China’s Stock Market

China’s economy has changed from a centrally planned economy (CPE), which was introduced in 1949, to a more market orientated economy since 1978 and is currently a significant participant in the global economy. There were some inherent shortcomings of the CPE, like the defective functioning of the planning mechanism, the monopolistic, non-contestable position of the State Owned Enterprises (SOE’s), the lack of financial sanctions, the lack of adequate incentives, the macro-economic, suboptimal allocation of resources, the autarchic isolation and Mao’s disastrous initiatives. This led to the reforms in the late 1970’s, which started with the de-collectivisation of agriculture, the gradual liberalization of prices, a diversified banking system, more autonomy for SOE’s, decentralisation of the fiscal system, development of the stock markets, the growth of the non-state sector and the opening to foreign trade and investment.

In Mainland China, the stock market reappeared in the 1980’s and has experienced a lot of growth ever since. The number of companies listed, increased from a dozen in 1991 to more than 600 in 1997. At the same time, the market capitalisation increased from less than 10 billion to more than 1300 billion RMB. The Chinese market has a number of unique features, like different shares issued to enterprises, state, individual share holders, who have different purchasing costs and circulation regulation. Other characteristics are strictly segmented markets for domestic investors and foreign investors, high transfer rates, high P/E ratios and high system risks. The Chinese government has formulated four principles of stock market development, namely: the legal system, standardization to normalize its stock market, supervision and self-discipline. One of the reforms that China gradually has implemented were the refinements in foreign exchange and bond markets and the sale of equity of China’s largest state banks to foreign investors in 2005.

China’s stock markets major turning point

Recently, the stock prices have been increasing caused by recoverable growth. Therefore, market-oriented adjustments are needed. China’s stock market went from a sustained slump to a stable development, but now, it has reached a major turning point. According to People's Daily Online, Zhou Zhengging states in a recent interview with the Chinese media, that the Chinese people should cherish this hard-won situation and use the opportunity to maintain the development of the stock market. Zhou Zhengging is the former chairman of the China Securities Regulatory Commission, a member of the NPC Standing Committee and vice president of the Financial and Economic Committee and according to him there is no serious bubble in China’s stock market.

China’s capital market has been stagnant since June 2001, which is not quite normal. Zhou claims that there are multiple reasons explaining this situation. One is a misunderstanding of the capital market’s development caused by flawed thinking. This type of thinking has had a negative impact on the capital market because people generally rejected China’s capital market and have been arguing and advocating a “new start”.

Efforts to improve and expand reforms resulted in the major shift and changes that occurred in 2006. Zhou emphasizes that China must cherish the situation they now have. Five factors can be distinguished that contributed to the turning point of 2006.

1. Firstly, the CPC Central Committee as well as the State Council have to consider the development of the capital market as one of their priorities. They also made important strategic plans and policy decisions.

2. Secondly, China has solved some of its major problems, by completing equity division reforms. This will have a long term impact on the healthy development of the capital market. In addition, shareholders no longer have the possibility to hold tradable shares as well as non-tradable shares at the same time or share the same equity property in order to strengthen the basic mechanism.

3. Thirdly, another factor conductive for the development of the capital market is the improved legal environment.

4. Fourthly, a favourable external environment for the capital market was created by the sustained and rapid development of the national economy. Zhou stated that especially the money market was more liquid, which helped to ease the shortage of funds in the capital market. This has been a problem for the past two years. In the meantime, the objective requirements for the development of China’s capital market have been raised by the growing demands of investors. 

5. Finally, improving the regulation and supervision of China’s capital market and the quality and efficiency of the companies listed, are factors that also contributed to the recovery of the stock market.

China’s stock market has no serious bubble

Earlier this year, the Shanghai and Shenzhen Stock Index set a record, when the largest single-day decline in the market occurred, which resulted in a nationwide debate. Some people were claiming that there was a serious bubble in the stock market. Zhou reacted on that by stating that this incorrect conclusion was caused by a biased analysis of the stock market. He recons that the decline was just an internal market rebound. Furthermore, he pointed out that as virtual capital, it is normal for stock prices to fluctuate. Moreover, certain bubbles are normal to occur in the capital market. There is no threat as long as the bubbles are small and do not form a risk to the healthy development of the market. Although the decline was an inevitable rebound, anxiety and rumours regarding “the existence of serious bubbles” in the Chinese stock market, further aggravated the fall. Zhou has warned investors for following these opinions blindly, because wherever the rumour comes from, it is not per definition correct.

According to Zhou, the rise of the stock prices of last year were actually recoverable growth. The Shanghai Stock Index reached 2,600 points at the end of 2006. However, the real level was just 2,200 points, because the calculation formula produced an inflation growth of 400 points, which had to be deducted. So ultimately, the level was basically the same as it was in June 2001. Nevertheless, the stock index did increased rather quickly in the period of December 2006 to January 2007. However, suppressing excessive growth by implementing administrative changes and regulations is not desirable. Instead, economic mechanisms and market-orientated adjustments should be used to address the problem.

In general, the development of China’s stock market is healthy. It is not moving too slow, which would be an enormous risk to the entire economy and financial system on the long run. The turning point quickened the speed of the capital market development. Naturally, there is always some instability in sustainable development, which is determined by the market mechanisms. China has to understand this and be prepared for it.

Premier Wen Jiabao has stated that China has to promote the development of a multi-layer capital market system. In addition, it should expand the size and proportion of direct financing, speed up developments of the bond market, steadily develop the stock -and futures market and strengthen the infrastructure of the market, improve the listed companies’ quality, increase supervision of the market and promote the market-oriented reform of the stock and bond issuing system. Zhou emphasized that supervision is particularly critical during periods of rapid growth. Fraud, inside knowledge and black market banking should be severely punished.

If you compare the Chinese securities market with mature markets, you will notice that China’s market is still in its “childhood”. The quality of investors is not yet high enough and the regulatory system not mature enough. Therefore Zhou stresses that new investors should have an adequate risk education in order to give them a clear understanding of the risks that are lying ahead. Furthermore, China should give more priority to developing a multi-level market system and should attempt to increase direct financing and to speed up the development of the bond market. The desirable result would be that the process of bond issuance should be open, market-orientated and transparent. China will be able to maintain the sustained and healthy development of the capital market during this 11th Five Year Plan period, trough cooperation, implementing the right policies and governing the stock market according to the legal system.