China grapples with equity conundrum

It is one of the peculiarities of China's rapid development that while the economy has been surging ahead at near double- digit growth rates, the local stock market recently hit a six-year low.

The Shanghai stock market is 2.2 per cent up on the year so far, but that followed a 15 per cent slump last year one of the worst performances in the world. Trading volumes are half the 2001 peak.

"The government, the regulators, the companies, everyone is trying to work out why this is happening," says Wang Kai Guo, chairman of Haitong Securities in Shanghai, one of China's largest brokerages.

Judging by the volume of announcements coming out of Beijing in recent weeks about market reforms, the fate of Chinese share prices is becoming an issue of acute concern to the government.

One plank of the authorities' strategy has been to try to channel more institutional funds into the equity market. An official at China Securities Regulatory Commission, the market regulator, announced yesterday that the government would loosen some of the restrictions on foreign institutions buying renminbi assets.

The regulators have taken the first step in allowing the country's insurance industry which has about $7.2 billion (Dh26.424 billion) in assets to begin buying domestic stocks. State media reported last week that Huaitai Insurance had become the first company to buy equities.

The central bank has also established the rules for China's large commercial banks to set up mutual fund operations, which could eventually lead to the banks channelling significant amounts of savings into equities.

Regulators hope these rule changes will lead to new funds coming into the market. In addition, the introduction of more professional investors should reduce some of the volatility.

"This is a tough market for retail investors," says Frank Yao, chief investment officer at Hua An Fund Management in Shanghai. "Over time it is clear institutional investors are going to play an ever larger role."

To entice retail investors back, the authorities halved the stamp duty paid on stock trades and have unveiled plans to set up a protection fund for investors with funds in bankrupt brokerages. Local media have reported that the fund might eventually be worth 60 billion yuan (Dh26.424 billion).

The regulator has also stepped up the pressure on failing brokerage firms. Analysts estimate that about half of the 130 Chinese brokerages are loss-making a product of falling markets and promises of guaranteed returns to investors.

Tougher line

The CSRC sent its own auditors into nine struggling companies and has ordered the rest of the brokerages to produce a report next month on their financial health.

Most market-watchers believe the authorities need to take a tougher line with the brokerages, forcing failed companies out of business and pushing for more consolidation. Yet the rhetoric has at least been stepped up.

There are signs that these measures are having an impact. The market continued its slide in January, reaching a seven-year low at one stage. However, it has more than made up the lost ground in the last three weeks as the slew of new proposals has been released. Shares listed in Shenzhen are now 8 per cent up this year.

Yet for most investors and analysts in China, the market's problems go much deeper than the remedial proposals announced so far this year.

"It is hard for these measures to change things radically," says Wang at Haitong Securities. "Without structural reform, there is really no long-term solution for the market."

When Chinese investors talk of structural reform, they are usually referring to the overhang of shares of public companies still in state hands.

Although the situation varies from company to company, non-tradeable shares, most of which are in government hands, account for about two-thirds of the equity of listed groups.

With the National People's Congress kicking off next week, rumours abound that the authorities are preparing a plan to address the issue. The problem is that previous announcements on the subject have only served to push the market down further, as investors feared a glut of new shares as non-tradeable equity was made tradeable.

Insider trading is rampant, investors say, and the rights of minority shareholders are poorly protected. Moreover, most analysts argue that even after the grim performance of the last three years, the mainland stock markets are still overvalued.

During the giddy boom of 2000-2001, the price/earnings ratio of shares on the Shanghai exchange reached 61. Although it has since fallen back to just above 24, this is still about 50 per cent above the valuations seen on the Hong Kong market. The mainland stock markets could still have further to fall.

- Financial Times