The Chinese equity market fell over the second quarter of 2013 on rising risk aversion on concerns about the health of the banking sector and continuing economic slowdown. During June, interbank interest rates rose steeply, raising fears of a credit crunch (sudden lending halt) across the economy. The MSCI China Index dropped by 6.4% in sterling terms over the period, underperforming the MSCI World Index which was up by 0.8%.
Spike in interest rates
We believe that the interest rate move by the Chinese central bank was meant to impose more discipline and tackle aggressive lending behaviour in the Chinese banking sector. The smaller banks should be particularly impacted, as they rely more on interbank funding and have a significant duration mismatch (borrowing short-term and lending long-term). Their focus on short-term profits without due consideration of the risks was the main reason behind the central bank’s move.
This was not an isolated event but part of a broader government agenda to rectify bad practices in the banking sector. Another example was the announcement of further anti-corruption measures which were intended to make China’s development more sustainable over the long-term.
Long-term government focus
The short-term pain in the stock market has proven more severe than we expected. It may also take a while to see the benefits from these corrective measures coming through. Nevertheless, the government agenda is aimed at ensuring sustainable development of the economy. The intention is not to cause a major crisis by implementing these measures. China continues to need a stable external and internal environment to carry out necessary reforms.
Focus on quality
Whatever the broader economic backdrop, it is important that we continue to focus on companies that have proper and professional practices. Management integrity, a long-term mindset and risk-awareness should become even more important going forward. As always we remain focused on quality in terms of business franchise and management.
