INVESTORS of shares listed on the Shanghai Stock Exchange now have more than 1 trillion yuan (US$161 billion) in borrowed cash riding on the world’s highest-flying stock market.

    The outstanding balance of margin debt on the Shanghai exchange surpassed the trillion-yuan mark for the first time April 1, a nearly fourfold jump from just 12 months ago. The Shanghai benchmark index has surged 86 percent during that time, more than any of the world’s major stock indices.

    While the extra buying power that comes from leverage has fueled the Shanghai Composite Index’s rally, it’s also sending volatility to five-year highs and may accelerate losses if a market reversal forces traders to sell.

    Margin debt has increased even after regulators suspended three of China’s biggest brokerages from adding new accounts in January and said securities firms shouldn’t lend to investors with less than 500,000 yuan.

    “It’s like a two-edged sword,” said Wu Kan, a money manager at Dragon Life Insurance Co. in Shanghai. “When the market starts a correction or falls, it will increase the magnitude of declines,” Wu said.

    In a margin trade, investors use their own money for just a portion of their stock purchase, borrowing the rest from a brokerage. The loans are backed by the investors’ equity holdings, meaning that they may be compelled to sell when prices fall to repay their debt.

    Chinese investors have been piling into the stock market after the central bank cut interest rates twice since November and authorities from the China Securities Regulatory Commission to central bank governor Zhou Xiaochuan endorsed the flow of funds into equities. Investors have opened 2.8 million new stock accounts in just the past two weeks, almost on par with Chicago’s entire population.

    The outstanding balance of the margin debt on China’s smaller exchange in Shenzhen was 493.8 billion yuan March 31. That puts the combined figure for China’s two main bourses at the equivalent of about US$241 billion. In the United States, which has a stock market almost four times the size of China’s, margin debt on the New York Stock Exchange was about US$465 billion at the end of February.

    For BNP Paribas SA economist Richard Iley, the surge in Chinese margin purchases is among signs of a bubble fueled by individual investors. More than two-thirds of new investors have never attended or graduated from high school, according to a survey by China’s Southwestern University of Finance and Economics.

    “Leverage cannot rise forever,” Iley wrote in a report last month. “The more the stock of margin debt climbs, the greater the risk of a disorderly unwinding of leveraged positions once net redemptions begin to accelerate.” (SD-Agencies)