about $10.2 billion at China International Fund Management, an investment firm in Shanghai.

The rescue package for Greece pulled together by the European Union and the International Monetary Fund may free Chinese officials to focus on containing asset prices and inflation at home rather than worrying about the global economy, says Li Daokui, an adviser to the People’s Bank of China. “The double-dip risk in the world economy is likely to be reduced to a minimum,” Li said in a telephone interview in Beijing. “The main policy focus should be on preventing excessive gains in asset prices and liquidity.”

The bottom line: China has too much of a good thing. Stocks have fallen on fears that the government will take strong measures to rein in runaway growth.

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