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Chinese shares plunge amid fears of default

Share prices in Shanghai slumped by 7 per cent yesterday amid fears that the “China effect”, which has helped to stoke growing global economic confidence in the past six months, is about to fizzle out.

The stampede out of shares came amid reports that the authorities in Beijing may be planning to protect state-run companies from their trading mistakes by allowing certain companies to default on derivative contracts struck for oil, coal and other commodities.

The massive stock plunge, which was driven chiefly by Chinese retail investors, also reflected concern that coming days will bring a litany of disappointment through official economic statistics. The slowing of bank lending and stimulus measures, some analysts warn, may show that the Chinese recovery has become an “unsustainable paradigm”.

“China is saving itself, not the world, even though it is aiding some economies at the margin,” Patrick Bennett, a Société Générale strategist, said. “Any risk appetite and investment in positions which have been based in the notion of China as the world’s saviour have been, and remain, ripe to be unwound.”

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The gloomier sentiment reverberated round Asian and Western exchanges. Although London was closed for the Bank Holiday, shares on Wall Street declined, the Dow Jones industrial average falling 47.92 points to 9,496.28. Resources and consumer goods stocks slid and the oil price was marked down below $70 a barrel.

Fears over the demise of the “China effect” may already be starting to have an impact outside the Middle Kingdom, Tokyo Mitsubishi UFJ analysts said. Sharply falling Chinese imports of copper and coal have begun to take their toll on one of the most accurate gauges of global trade — bulk shipping rates. Analysts believe that the benchmark rate could plunge 50 per cent between now and the end of the year. The Baltic Dry Index, which has rallied strongly this year from its 2008 collapse, is expected to follow suit.

Shipping brokers in Singapore said that alarm was now returning to the market after China’s all-powerful State Council declared that it was studying the issue of overcapacity in the steel and cement sectors. That was seen as a signal that the roar of raw material imports may be muted to a low purr.

Rumours began circulating over the weekend that the Chinese regulator in charge of state-owned enterprises was considering giving certain companies — mainly airlines, steelmakers and other big users of derivative products — the unilateral right to default on those contracts.

The gambit would leave dozens of banks and brokerage firms that acted as counterparty to those derivatives contracts out of pocket. It is believed to be a response to huge losses incurred by Chinese companies as hedge books turned sour this year. Banking sources in Shanghai described the rumours as “puzzling and very disturbing if true” because of the implication for thousands of legally binding contracts struck worldwide with Chinese companies.

Potentially a source of massive disruption throughout derivative, forex and commodity markets, a state-sponsored default would be “unthinkably bad for the reputation of China Inc”, a senior banking official in Singapore said.

Chinese industrial profits in the first seven months of the year were 17.3 per cent lower than over the same period in 2008, according to official data.

Qian Wang, a JPMorgan economist, remained optimistic. “We believe that the plunge since early August, after the 103 per cent gain since late 2008, was likely triggered by excessive fears of aggressive policy tightening, while the fundamentals remain intact,” he wrote in a research report.

Causes for concern

The suggestion that Chinese firms could walk away from loss-making derivatives positions with foreign banks is not the first time that China has rattled Western companies in recent months

The arrest of four Shanghai-based executives of Rio Tinto on industrial spying charges after the high-profile collapse of Rio’s deal with the Chinese group Chinalco is viewed as political

After the implementation of new anti-trust legislation last year, China blocked a move by Coca-Cola to buy the local juice maker Huiyuan — a much-loved Chinese brand

Rules requiring foreign companies to disclose in detail how exports to China are made are to be strengthened. Beijing recently threatened to add IT and software to the list, sparking alarm in Japan and the United States

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WaveRider

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