The combined market capitalization for the Shanghai and Shenzhen bourses was just US$513 billion at the end of last year, just over 70% of Hong Kong's US$712.3 billion.
Shanghai's cavernous trading floor represents the city's ambition of becoming the financial center of East Asia, but while virtually every other Asian market soared last year and the Chinese economy jumped by an impressive 9.1%, domestic Chinese stock prices continued an overall steady decline that has haunted the market since 2001.
The Chinese government is renowned for the grand pronouncements it has made over the years stating that the capital markets are opening up and that real and serious reform is now under way. These fake orgasms have left observers and investors somewhat cynical about the prospects for real reform, and it is in this context that China's cabinet, the State Council, announced new legislation in early February intended to resuscitate China's domestic stock exchanges.
The new policy statement addressed every major issue confronting the feeble capital markets. It granted insurance companies and pension funds more freedom to invest in stocks and gave the Country's sickly brokerages the right to list and issue bonds to raise capital. It promised to place private and foreign-funded companies (with a specific invitation to Taiwan companies) on an equal footing with state-owned enterprises when it comes to gaining approval for listings. It allowed a resumption of IPOs on the Shenzhen exchange and restarted plans for the establishment of a 'second board' for smaller cap startup enterprises that has been on hold since 2000.
The announcement also included a pledge to introduce preferential tax policies to encourage investment in the domestic capital markets and included a vaguely worded call for a solution to the most intractable problem facing China's stock markets – the non-tradable state shares.
The new official show of resolve set off a wave of good will amongst domestic investors and by the end of the week following the announcement, the markets had risen back to the levels of August 2002, after hitting a four and a half year low in November.
But is it all just another fake orgasm? This time, maybe not. This year is shaping up to be a year of serious economic reform led by China's 'fourth generation' leaders. The advocates of a slowdown in investment seem to have won out. To accompany its lower growth target of 7% this year, the central government is likely to introduce further measures to slow down bank lending. This will force many companies to reduce reliance on the technically insolvent state-owned banks.
An increasing number of Chinese companies are seeking to raise money on foreign stock exchanges (the total value of overseas IPOs is predicted to be between US$15 billion – US$20 billion this year), so there is an urgent need to improve the credibility of the domestic markets and allow them to become a more important source of capital.
By mid-March concrete reforms were already well under way. The long-delayed qualified domestic institutional investor (QDII) scheme was jumpstarted when the National Council Social Security Fund, a pension fund, was approved to invest in overseas capital markets. Hong Kong's exchange will be the eager first recipient of Mainland investment under QDII.
Following the State Council's explicit call for expansion of the qualified foreign institutional investor (QFII) scheme which began in late 2002, Chinese media reports predicted that foreign institutional investors – of which there are currently 12 with a combined investment limit of US$1.7 billion – would take up a 10-15% share of China's stock market within two years.
If QFII is anything to go by, the pace of QDII will be slow at first and the initial cap on overseas investment is likely to be low, so as to prevent a rush of money from the domestic markets to lower-priced overseas assets. The National Council fund was approved to invest just RMB5 billion (US$604 million) of its total RMB133 billion (US$16 billion).
Analysts say they expect the QDII scheme will be aimed at influencing market sentiment rather than reducing the country's expanding foreign currency holdings. China's foreign reserves are the second largest in the world after Japan and swelled to US$416 billion at the end of February from US$403 billion at the end of December.
Another immediate effect of the State Council announcement was the first wave of China's brokerages issuing corporate bonds. Faced with numerous corruption scandals and a 32% slide in stock prices since mid-2001, official figures show 98 of the country's 131 securities houses made a combined loss of RMB4.1 billion (US$495 million) in the first nine months of 2003. But in early March three brokerages were approved to issue bonds and approvals for another four were expected to follow soon after.
The government's reforms are more than hot air but the problem is how to introduce non-tradable state shares into the market without repeating the calamitous experience of 2001 when a similar attempt set off the slide that has only recently leveled off.
When China's Shanghai and Shenzhen stock exchanges were launched in the early 1990s, only state-owned enterprises were allowed to list and the state essentially retained two-thirds of the shares in these new 'public' entities. The problem is that if those shares are all introduced into the open market it will drag down the value of existing tradable shares.
The February announcement was necessarily vague in calling for a "timely and suitable" solution to the problem of state shares. It was left to Li Rongrong, head of the State-owned Assets Supervision and Administration Commission, the government agency controlling state shares, to address the issue in an interview with Xinhua news agency in which he said that regulations covering their sale would come out at the "proper time," when investors are calm and the market is stable.
"There is no reason for people not to be confident about the future trend of the stock market," he said.
If the highly credible Li can liquidize state shares without causing another meltdown then perhaps this really could be the end of fake orgasms in China's capital markets.