The surge in China's stock market & real estate prices

Investors are rightfully worried about the formation of asset bubble after the revelation that Chinese banks lent out US$670.9 billion, a full 91.6% of the country’s lending target for the year in the first quarter. Most are wondering if it was being directed into areas conducive to a long-term recovery. With such a huge sum of money flowing around, coupled with lax regulation and tracking by the banks, it is not difficult to guess which are the likely places the money will end up in. For answers, look no further than the China stock market and prices of real estate.

Not long ago, Beijing, worried that hot money flowing into unwanted sectors could cause bubbles rather than sustain economic growth, has warned mainland banks against using wealth management funds to directly invest in secondary markets of A shares, managed funds and pre-IPO companies. The warning come ahead of the revival of mainland initial public offerings and after an estimated 50 percent of bank lending has been poured into surging stock and real estate markets.

As such, the recent run-up in China stock market cannot be attributed to any improvement in economy or the companies’ fundamentals. Guilin Sanjin Pharmaceutical, the mainland's first IPO since September 2008, was oversubscribed 165 times and raised about 910.8 million yuan.

The sharp reduction in lending in April – to US$87 billion from US$278 billion in March – could be seen as a return to a degree of normalcy. Not as far as the People’s Bank of China is concerned. The central bank advocates a continued loose monetary policy on the grounds that a real economic recovery has yet to take hold. Increased liquidity may help in the short term, but it presents serious long-term risks. Many have highlighted a possible non-performing loan crisis down the road.