SHANGHAI China's ballooning stock market bubble, fuelled by excessive liquidity, is likely to burst in the first half of 2010, punctured by economic concerns arising from higher-than-expected inflation, Morgan Stanley Asia Executive Director Jerry Lou said on Thursday.
China's benchmark Shanghai Composite Index .SSEC may peak around 4,000 points, as banks continue to lend massively to infrastructure projects initiated this year under the government's $586 billion stimulus package, Lou told a media briefing in Shanghai.
The Shanghai index ended Thursday down 3.62 percent at 3,170.979 points.
"An asset price bubble is forming in China, but that process hasn't finished yet," Lou said. "There's little room to reduce lending next year. Too much money boosts gross demand, which would translate into inflation."
China has boosted government spending on infrastructure and social welfare projects, engineered a lending boom and re-pegged its currency to the U.S. dollar to support exports in response to the fallout of the global financial crisis.
These measures have proved effective in the short term with China's economic growth likely to exceed 9 percent in 2010, but on the other hand, they aggravated the imbalances which are at the heart of China's mode of development, Morgan Stanley's (MS.N) Lou said.
"We see higher investment and savings rate, and thus increasing imbalances," Lou said. "I don't expect to see a so-called golden decade for China. If China cannot stop the bleeding, it needs a blood transplant."
Lou suggested investors should buy energy and consumer-related stocks which would benefit from inflation next year, but should avoid property, steel and banking stocks.
China's property prices are too high, and the government should levy higher taxes to curb speculation and make homes affordable to ordinary Chinese, he said.
Lou also suggested that China should decisively deregulate its capital market and allow an one-off revaluation of its currency, the yuan, in a bid to restructure its economy quickly, even at the cost of tens of millions of lost jobs.
(Reporting by Samuel Shen and Jacqueline Wong; Editing by Lincoln Feast)