Business | Markets
Channel Sponsor
China's bubble vulnerability
At the start of 2004, a man walked up to the offices of China's stock market regulator in Beijing and tried to set himself on fire. His reason? To complain about the collapse in share prices.
- Financial Times
- Published: 00:00 February 7, 2007
At the start of 2004, a man walked up to the offices of China's stock market regulator in Beijing and tried to set himself on fire. His reason? To complain about the collapse in share prices.
Fast forward two years and the country is in the grips of a bout of stock market fever. Having seen the market rise 130 per cent in 2006, bringing to an end a five-year slump, thousands of investors are signing up every day to open brokerage accounts.
The Shanghai stock exchange has even warned that record trading volumes could destabilise its electronic trading system. Yet such success has brought a new headache for the regulators. Having spent several years being criticised for the prolonged market slump, they now face the opposite problem - trying to prevent a bubble developing in the equity market.
In recent weeks, several warning signs have emerged that the market is over-stretched. The surge in share prices saw Industrial and Commercial Bank of China become, at one stage, the second largest bank in the world behind Citigroup - only a few years after it was considered to be nearly insolvent.
Chinese shares listed on the Hong Kong market have a price-earnings (P/E) ratio of 18: the same companies on the Shanghai market have a p/e ratio of 33.
For the regulators, such figures bring back bad memories. The previous collapse in the mainland market, beginning in 2001, came after a large gap opened up between valuations in Shanghai and Hong Kong.
Reforming the stock market has been one of the main pillars of government economic policy over the past two years. Officials want to encourage flotations to take some of the strain off the banking system, which has been the main source of capital for Chinese industry.
Yet a slump in share prices could stifle new-found investor confidence in equities and limit the amount of capital raised from the market.
"What China really needs is 20 years of steady 15 per cent increases in the market, but it got 130 per cent in one year," says Jonathan Anderson, an economist at UBS. "If continued speculation leads to a sharp fall, it could close off that [initial public offering] pipeline."
Limits
The problem for Beijing is that the market is highly vulnerable to bubbles.
China has 34,000 billion yuan ($4,372 billion) in bank deposits that receive a meagre two per cent return and there are strict limits on how much money citizens can take out of the country.
So when confidence in equities is high, there is a huge surge of liquidity into the stock market that bids up domestic share prices to unrealistic levels.
The government has already taken modest measures to cool the investment climate. Licences for new mutual funds have been put on hold and the banking regulator is investigating the use of personal loans to buy stocks.
Beyond that, the government has other options.
For a start, it can increase the supply of new shares. The regulator usually operates a queue system for IPOs but officials say, at the moment, any company with the necessary qualifications can go ahead with a listing.
With big companies already listed in Hong Kong increasingly looking at mainland listings, Shanghai could see 200 billion yuan in IPOs this year and outstrip Hong Kong, according to PwC, the consultants.
A government reform of the shareholder structure of listed companies, which is gradually eliminating the large overhang on non-tradeable shares, will also release a new wave of supply on to the market. Up to 500 billion yuan of shares could, in theory, start to be traded over the course of this year.
Although the authorities say they favour letting foreigners play a bigger role in the market, any further increases in the limited quota for foreign investment in mainland stocks are unlikely at the moment.
The government could also take further measures to mop up liquidity in the financial system by increasing bank reserve requirements and restricting new lending. Investors are also on the look-out for a strongly worded editorial in the People's Daily or the Xinhua news agency that warns against putting more money into the stock market.
If all these measures do not calm the market, there is likely to be a serious debate about introducing a capital gains tax for equity investments.
The Ministry of Finance has, for the first time, ordered that individuals with income of more than 120,000 yuan a year report stock trading profits, which some analysts see as a preparation for a new tax. The government has had some success in using a capital gains tax to reduce speculation in the Shanghai property market over the last year. Yet officials say there are fears that a capital gains tax would prompt an exodus from the market.
Share this article
Popular in Business
-
Budget travel
Airlines in the region
Take a pictorial look at some of the budget airlines in GCC
Business Editor's choice
-
Credit swaps... a fair trade
Would you swap an unbuilt unit at the Lagoons for an apartment at JBR?
-
New face of safety
Volvo reveals a sleeker S60, ready to hit the roads early next year
-
When the Web lives worldwide
Cutting-edge firms are building massive data facilities all over the globe
