A continued falling market seems irrational in a growing economy, but the China bourses remain stubbornly pessimistic. Stock investors are now pinning their hopes on more reforms of the securities sector to end this long-running bear market. The Shanghai index has dropped 9 percent since the start of the year, after shedding 22 percent in 2011. Trading volumes have gone down, as has investor confidence.
Two measures - which can roughly be bracketed as long-term and short-term - are now doing the rounds, aimed at regaining some market stability. In an attempt to encourage retail investors to take a long-term approach to their stock portfolios, the government will introduce a ‘differentiated dividend tax’ on stock dividends for individuals from January 1, 2013. For individuals who hold shares for at least a year, the dividend tax will be halved to 5 percent. The rate will be doubled to 20 percent for those who hold shares for one month or less. For investors who keep equities between a month and a year, the tax will remain unchanged at 10 percent of the dividend.
Differentiated dividend taxes mean that longer investors hold shares, the lower will be their tax burden. This might coax retail investors to engage in long-term investment strategies and suppress their tendency for short-term speculation, while bringing more focus on companies that pay higher dividends. The effect of this tax sop, however, may be limited. What the market really needs is more capital to drive up large-cap shares and support growth.
In the short term, this flow of extra capital may be possible. Regulators have taken a decision which will allow bigger market movements and boost foreign investor role in the A-share market. Last week, the government expanded the investment quota under the Renminbi Qualified Foreign Institutional Investors (RQFII) program that allows investors to bring in yuan raised overseas into the mainland China stock market. The China Securities Regulatory Commission, People’s Bank of China and State Administration of Foreign Exchange together announced their intent to increase the investment quota under the RQFII pilot program by 200 billion yuan (Dh117.9 billion), bringing the total quota to 270 billion yuan.
This RQFII quota mechanism, launched in December 2011, allows the Hong Kong units of Chinese financial companies to raise yuan offshore for investment in domestic capital markets, but within a strict quota. Brokerage houses, however, say this quota needs to be raised much higher for significant impact.
Long wait for convertibility
The trouble with the Chinese markets is that efforts always fall short of expectation. For the past year, the China Securities Regulatory Commission (CSRC) has cut trading fees and pushed companies to increase dividends to pump up the stock market, but the major hurdle always comes back to convertibility. China has always encouraged inflows and restricted outflows of funds - a practice it now finds difficult to overturn. While the yuan is freely convertible for trade transactions, investment in stocks or bonds onshore can only be made using quotas assigned by the government while direct investments need regulatory approval.
The utility of capital controls has declined over the years and there is growing recognition that China needs to further open up its capital account by extending convertibility for certain transactions and individuals. Regulators - of stock markets as well as banks - have been promising more ‘balanced’ and ‘neutral’ measures that include rules allowing large institutional investors to move money out of China in stages. The timing, however, is anybody’s guess. It could take either a single year or “few years.”
In addition, convertibility for direct financing, direct investment and extending credit also needs to be facilitated. After the 18th Communist Party of China congress ended recently, expectations ran high for freer movement of capital in and out of the country. It’s not as if China has been recalcitrant. In the past decade it has overhauled its exchange-rate system considerably, revalued the yuan, ended its peg to the US dollar and given banks more freedom to set interest rates. The only jarring note comes when the CSRC reiterates, time and again, that they will continue to exercise control to prevent any “great volatility in the market.”
— The writer is a freelance journalist based in China.