Three trillion. Over 12 months, that is the market value, in US dollars, erased off the A-share market as the Shanghai Composite Index fell 62% in 2008. By the time of Wall Street’s collapse in the fall, China’s investors had long since given up hope that the market slump was a short-term phenomenon.
"In terms of declines, it was one of the worst in the world. The level of the index was too high. It was not sustainable," said Frank M. Song, director of the Research Institute of China Finance at the University of Hong Kong.
It was a dismal year for the securities industry, a vicious hangover from the dizzying growth of 2007. Then, regulators and market participants alike saw little to complain about in China’s market.
Even in 2007, however, there were signs of problems. With so much money to be made in the market, brokerages passed on providing many of the basic services that come as standard elsewhere in the world. Masses of retail investors, basing decisions more on sentiment than on real information, drove stocks far beyond reasonable valuations, while investment options were limited to buy-and-hold. A strict but ineffective regulatory structure did little to encourage companies to develop effective internal governance mechanisms.
High numbers of non-tradable shares, despite the ostensible completion of reforms, meant that the market remained fundamentally skewed. And in the excitement of gradually welcoming foreign capital into the market, regulators left basic investment necessities unmet.
These problems have not gone away, as Beijing is well aware. In 2009, it may finally have the opportunity to address them. The market’s collapse could actually provide an ideal chance for change.
"With markets so down, this is a good time to do it," said Chris Ruffle, co-chairman of Martin Currie and director of the A-share China Fund.
The necessary changes are not revolutionary, but all require a focus on long-term results. That may prove difficult for Beijing, which has displayed a tendency in the past to favor short-term measures to raise index numbers, such as cuttingthe stamp duty to lower the price of stock transactions, and limiting the release of newly tradable shares on to the market.
Taken separately, the five measures listed here – addressing the problem of non-tradable shares, improving the quality of domestic brokerages, expanding and fixing the Qualified Foreign Institutional Investor (QFII) scheme, widening and deepening investment options, and encouraging better corporate governance – are not sufficient to address all of the problems facing the securities industry.
But taken together, they outline an approach that emphasizes openness and competition without excessive government interference. The reforms are within Beijing’s reach, and in some areas progress is already being made.
Too often, however, good ideas are hobbled by fear of the unknown and a desire to control the market’s direction.
Economic growth forecasts for 2009 are not optimistic, and the investors may remain gloomy for some time. The challenge is for Beijing to look beyond short-term concerns to create a foundation for more sustainable growth.