In the space of 48 hours at the end of April, China’s financial regulators demonstrated the balancing act they face in managing the domestic stock market.
On April 24, the Ministry of Finance announced it was cutting the tax imposed on share transactions to 0.1% from 0.3% in what turned out to be a successful bid to boost investor sentiment. Then, on April 25, the Shanghai Stock Exchange suspended trading in Zijin Mining for 30 minutes after the gold mine operator, making its market debut, saw its shares rise by as much as 208.56%.
Neither of these events is a new phenomenon. Share offerings by Chinese firms, especially those that are state-owned, are often priced very low. This is supposedly done to give the public ample opportunity to share in these firms’ new-found wealth.
In reality, the number of shares on offer isn’t enough to satisfy demand so investors who miss out on the IPO plunge in once the stock starts trading, thereby pushing prices up to vastly inflated levels. The winners tend to be the larger, better-informed investors or investor groups who got in and then get out early. A desire to crack down on this practice was behind the decision to suspend trading in Zijin.
Government intervention to revive – or dial down – the stock market is also common. The episode that culminated in the stamp duty cut began months earlier with verbal support for the market from officials. This was followed by the resumption of approvals for new mutual funds, a suspension of corporate income tax paid on mutual fund income and changes to the non-tradable share reform program intended to combat share-price volatility.
While these two events illustrate the wide scope of issues that China’s financial regulators must deal with, they also invite questions as to where and when it is appropriate for the regulators to get involved.
Improving the IPO process certainly requires regulatory input, just like dealing with fraud and insider trading. But regulators shouldn’t play such an active role in stimulating the stock market. All this has achieved in China is the creation of an environment in which investors feel they can rely on the government to step in when times get tough.
The underlying risk is that investment decisions will not be based on company fundamentals but on short-term flights of fancy courtesy of a regulator that doesn’t know when to stop regulating.