Slowdown in new issues fuels fears over China

The first signs that China's stock market bubble may be about to burst emerged yesterday as research from the Chinese Xinhua Finance company and the Milken Institute indicated a sharp decline in the value of shares recently floated on the Chinese exchanges.

The China IPO (initial public offering) indicator tracks the price of shares listed on the Shanghai, Shenzhen and Hong Kong markets. The latest calculation of the index, for November, shows that the Chinese markets gave up most of their gains from the summer, "demonstrating a growing belief that Chinese equities are overvalued and fears of tightening monetary policy to control inflation", according to Xinhua. Of the 118 equities included in the previous two months, 15 increased in price and 103 fell.

Economists have long wondered how long the Chinese stock market boom could last. The composite CSI 300 index of large Chinese shares rose by 160 per cent in local currency terms last year, the largest increase in any mainstream stock market in the world. Anecdotal evidence suggests many Chinese of relatively modest means have begun to play the market, and some foreign funds have turned to the East as returns in Western markets have faded during the credit crunch. A sharp, sustained correction would have an immediately devastating impact on them, with wider reverberations throughout Asia and the world. The 15 per cent fall in the Chinese market last February prompted a worldwide equity sell-off.

The biggest threat to the stability of the Chinese markets is the growing evidence that the economy there is overheating. Growth this year is forecast to top 10 per cent again, but it is now accompanied by rising price levels.

Chinese inflation accelerated to 6.9 per cent in November, a decade-high. Food prices in particular have been pushed higher as an increasingly prosperous Chinese middle class turns to a richer diet.

China's export drive and the accumulation of vast foreign exchange reserves $1.4 trillion (710bn) at the last count have also contributed to the growth of spending power in the Chinese economy, though much of it has been directed into investment rather than consumption, again an inflationary bias.

The notoriously undervalued renminbi, though it has been creeping up in recent months, is a further factor. The US administration and international bodies such as the G7, the IMF and the World Bank have urged the Chinese authorities to allow the renminbi to float up to a more realistic level; such a move would relieve inflationary pressures. The downside, feared by Beijing, is that it would also dampen China's breakneck growth, viewed as essential to provide livelihoods for Chinese workers entering the labour force. China needs to create around 25 million jobs per annum.

In an acknowledged response to inflationary pressures and the bubbles in equity and real estate markets, the central bank, the People's Bank of China, increased interest rates half a dozen times and increased the commercial banks' reserve requirement ratios 10 times during 2007. Recently it raised its benchmark one-year lending rate by 18 basis points to 7.47 per cent.

Any prolonged disturbance in financial markets would make the authorities' strategy vastly more difficult, as well as jeop-ardising China's economic growth. In 2008, for the first time, China is expected to contribute more to global economic growth than America. Were China to stall after a stock market crash, the chances of a global recession would thus be greatly magnified. The World Bank warned yesterday that world growth would ease to 3.3 per cent in 2008, down from 3.6 per cent last year.