The speculative state

Rumours often move markets. Take Corona Extra, which had seen five years of phenomenal growth in the United States in the period before 1987. Then murmuring started that the Mexican beer tasted a little too like piss. Allegedly, the whispering campaign was started by a distributor of a rival beer, the LA Times reports. But before the scare was over, a sizeable chunk of the American public seemed to believe that Corona was tasking its workforce to urinate into its bottles. In the six months after the rumour was first stoked, Corona sales slipped 20% in California, its top market in the US.

In a further example of rumourmongering gone wild, a website run by CNN suggested that Steve Jobs had suffered a heart attack in 2008. The false report wiped $5 billion off the market value of Apple, albeit for 10 minutes.

And in April 2013, Wall Street set off on a rollercoaster ride after the Associated Press had its Twitter account hacked, and a fake tweet subsequently claimed that explosions at the White House had injured President Obama.

If each of this incidents could happen in the American marketplace, it won’t surprise WiC readers that rumours can wreak havoc in Chinese financial markets too. In a country where political and corporate transparency is already limited, the more outlandish the rumour gets, the more it can often be believed. For example, an online report in 2010 claimed that the central bank governor Zhou Xiaochuan had fled the country because the Chinese banks had supposedly lost $430 billion on their investments in US securities. The news spread fast, only retreating when Zhou reappeared at a public function.

However, even by China’s dizzying standards, the last few weeks have seen market-moving speculation escalate to new highs (or lows, depending on your viewpoint). Much of the gossip centres on Sasac, the holding company that oversees the activities of more than 100 of the biggest state firms. There has also been feverish whispering about the future activities of the People’s Bank of China (PBoC). Both institutions have found themselves at the centre of massive speculation, that’s added fuel to the record-beating rally in Chinese stocks. Rumours have led investors to punt on a pending programme of quantitative easing as well as on a sudden surge in M&A transactions among some of the largest state-owned firms.

So is it a case of buy-the-lie, or is there more to it?

Are state firms set for a bout of M&A mania?

A year ago most of the talk about restructuring the state sector centred on the so-called mixed ownership reforms, which hoped to bring private sector capital into industries dominated by state giants (see WiC230).

But the unexpected merger of trainmakers CSR Corp and CNR Corp (see WiC259) has served as a game-changer for many observers, who now seem to think the newer M&A trend is to merge state-owned enterprises (SOEs) so as to create even more powerful national champions.

Adding substance to the speculation: some of the Party’s official mouthpieces have talked up this very prospect.

“Some have suggested that the Divine Train (the local nickname for the merged CSR and CNR) has been created,” Xinhua said in an article last week. “Will the Divine Ship or the Divine Oil arrive soon?”

By “Divine Ship”, the news agency was referring to a potential merger between China Shipping Industry Corp and China State Shipping Corp. Like the CNR-CSR combo, the shipbuilding duopoly is dubbed locally as the “north ship” and “south ship” (see WiC260), in reference to where they are geographically strong in China.

Combining the two energy titans CNPC and Sinopec to create “Divine Oil” would rank as “the most audacious merger” of all, Xinhua reckoned. However, the news agency also noted that pairing of the two oil producers Sinopec and CNOOC, or even a merger between CNPC and Sinochem, wasn’t entirely impossible either.

Commentary like this means that other media outlets soon follow, and China’s brokerages are delighted to stir the pot, guessing enthusiastically about which state firms may be set for combination. Financial portals, for instance, began to regurgitate an earlier rumour about the state-controlled telecom sector which suggested that China Mobile would take over a national TV broadcaster. As a consequence, China Unicom would be paired with China Telecom, so as to better compete with its larger rival, the speculation suggested.

Then at the end of last week the shares of shipping firms surged on reports that the central government was planning to combine four struggling state firms in the sector. The list included Cosco and China Merchants. Any tie-up would have resulted in the world’s biggest shipping conglomerate.

The speculation has flowed hot and breathless for days. Then on Monday there was the mother of all M&A rumours. Again it came from a normally reliable state media outlet. Citing “authoritative sources” the Economic Information Daily (a financial newspaper run by Xinhua) reported that the central government was intending to cut back the number of centrally-administered SOEs – state firms under Sasac’s oversight – to 40 from the current 112. Inevitably, the plan would necessitate some frantic merger activity, and the report got a lot of attention, taking Chinese stocks to a seven-year high as investors excitedly bought the shares of state enterprises.

On Monday evening Sasac denied the report, claiming that the Economic Information Daily had not verified the news before publishing it. (Both CNPC and Sinopec also published regulatory disclosures on Monday denying that they would merge. But by then, shares in both the companies had already surged by the 10% daily limit in Shanghai.)

China planning on its own QE too?

The rumour mill got going again early this week when Reuters ran an exclusive story suggesting that Chinese policymakers were ready to unleash their own version of quantitative easing (QE). Citing unidentified sources, the newswire said that the People’s Bank of China and the Ministry of Finance had reached consensus on the move. Both the timing and the scale of the easing programme would exceed expectation, Reuters suggested.

On Tuesday, the Wall Street Journal also got hold of “officials with knowledge of the central bank’s deliberations”. It said that Chinese banks would be allowed to swap local government bailout bonds for cash. The unorthodox strategy, which could be adopted in the next couple of months, would represent “the most aggressive easing tool since [China] launched a massive stimulus plan in 2008 to counter the global financial crisis”, the Journal said.

Bloomberg pounced on the story too. Citing people familiar with the matter, it also reported that the PBoC was discussing whether to let the banks tap its pledged supplementary lending (PSL) programme to buy local authority bonds. The PBoC last year channelled Rmb1 trillion ($161 billion) through the PSL facility to China Development Bank for redevelopment of shantytowns.

A columnist at the Hong Kong Economic Journal (HKEJ) wondered whether Beijing’s spin doctors had been behind the slew of stories. “Several authoritative international media firms have had these ‘exclusives’ in quick succession. It isn’t something that can happen randomly. More likely someone has been feeding the stories deliberately,” the newspaper suggested.

Similar to Sasac’s rebuttal, the PBoC subsequently played down the likelihood of aggressive changes in monetary policy. The central bank has sufficient tools to maintain the supply of cash at reasonable levels, Ma Jun, chief economist of the PBoC’s research bureau told China Business News. He also insisted that the Chinese economy could weather the current slowdown without the need for major stimulus, citing healthy levels of job growth.

All talk, no substance?

“Chinese QE” isn’t a new topic for the domestic media. There has been no shortage of reports on the central government’s plans to bail out debt-laden local governments, for instance, or to recapitalise the banking system.

In our Talking Point last year titled “China’s new QE plan”, we also examined discussion in the local press that Beijing was mulling the creation of its own version of Fannie Mae as a means to dissolve the toxic liabilities linking the real estate developers, the local governments and the banks.

According to the HKEJ, there is no question that Beijing’s decisionmakers are contemplating how best to inject fresh liquidity into the financial system to support economic growth. But China’s central banking bosses aren’t too receptive to descriptions of the move as “quantitative easing”. That’s because the term has been demonised by Chinese critics, who have accused Washington of printing cheap money and fostering financial instability worldwide via QE.

“It is possible that Beijing wants to forewarn of its monetary actions, and give international stakeholders some sort of expectation,” HKEJ also wrote. “By taking the initiative to leak the news, China can also add its own spin that China’s PSL isn’t equal to QE.”­­­­­

The Economist also reckons comparisons with QE are flawed, although it thinks that Chinese monetary policy has unquestionably been loosening.

Likewise, Sasac has found it tough to deflect all the rumours completely. That’s because it is well known that it plans to cut the number of central SOEs in its portfolio – the goal being to create a smaller number of stronger entities capable of paying higher dividends.

All the same, what has been surprising in the current round of speculation is the credence given to the rumours by the state press, as opposed to their more conventional policy of cracking down on false reports.

Xinhua has been at the vanguard here. In one telling case it even instructed investors not to worry too much about company denials, arguing there was a patriotic inevitability to the consolidation of China’s state sector.

What’s more, state firms including the newly-merged trainmakers had denied similar stories in the past, before admitting that consolidation was going to happen, the news agency pointed out.

“Many state firms have denied they are in M&A talks. But CSR and CNR have also gone through the rumours, then the clarification, and then the merger process. Many central SOEs have been broken up into several competing entities for years. It is time for consolidation, to clench the fist and to unite together against outsiders,” Xinhua trumpeted.

So why the speculation now?

“Why are stock market rumours flying all over the sky lately?” asks Pi Haizhou, an independent financial commentator. “The biggest reason is that the central authorities aren’t doing a proper job… It is necessary to legislate much harsher penalties on rumour spreaders and hold every gossipmonger responsible.”

Some of the speculation is being generated by profiteers, keen to cash in on surges in share prices. But other rumours might be better categorised as trial balloons, released by government officials to test market reaction. No one has suggested publicly that the central government is drumming up interest in market-moving news to jack up share prices (indeed, many commentators are worried that stock prices have risen too fast and too far). However, the commentaries in the state media have been unusually bullish. The People’s Daily published seven articles in a row last month explaining how Chinese stocks are set for a healthy run. “The Renmin Ribao (People’s Daily) is quickly turning into the Gumin Ribao (Investors’ Daily). It underlines the central government’s determination to develop the capital markets,” a senior official at the Shanghai stock exchange told an investment forum recently.

“If one looks carefully at the to-do list of Chinese policymakers, be it the restructuring of the state sector, or the deleveraging of the financial system, a healthy and robust stock market is much needed,” the HKEJ also suggested.

So should international investors ditch their due diligence and go with the gossip instead? In an article in the Financial Times this week, the boss of fund management giant GAM cautioned that many of the SOEs face deteriorating fundamentals. “As Chinese equities continue to rise, it is tempting for investors to join the herd indiscriminately. Given the country’s complexity, this would be a mistake,” Alexander Friedman advised.

But rival fund house Franklin Templeton has produced data suggesting the rally has a way to go. Its survey of Chinese investors found 71% of them expected growth in the stock market this year, while only 6% held a negative outlook. Bar ron’s said the survey indicated local investors were “super bullish”.

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