As many of Asia’s markets continued to struggle late last week, stocks in China started to bounce back, highlighting just how volatile China’s market has become—and just what a challenge it presents to Beijing, which is anxious to keep the country’s hot, semicapitalist economy growing as it heads into the 2008 Olympics. The Shanghai and Shenzhen stock exchanges are critical to the ruling Communist Party’s development plans, because they provide a channel for enterprising Chinese firms to raise capital and a way to gradually privatize inefficient state-run companies. But last week proved that a young stock market is an unpredictable tool of reform, even in the hands of a government determined to maintain order. If Beijing can’t keep markets from overheating and fix underlying problems, it won’t be able to create an efficient means of raising capital or imposing discipline on state-run firms.
China’s stock markets, established in 1990, languished for years because of corruption, red tape and other problems. In March 2005, they almost collapsed, and new listings were suspended temporarily. But over the past two years, Chinese stocks have exploded, climbing 155 percent in Shanghai. Flocks of investors have followed, with new accounts tripling since 2005. The 1,400 companies listed on both markets now have a total value of about $1.4 trillion—mostly from domestic investors, since access to foreigners is limited.
Some emerging-market bulls believe that with recent reforms, China’s markets are coming of age. But they are still plagued by fraud, weak corporate governance, poor transparency and an overwhelming bias toward secretive state firms, many of which allow only minority shares to be traded. The boom, skeptics say, owes mainly to the influx of money into China, a result of its trade surplus and undervalued currency.
With rising incomes, Chinese investors are turning to stocks, in part for lack of options. Individuals and many institutions are largely prohibited from investing overseas. China doesn’t have much of a bond market, and its banks—where 90 percent of Chinese keep their savings—offer just 2 percent interest, not enough to keep up with inflation. Stocks offer a way to profit from China’s boom, and investors are betting that the government won’t let the market crash, especially not before the 2008 Olympics. Many officials (or their families) are deeply invested themselves, and worry that a crash could trigger embarrassing social unrest. The result is too much growth too fast. “The significant structural woes of the market are still there,” says Fred Hu, a managing director of Goldman Sachs in Hong Kong.
Investors are probably right that Beijing will do all it can to prevent a slump. The government remembers the angry protests that broke out over stock-market crashes and investor fraud in the 1990s. Beijing has intervened after past crashes by creating special funds to buy shares and boost prices. But that’s only reinforced public faith in the market, drawing in more hot money and undermining discipline. Wen Xuan, an economist at the University of International Business and Economics in Beijing, says the bailouts “twist people’s behavior.”
Recently, Beijing has tried more indirect methods. In late January, one senior government official cautioned against “blind optimism” among investors. Weeks later the government warned banks to scrutinize loan applications to make sure borrowers weren’t using the funds for market speculation.
Yet analysts say such moves have only confused investors—and some officials. Beijing attributed the fall last Tuesday to “profit-taking, overly high valuations and normal market volatility.” But one economist, who spoke on condition of anonymity, said senior leaders told him privately that though they were relieved by the decline, they were caught off guard by its sharpness and were struggling to figure out what prompted it.
Many observers argue that the party cannot stabilize the stock market by trying to micromanage it, and have urged the government to make more fundamental reforms—a theme U.S. Treasury Secretary Henry Paulson is expected to stress in Shanghai this week. Beijing has already taken some significant steps, forcing state enterprises to clarify their ownership and allow more shares to be held by private investors. It has also strengthened its anticorruption agencies, and made it somewhat easier for private companies to list on the exchanges; analysts say nearly 20 percent of listed firms are now privately run. In addition, news agencies reported late last week that the government may soon allow qualified foreign investors to control 5 to 10 percent of the market (up from about 1 percent). That will boost prices. But foreign investors will also demand better information and otherwise put pressure on inefficient firms.
No doubt, China’s popular stock craze is likely to spread. The day after stocks tumbled last week, Chinese investors were back in the game, amid typically mixed signals from on high. At a Beijing branch of China Galaxy Securities, a state-owned firm, a voice over the loudspeaker reminded the crowd: “Just because you see a lot of people here today, don’t believe those who say there are many more investors putting money into the market. The reality could be just the opposite.” It was a cryptic warning, but a clear reminder that Beijing is closely—and nervously—watching.
