Stock market fails to reflect economy

03/07/2003
China Daily

The stock market should be in tune with the performance of the economy to guarantee economic development, urged an article in the Beijing-based Economic Information Daily.

The stock market has been bearish since last year despite China's robust economic growth.

The article, which focused on analyzing the discord between the "economic barometer" and the real economy, held lameduck public companies as a main defect of the stock market. But it fell short of proposing any solutions to the current situation.

China's stock market was established in the early 1990s -- the beginning of the transition from the planned economy to a market one - and it boomed rapidly with government backing.

The market then assumed the mission of raising capital for State-owned enterprises and it did help the reform of the State sector go smoothly.

But the market has been distorted for a long time because of the misunderstanding that the sole function of the market was to finance State companies, the article said.

One result was the stipulation that two thirds of the shares of State companies could not be traded, ensuring listed State companies pool funds on the one hand and retain a holding status on the other.

Public firms growing up in such a distorted market have many "congenital deficiencies," said the article.

As the government used to adopt a rigid approval system for listing and offering additional issues of shares, getting listed largely hinged on government lobbying rather than asset quality.

Many State companies used devious means such as cooking with account books - dubbed "packaging" - to meet the standards required for listing.

Although the government scrapped the approval system in 2001 in favour of a more open registration system, the situation did not improve much because the bid for listing is not open to fair competition.

Many State companies, relying on the holding status of State shares, did not replace their outdated management style with modern corporate governance system after going public. Some public firms made false reports to fool shareholders and rig share prices. Some even used the income from shares to buy other shares rather than expand their own business.

The poor quality of public firms is a key reason for the bearish market, said the article.

However, drastic fluctuations still break out from time to time.

Rather than opting for economic or legal measures, the government has become used to stepping into the stock market directly. A policy-oriented stock market contains huge risks.

The risks could sometimes be magnified in that the majority of buyers of China are small investors, who tend to follow the herd once slight fluctuations occur.

The government is in quite a dilemma: its frequent interference has yielded great risks, but to curb risks, it thinks it necessary to interfere once more. This creates greater risks.

Drastic fluctuations co-produced by manipulation and government interference have become a main feature of the Chinese stock market, said the article.

There was a memorable act of interference in 1996, when a prospering economy ignited a surge in the benchmark Shanghai Composite Index from 537 points in January to more than 1,000 points in October.

Over the following two months, the government released 12 decrees to curb this increase but in vain.

As a last resort, the official People's Daily published a commentary calling for "correct understanding" of the stock market in December 1996. That day nearly all shares plummeted 10 per cent, which is the daily trading limit.

The market stagnation in the past two years was sparked by a contradictory government scheme to sell State shares, the article noted.

But the article said the root cause of the current disharmony between the stock market and the economy is the unstable psychology of investors.

The government has paid increasing attention to the supervision of the stock market since 1995, rather than merely focusing on fostering the market as it did previously.

Increasingly tight regulation reduced the room for over-speculation and made many investors withdraw from the market, resulting in temporary price stagnation.

Moreover, the shadow over investor psychology is growing as the market is preparing to go international, said the article.

The government launched a Qualified Foreign Institutional Investor (QFII) scheme last year, which enables foreigners to trade shares of domestic companies via approved custodian banks.

This opening-up could nullify the skills that many investors have acquired in a closed market environment over the past decade.

Moreover, it is unclear what the government will do to improve its supervisory techniques to international standards.

Such vagueness has become a barrier to making clear investment decisions, and it is natural that many investors will quit the market for the time being, said the article.