The myth of the China stock market misleading nominal investors
Stephen Green, Head of the Asia Programme, Royal Institute of International Affairs, Project Syndicate
Across China, many look at Shang Fulin as a savior. The new head of China's Securities Regulatory Commission (CSRC) takes the helm in the midst of an 18-month bear market, one caused by government policies -- or so conventional wisdom has it. His challenge will be to resist the temptation to seek short-term popularity, recognizing instead that China's stock market must endure short-term pain to win long-term gains.
Eight myths cloud debate over stock market policy in China. Shang's job will be easier if each is dispelled:
1. China's stock market has grown extremely large, extremely quickly. At the end of 2002 the official capitalization of China's stock market was US$458 billion, making it the eighth largest in the world -- an apparently astounding achievement given where China was a decade ago.
Unfortunately, the figure is misleading, because it includes non-tradable, state-owned shares valued at market prices. In 1992, the State Council, seeking to stop mass privatization, ruled that two-thirds of the equity capital of restructured state-owned enterprises (SOEs) had to be issued to state organs and could not be traded. Former SOEs -- whose market valuation is pumped up by the artificial shortage of tradable shares -- account for more than nine-tenths of the 1,224 companies listed on China's stock exchanges.
Strip out all this non-tradable equity and what is left is a market worth about $145 billion (around 12 percent of GDP) at the end of 2002. The equivalent figure in developed markets is usually over 100 percent of GDP. Because share prices, therefore, cannot possibly affect the macro-economy, Shang should be able to improve the quality of regulation without worrying about the effect on growth.
2. Initial public offerings (IPOs) are now as important a source of capital as banks. During the 1990s, the stock market did grow in significance for Chinese firms, or at least for the former SOEs that were listed. But enterprises still rely on banks for the bulk of financing. In 2002, domestic share issues raised $8.9 billion, while banks provided twenty times that amount. The corporate debt market remains tiny. Indeed, only 20 corporate bonds are currently listed in Shanghai and Shenzhen.
3. The stock market allocates capital more efficiently than banks. One rationale for creating China's stock market was that it would channel finance to where it was most needed, side- stepping indebted and inefficient banks. But all stock markets rely on their local institutional environment. While the CSRC should be congratulated for its good work in improving this environment, more needs to be done.
Firms do not compete freely for stock market capital; former SOEs, indeed, receive preferential treatment. Fraudulent disclosures are commonplace. Artificially low interest rates create extra incentives for putting money into shares. Tough regulatory enforcement need to continue. More private firms must be allowed to make IPOs.
4. Restructuring a SOE into a shareholding firm and listing it improves performance. Good theory, but, again, only one-third of most SOEs' shares are privatized. Local officials remain involved in running listed firms, and while regulatory institutions remain weak, asset stripping on the part of managers and owners is extensive. Real privatization is needed. Shang needs to grasp the nettle and come up with a new scheme for selling off the central government's shares.
5. China's stock market is dominated by small investors. Roughly 68.7 million individual share accounts were opened by the end of 2002. A majority of these are empty or disused. A recent survey by the Shanghai Stock Exchange found that only 8 million of its 35 million accounts were active. Institutional investors fraudulently opened millions of accounts in order to manipulate prices. A plausible estimate is that there are just 10-20 million active individual investors. China is not yet a nation of shareholders -- another reason why Shang need not worry too much about pursuing unpopular policies.
6. The market lacks institutional investors. Sixty-one closed and open-ended investment funds currently own about 10 percent of traded shares. But demand for asset management outstrips supply, and several thousand financial-management, trust, and consultancy companies now manage individual and corporate wealth. These are institutional investors in everything but formal registration. A survey conducted in 2001 suggests that funds under their management account for about 40 percent of the market.
7. The CSRC, the securities and fund-management firms, and listed companies are all ultimately owned by the state and so little improvement in regulation is likely. For much of the 1990s, the political logic was clear: Use the stock market to finance former SOEs and slacken regulation. That logic is now in question. An increasing number of officials recognize that privatization is the only way to improve efficiency and to raise funds to meet the government's liabilities. With intensification of privatization, the CSRC should be freer to do its job properly.
8. China's stock market cannot be a vehicle for privatization. According to Changjiang Securities, 320 listed companies experienced a change in their controlling shareholder in 1996- 2001. However, this usually involved the off-market sale of locally held state-owned shares to a private investor. At least 150, and perhaps as many as 200, listed firms have been privatized. As the government steps up privatization, the CSRC must encourage such sales and continue to establish a framework for mergers and acquisitions to support them.