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China stimulus? Stocks hit 7-month high on PBOC easing hopes

Concerns over the state of the Chinese economy have started to loom again as the country's shares hit a seven-month high Monday on speculation of more stimulus from the Chinese central bank.

The country's blue-chip CSI 300 jumped 3.3 percent Monday, lifting sentiment across Asian stocks. While investors have heard nothing from the People's Bank of China (PBOC) officially, analysts are starting to predict that more easing could come soon.

"The Chinese bourses do not reflect the real economy much. Instead, they are driven by expectations of central bank policy and sheer speculation, much more than more mature equity markets," Holger Schmieding, chief economist at Berenberg Bank, told CNBC via email.

He explained that hopes for additional stimulus are driving the upturn. "The ups and downs of Chinese markets mean little for the economic outlook. While China is in a difficult transition, it still has all policy means available to avoid a hard landing for the time being. The PBOC will likely add some stimulus in coming months."


China published weaker-than-expected investment, lending, retail spending and factory output data on Friday. This after a raft of poor numbers this month started to concern investors of a Chinese slowdown..

"This ongoing slowdown is pushing speculation of more monetary stimulus higher," Christophe Barraud, chief economist at U.S-based financial services firm Market Securities told CNBC via email.

"However, the PBOC prefers using more-targeted easing measures such as liquidity injections - by choosing whether or not to roll over funds as they come due - rather than using conventional tools such as RRR (reserve requirement ratio), rate cuts. I believe that the PBOC will keep a low profile until the yuan is officially included in the International Monetary Fund's special drawing rights (SDR), expected to be in October."


China and the IMF

SDRs are an international reserve asset created by the IMF in 1969 to supplement its member countries' official reserves. The value of the SDR is currently based on four major currencies: The U.S. dollar, the euro, the Japanese yen and the British pound. The Chinese renminbi (yuan) will join the SDR basket of reserve currencies on October 1, 2016.

But China's relationship with the IMF has not been smooth sailing. The IMF recently warned that Chinese's economic growth will decline for the next five years and will fall below 6 percent in 2020. In a report released last week, the IMF said China was struggling with slower private investment and weak external demand.

Saker Nusseibeh, chief executive officer at Hermes Investment Management told CNBC Monday that the Chinese government may not do something immediately on the IMF warning, but will be working to improve the imbalance, particularly in the regional banks in the near future.

"They know they have a problem in the regional banks and they want to control it without actually displeasing those people who are benefitting from the credit boom. In other words they don't want to slow down the economy too much, they don't want to service too much. They know they have a problem at hand and they want to deal with it slowly," he said.

Hermes' Nusseibah added that the PBOC "might" take more aggressive action and highlighted the housing market in China is a problem. "I think people are buying more flats than being built. On the other hand, the PBOC wants to ensure the economy doesn't slow down. So as a balance they will probably try to do something in the next few weeks."


Shenzhen-Hong Kong Stock connect

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Meanwhile, some analysts have pointed to China's rally also being fuelled by renewed hopes for the launch of the Shenzhen-Hong Kong Stock connect in 2016. Local media reports have cited that this scheme would be launched officially in December and would allow investors from both regions to buy each other's stocks.

"China A-shares have strengthened in August, with the potential launch of the Shenzhen-Hong Kong Connect driving the latest move up," Daryl Liew, head of portfolio management at Reyl Singapore told CNBC via email.

"China A-shares have de-rated significantly from the peak levels a year ago and are currently trading at reasonable levels at a forward PE (profit-to-earnings ratio) of 12.5x, in the middle of its 5-year range. With many equity markets trading at relatively expensive valuations, China's stock market is looking rather attractive," he added.


Debt concerns remain

But while the stock market might remain attractive, concerns about the larger economy continue to loom. China has been struggling with its debt-ridden regional banks for a long time now. According to an analysis of China's 765 regional banks by UBS Global Research, the recapitalization and bailouts have started and have made unexpected progress.

"Our research suggests that 2015 was the first year since the early 2000s that sizable banks were bailed out," Jason Bedford, analyst at UBS explained in a research note Thursday, adding that the process is still at a very early stage and that bad debt accumulation is significant and still rising. UBS' Bedford also noted that the write-offs and disposal of bad assets in Chinese banks have risen three-fold since 2013.


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