China's anti-corruption drive is a sideshow

FT.com

The exchange of gifts in China has been subdued this year-end, an acknowledgment that, at least for the time being, it is better to be discreet. Fewer officials are on the list of recipients and the amounts spent have become more modest.

If China is finally tackling corruption, that is good news. Corruption has become so pervasive that it is jeopardising social stability, leading to misallocation of resources and capital and stymying the progress that China has made in raising the general level of prosperity and wellbeing.

Wang Qishan, who is spearheading the anti-corruption campaign, is an apt choice for the task. He knows how financing in China works, having run China Construction Bank. Because of his age, the 64-year-old will be on the Politburo Standing Committee for only one term, which means he has little to lose. And he has no children.

Analysts are penning hopeful reports that 2013, the year of the snake, will also be the year that the stock market finally regains its animal spirits.

Hopes that China is serious about tackling corruption are contributing to the cheery outlook. After being flat most of the year, the Shanghai Composite rose more than 14 per cent in December. Will next year be a solid continuation of that trend?

The theoretical arguments are sound.

"We think 2013 is shaping up to be a good year for Chinese equities on [expectations of] a sustainable economic growth recovery, improving earnings visibility, attractive valuations and rising risk appetite,” a HSBC report says.

It adds that downside risk is limited. That makes sense, since valuations in China are about half those in India despite more robust economic prospects for the former. (Although buying Japan in the belief that it was cheap has not worked for more than 20 years.)

There are signs that the Chinese economy is picking up. While exports remain depressed the most recent numbers suggest that manufacturing, supported by domestic demand, is gaining momentum. In December, the purchasing managers' index measuring growth versus contraction rose to a 19-month high.

HSBC expects the economy to expand at a rate of 8.6 per cent next year, higher than the consensus of just over 8 per cent.

Moreover, Chinese regulators have been doling out quotas for stock market investment at an accelerated pace to a larger universe of qualified foreign institutional investors, and to the Hong Kong arms of Chinese institutions, in an effort to increase demand.

But those who do business in China remain sceptical. To many, the anti-corruption drive is merely a form of score-settling. Money continues to leave China, as more and more wealthy people put their money out of the reach of their peers. The stock market in China has always been influenced more by capital flows than by economic fundamentals. That means the beneficiaries of the anti-corruption campaign are more likely to be Hong Kong property developers than listed Chinese companies.

That is also why the hedge fund managers who like luxury goods as a proxy for the growth of corruption in China continue to hold the shares of companies such as Richemont and Prada.

Mainland sales of watches and jewellery may go down but sales offshore are likely to continue as prudent Chinese continue their extravagant purchases – just not in China itself.

Even if the market does show signs of recovery, the overhang of companies waiting to list may overwhelm demand. At last count, there were 831 deals in the pipeline.

In addition, the big state-owned companies that dominate the market still do not pay dividends.

"They say, why would I make my company smaller? That way I will have less to play with,” notes a top executive at one of the local banks in Hong Kong with extensive knowledge of China.

Pessimists fret that the banks, which account for a large part of the stock market index, are likely to have a bad year because of the problems in the wealth management industry.

The banks have been putting their clients into products offering higher returns than deposits but despite Beijing's best efforts to regulate these products and highlight the risks, clients believe that promised returns are guaranteed.

The prospect of riots in the streets has almost always forced Beijing to compensate for retail financial losses, which in this case means leaning on the banks to compensate investors in these products.

There has always been a disconnect in China between the macro economy and the stock market. This year, it seems that once again, hopeful signs on the real economy side will not translate into meaningful stock market gains.

Copyright The Financial Times Limited 2013.