Tightening liquidity concerns weigh on market

Chinese shares fell to a six-month-low on Thursday, as patchy economic data and an equity retreat in emerging markets raised concerns of a liquidity drain in the world's second largest economy.

The Shanghai Composite Index closed 2.83 percent lower at 2148.35 points on Thursday, with pessimism building on a lackluster economic performance, the progress of IPO resumption in the domestic market and hot money outflows from emerging economies.

A slew of previously released economic data undercut investor confidence. The Consumer Price Index, a main gauge of inflation, eased to 2.1 percent in May, while the Producer Price Index (PPI), a measure of inflation at the wholesale level, fell for a fifteenth month to 2.9 percent in the same period.

Meanwhile, exports rose 1 percent in May and the Shanghai Interbank Offered Rate (Shibor) surged 9.58 percent ahead of a three-day-holiday in China that ended Wednesday, stoking fears of tightening liquidity.

Yuan-denominated loans fell dramatically over the past three months, sliding from 1.06 trillion yuan (172.8 billion U.S. dollars) in March to 667.4 billion yuan in May.

Meanwhile, the MSCI Emerging Markets Index shed 9 percent to hit a nine-month-low after Ben Bernanke, chairman of the U.S. Federal Reserve, indicated late last month that the Fed might taper its massive bond-buying program if the U.S. economy continues to improve.

So far, investors have pulled 834 million U.S. dollars from stock funds focused on China, compared with 4 billion U.S. dollars withdrawn from other emerging markets, according to data from EPFR Global, a global fund flow tracker.

With expectations for scaled-back liquidity in the U.S. running high, investors are pulling assets out of emerging markets.

From Monday to Thursday, shares were down 4.97 percent in Thailand, 4.64 percent in the Philippines and 3.9 percent in Indonesia.

The Fed may start to unwind its bond-buying program as early as late September this year, according to a research note from Nomura Securities.

Yet the impact may vary among markets, with Hong Kong and Singapore seen as most vulnerable and China expected to be resilient, Nomura said.

"A QE exit could turn positive for the China market," said Chang Jian,China economist at Barclays Capital. "The turnaround of the U.S. economy will boost demand for exports from China, reduce the inflow of hot money and ease the pressure for currency appreciation."

Authorities will also be less pressed on the monetary side to move ahead with interest rate liberalization, Chang added.

Zhang Zhiwei, chief China economist at Nomura Securities, said higher interest rates in China do not merit a capital migration back to the United States, where rates have been kept near zero for years to revive an anemic economy.

Even if an outflow does occur, he added, China's capital control will limit the scale and the central bank can flood the market with money set aside by banks.

In its biyearly Global Economic Prospects Report released Thursday, the World Bank cut its global economic growth outlook to 2.2 percent for 2013, citing slower-than-expected expansion in emerging markets such as China, India and Brazil.

It also slashed its forecast on China's growth to 7.7 percent from 8.4 percent, warning of a potential slowdown caused by a drop in investment.

The Chinese economy grew 7.8 percent in 2012, marking the lowest growth in 13 years. The growth target set by the government this year stands unchanged at 7.5 percent, a sign that authorities are willing to tolerate slower growth in the process of achieving quality growth driven less by exports and investment and more by consumption.