Despite warnings by Chinese regulators against irrational exuberance, the central government has a vested interest in keeping the current stock market boom alive. On Tuesday, the China Securities Regulatory Commission (CSRC) warned investors against borrowing too much money or selling their homes to buy stock. But the same government recently opened the spigots by boosting liquidity over 1 trillion yuan – more kindle for a rally which has catapulted the Shanghai and Hong Kong stock markets to 7-year peaks. Beijing wants consumers to feel that the stock market is creating wealth so if they are happier about stocks, they’ll be less worried about the sinking values of their properties – which is where all the policy support is going at the moment. Happy consumers would keep retail spending rising, a key factor in the shift to a consumer driven economy which is a vital plank of a reform programme to rebalance the economy. “The liquidity-driven bubble looks likely to continue for now. The (Chinese) government has multiple reasons to keep the equity rally going,” a report by BNP Paribas said. “China’s equity market is policy-driven and the authorities have a lot more sway over its performance than in the West. We expect this upswing to continue for now,” Lombard Street Research, a UK economic research house, said in a report. The Shanghai Composite Index has more than doubled since last September and the Hang Seng Index has surged roughly 20 per cent since March. The markets in Hong Kong and Shanghai are poised for their biggest monthly gain since 2012. Retail investors, meaning consumers, account for about 80 to 90 per cent of daily turnover in the stock markets. The stock market boom will generate a wealth effect for these consumers which should bolster consumption and possibly reignite demand in a property market depressed by a glut in supply. “There are signs of spill-over from the equity market into the (mainland) property market, as reflected in the slight increase in average property prices over the past few months,” BNP Paribas said. More importantly, Beijing needs capital markets to take the strain off a government-backed banking system where moral hazard runs high and defaults by several companies seems ready to accelerate. BNP said the Chinese government would uphold the stock market boom because is it is the easiest way to support the recapitalisation of banks and to repair the balance sheets of over-leveraged companies. “From Beijing’s standpoint, a strong equity market allows rebalancing in the banking sector to take place but does not exacerbate the Chinese economy’s imbalances,” said Lombard Street. “Banks are in need of substantial recapitalisation, which the authorities would prefer to carry out in a stronger market.” And even if the markets become too frothy and people lose money, that will help create a sense of risk taking and risk management which is crucial to more efficient capital allocation. The inefficient use of capital has been a key structural problem in China’s economy.