China's stock market reforms
by George Zhibin Gu
On the morning of May 9, the employees of a leading Chinese investment
brokerage in Guangdong returning from the nine-day Labor Holiday were
surprised by an unusual memo from company management. They were told that
tough days were ahead following the government's announcement that formerly
non-tradable shares in Chinese companies would be allowed to float freely
soon. The managers predicted that the Shanghai stock index could fall another
10-20%, to the 900-1,000 level perhaps, as a result of the reform measure.
Sure enough, even though the measure to float
non-tradable shares had long been expected, the immediate reaction of the
market was a sharp dip. By that afternoon, retail investors were calling the
day another "Black Monday". Both Shanghai and Shenzhen saw a wave of
selling, with the Shenzhen stock index dropping 4% and Shanghai 2.5%. More
than a week later, the two markets were still directionless. The key question
on the mind of 71 million Chinese investors was: where is the bottom? China's
stock market, beset by confusion and worry, now stands at a 6-year-low, having
seen a greater fall than even the overinvested NASDAQ in the US.
The depressed markets make a dramatic - and to naive outside observers,
inexplicable - contrast to the sizzling economic numbers China presents year
after year, numbers which have not stopped the continuous panic selling of
domestic shares. The truth is that most Chinese stocks were overvalued for
many years.
What went wrong?
The "Great Bear Market of China" had
many causes. China's two baby stock markets were established only in 1992.
Disturbingly, a legal charter for the markets emerged only in 1997 - a clue to
the uncertainty of officials as they experimented with market-oriented reform
measures.
Numerous bull and bear markets have come and gone. During the bull periods,
stock prices rose wildly, often reaching price/earning ratios over 60 or even
more. Many unprofitable companies had their glory days, as if unprofitability
was a minor detail. The party's end was all too predictable. The bear market
that began in late 2000 has erased some 50% of the market's value. Chinese
investors experienced shock after shock during this period. Many listed
companies went virtually bankrupt; hundreds of senior executives were sent to
prison; and widespread financial abuses became a daily feast for the Chinese
business press.
In this environment, the non-tradable share reform
measures struck many investors as an unwelcome, bitter medicine. The
non-tradable shares are shares that have been held by various government units
as well as legally defined entities. Their sale would bring enormous downward
pressure on the markets because the nontradable shares constitute 64% of
market value, 74% of which belongs to the state. To countless investors,
holding mainland Chinese stocks has become something like holding a falling
knife. The resulting exodus of capital has pushed down the markets even
further.
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