Fed tapering may hit China equities : BofAML

Despite economic strength, China will likely see its stock markets slide as U.S. Federal Reserve's "tapering" triggers a broad selloff in emerging economies, according to an investment strategy note released by Bank of America Merrill Lynch (BofAML) on Wednesday.

The Fed signaled that it would scale back the 85-billion-dollar monthly bond buying, and the market anticipated the Fed would reduce its stimulus as early as September. Jitters over monetary tightening have caused huge capital outflows in Asia and plunged the Indian rupee to a record low.

"Economically, China is probably better positioned than most to handle external shocks. However, stock market performance can decouple from economic growth," wrote David Cui, China strategist at BofAML.

"Our chief concern about tapering is hot money outflow," the BofAML note said. "We suspect that carry-trade is quite prevalent. Much of the position may be parked in the shadow banking sector. Any sudden outflow may prompt a credit crunch."

Chinese stock market dived five percent on June 24 after the country's interbank offer rates went to double digits over fears of credit crunch. The stock market slumped six percent during the next day's trading before the central bank's promise of a liquidity injection reversed the trend.

China, with relatively fast GDP growth, a closed capital account and a healthy current account, can resist external shocks, but troubles in the region would be unlikely to leave equities unscathed.

"An ebbing tide lowers all boats," Cui said. "This is perhaps especially so at the early stage of an unwinding -- when investors rush out of the door, they tend to sell where there is liquidity rather than what they should. China's equity market has the highest liquidity among emerging markets in the region."