Chinese stock markets up 50% in 2000 despite weakness

Asian Economic News, Jan 22, 2001

BEIJING, Jan. 16 Kyodo

China's domestic stock markets in Shanghai and Shenzhen rose 51.7% and 50% respectively in 2000, the official Xinhua News Agency reported Tuesday.

But observers say the dramatic gains are artificial and the government policies that support them are only prolonging inefficiencies that would be better addressed now.

Government support, limited listings, restricted market access and a lack of alternatives for China's high-saving domestic investors have created a hothouse environment for the equity market in which prices balloon despite the poor quality of listed firms.

Price to earning ratios in China's domestic A-share market average 70%, according to China International Capital Corp.

The country's B-share markets -- reserved for foreign investors, who are not allowed to hold A-shares -- jumped 130% in Shanghai and 60% in Shenzhen, Xinhua said.

Observers say the gains were off a very small base, fueled by speculation China's domestic and international markets would be merged. The B-share market had languished for years at single-digit price to earning ratios, meaning the same company's shares would often trade on the B-share market at a fraction of it's A-share price.

Market regulators began hinting in mid-2000 that the A and B-share markets would be merged but gave no details. Speculation that arbitrage would bring share values in the tiny B-share market up closer to A-share levels gave a substantial boost the ''for foreign'' market, attracting many A-share investors. More than 80% of B-share investors are actually Chinese nationals who avoid restrictions -- B-shares are nominally off-limits to Chinese -- with tacit government approval, observers say.

Both markets have been abused by struggling state-owned enterprises to get cheap capital, and the government continues to support artificially high equity values to protect favored companies and investors. Only two or three dozen of China's 1,058 A-share listings are private companies. And although the ranks include many struggling state firms, China has yet to delist even one company.

''You could list a monkey-on-a-stick and it would perform well,'' quipped one Hong Kong trader.

Even when a company fails its stock price often rises because investors know the government will do whatever necessary to save it.

When Zhengzhou Baiwen, a struggling retailer, defaulted on loans late last year its share price shot up before it was sold to another firm who wanted a back-door listing.

Such behavior creates a ''serious moral hazard'' that will ''come back to bite somebody,'' predicted one Western diplomat who follows China's equity markets.

China has already pledged to merge the two markets and open its capital account incrementally within the next three to six years, allowing foreign investors into domestic markets and vice-versa. Once this happens there will be nothing to prop up the value of state-owned equity as domestic money begins to flow abroad to chase down better investments.

The best-case scenario is that reforms continue bring in better and larger companies and investors, deepening the market and improving the quality of listings.

The situation is precarious, though, and change that is too fast or too slow could lead to a collapse, he said.

Regulators are stepping up enforcement and cracking down on speculative behavior, ''but not too hard,'' he said.

The market is only 10 years old, and the Securities Law governing listings and outlining acceptable behavior for traders only went into effect in 1999.

''The market is really just a baby,'' said the Hong Kong trader.