Market
Alexis TheShanghaiStockMarket:TheSocialistStock Hernandez Economics 461 Dr. Elliott Parker June 4, 2007
Abstract The Shanghai Stock Market (SSE) began 17 years ago and has gone through many changes. The SSE differs from most stock markets in the respect that the Chinese government has a prominent role in it. Factors such as volatility have produced instability in the market and some think green investors are to blame. 2005 Stock Reform led to a more competitive market but only in time will we understand what kind of worldwide influence the SSE is capable of.
Introduction The Shanghai Stock Exchange (SSE) opened its doors and began December 19th, 1990. Shanghai has a long standing tradition of selling securities that date back to the nineteenth century and continued until the Communist Party of China (CPC) came to power in 1949. The CPC takeover destroyed many types of capitalistic institutions and the SSE was no exception; as China progressed, old ways of thinking were challenged and capitalistic change was in the air. Wrinkled investors who remembered investing before Maos reign came to the new-fangled SSE along with fresh faces who grew up with CPC rhetoric that taught them that taught them the evils of privatization. Together, old and young eyes gazed in awe upon glowing computer screens which marked a first for Chinese finance and bared a slight resemblance to stock exchanges such as the New York Stock Exchange (NYSE) (Su, 2003: 6). Times were changing for China and the new SSE symbolized how different the 1990s were from the Mao Zedong era, this was both exciting and fearful because know one knew what to expect. History For the first time, Chinese were given an opportunity to invest outside of the state run Peoples Bank of China (PBOC) which provided relatively meager investing opportunities with low interest rates (Gao, Jin, & Riedel, 2007: 137). The SSE was started by the Chinese Central Government and mirrored the CCPs intentions of maintaining effective state control. Many of the securities listed on the SSE are from State Owned Enterprises (SOEs) even today the party has a good chunk of SOE stock in their possession. While there is a strong government presence, the market has many features that make it resemble stock exchanges like the NYSE with respect to the buying and selling of securities which are dealt with in similar fashion but the large government presence makes the SSE different.
Types of Stocks To understand the Shanghai Stock Exchange is to understand the barrier of control that the CPC uses to maintain its socialist-style stock market. First, the SSE is focused mainly on State Owned Enterprises (SOEs) that are a part of mainland China whereas the Shenzhen is oriented more towards joint ventures, increasing relations with Hong Kong businesses, and is more accessible to foreigners ( Su, 2002: 11). The SSE is composed of different types of stocks which help to limit the potential impact that foreign investors are allowed to have. Furthermore, the Chinese Government allocates only so many shares for Chinese nationals to purchase. Thus China has designed a split-share system that applies to the SSE and all Chinese stock markets. The state apportions A-Shares for Chinese Citizens only; A-Shares make up the dominant percentage of shares in the SSE. Foreigners are limited to obtaining B-Shares so that they have restricted access to SOEs which prevents foreigners from exerting large influence while still encouraging outside investment (Su, 2002: 8). In 1994-1997, B-Shares only made up 5 percent of all Chinese stock markets. (Su, 2002: 10). In Integrating China into the Global Economy, Dr. Lardy mentions that B-Shares can only be bought in U.S. and Hong Kong dollars (1998: 8). The usage of different currency is a protection measure used to safeguard Renminbi (RMB) from the affects of foreign investment. In addition, A-shares are divided up into state shares (which are controlled by the Central Government) and legal shares that companies use to provide services i.e. supplying workers with stock. (Su, 2002: 8). Many non-tradable shares (NTS) fall under these two categories. NTS are a double edged sword for they help the state establish control but keep the market illiquid; NTS also provide incentive for insider trading and corruption among those who own NTS (Beltratti &Bortolotti, 2006). Volatility and Green Investors
Mainland China is at the essence of the SSE for most of the SOEs listed are from there. Most of the investors are Chinese nationalists who own A-Shares; Chinese investors are given a predominant role in the SSE while foreigners are limited to B-Shares. Wall Street Journal writer Scott Patterson says that the SSE average price earnings ratio is about 50. (2007). This is a very high ratio which is great for Chinese investors but bad for foreign investors who can only tap into a limited amount of stocks that dont reflect the p/e ratio. Instead, Chinese Citizens are left to benefit which is the intent of the central governments plan (2007). What this means is that most of the purchasing power is in the hands of Chinese investors and the Central Government. Many Chinese investors are fairly new to the whole investing process and as Washington Post journalist Ariana Eunjung Cha puts it, Until recently, it was hard to blame the average Chinese investor for assuming that the stock markets only go up. Since June 2005, the Shanghai composite index has gained about 300 percent. (2007). Green investors are prevalent in the SSE, and with an average of 300,000 new accounts being opened daily shows that this trend will not change for awhile (Rose, 2007). Volatility is closely tied to beginning investors and their novice strategy to tackle the market. Thus the amount of green investors makes the SSE susceptible to much volatility and short term speculation. As mentioned earlier the SSE is fairly new but has already had many dramatic twists and turns. The Market has had much volatility when compared to most stock exchanges. The Shanghai A-share index rose from about 400 in July 1994 to more than 1,000 in September, (Su, 2002: 79). Economists Dayong Zhang, David Dickinson, and Marco Barassi attribute the markets high state of volatility to the simple fact that many of the Chinese investors are uninformed and less experienced when it comes to investing in stocks (2005). During the 1990s the market was a solid bull market with huge gains. People were afraid that the economy was overheating which is one reason why the Peoples bank of China completely withdrew from
the market in 1997 (Gao, Jin, & Riedel, 2007:139). Also, one can not blame the Chinese investors because in the 1990s the Chinese Stock Market averaged returns of 200 percent; Ashares had an average hold time of one to two months (Gao, Jin, & Riedel, 2007:139). People would more likely to be short-term speculative investors if given such conditions. The 1990s were a time characterized by fast growth thus short-term speculation was normalized. The Central Government and Reform The Central governments influence is prominent and arguably controls the SSE more than any country controls its stock exchange. In 2001, the CPC had to discard some of its state owned shares in order to finance the massive social security plan for Chinas large population. This news was troubling and the SSE dropped 25 percent in three months (Gao, Jin, & Riedel, 2007: 147). Eventually the Chinese had to stop selling their shares because their actions devalued the entire market, (Gao, Jin, & Riedel, 2007: 147). From 2000-2005, the SSE was a losing market and it seemed like the gains that happened in the 1990s were just disappearing. The market needed to be revitalized and the Central Government went into action by devising a series of reforms in 2005; Chinese officials believed that slowly introducing NTS into the SSE would get it back in shape. According to Beltratti and Bortolotti, the NTS made up 55% of the Chinese Stock market and made the entire market prone to much volatility and insider trading (2006). Reform was needed for the market if it were to thrive again. In 2006, almost all mainland companies had released their NTS into the market and the SSE was a bull market once again. Overall, SOEs that have released their NTS have seen an increase in their stock prices (Beltratti & Bortolotti, 2006). The act of releasing non-traded stocks has been a positive experience but since the reforms has growth skyrocketed at an astounding rate which makes some investors worried. Volatility Continues
In 1997, the Asian Financial Crisis showed how dependent Asian economies are on one another and also got the attention of the world by showing how influential an Asian country is on other markets. The SSE had its largest percentage loss (8.8%) in history in February and the loss was felt across the entire world. It was on the increase from the 2005 reforms and investors didnt what to expect, the characteristic volatility was back. Chinas other securities exchanges decreased and people worldwide were affected and foreign investors withdrew in droves to prevent any sort of negative outcome. Newsweek International writer George Wehrfritz said that worldwide investors feared that Chinese volatility was linked to the rest of the world (2007). The SSE has grown tremendously and many investors in February believed that the SSE had become a world player. Former US Reserve Chairman Alan Greenspan has been quoted in The Standard (Rose, 2007,) as The end is nigh. 2007 has been a banner year for the Chinese Economy with 11 percent annual growth rate within the first quarter which dwarfs the U.S. which is less than 1 percent (Patterson, 2007). The SSE index has been at record highs but due to recent events there have been drastic losses. How long the Shanghai bubble will last is a mystery. Figure 1 illustrates the growth of the SSE over the last six months. (Yahoo Finance, 2007). Recent Transactions Chinese officials and foreign investors worry that the SSE is a bubble that is about to burst, (Patterson, 2007). Wednesday, May 30th 2007, the government raised the stamp tax from . 01 percent to .03 percent. The central government implemented this measure in attempt to cool down the hungry market by preventing short term speculation, (Patterson, 2007). Short term gains are inviting and help to explain why the SSE is constantly getting new investors. Even with the news of an increase on the stamp tax the SSE managed to have a record day with regards to opening new accounts; 426,000 new accounts were open on Wednesday. The real news of the day was the fact that the SSE dropped 6.5 percent which was one of its biggest losses
throughout the entire year. Investors were worried that the drop would hurt other stock markets like it did in February 2007 but foreign stocks were relatively unchanged by the SSE loss (Wehrfritz, 2007). The next day, the SSE was close to a 3 percent increase in the afternoon and finished up 1.4 percent. Having one of the worst days in 2007, the SSE looked as if nothing had phased it. Friday, the SSE dropped 2.65 percent which was more in line with what the government wanted to slow down the ferocious market. For the weekend, both the Shanghai and Shenzhen Stock Exchanges had a loss of 5 percent capitalization (Zengxin, 2007). Understanding the effects of the Shanghai stock exchange on overall Chinese economy is debated. One has to wonder if the SSE would not suffer so much from volatility if there werent so many green investors or if the volatility stems from the central government control of many companies and shares. A big event happened June 1st 2007. A new law came into effect which allows all SOEs to declare bankruptcy. The rule is something that is much more suitable to instigate free market economy. Frank Borman, a former airline owner had this to say, Capitalism without bankruptcy is like Christianity without hell, (The Economist, 2007). His quote makes a good point because bankruptcy is a necessary holding tank for companies and assets. Several companies as the author puts it are functionally dead which need to be put out of their misery through declaring bankruptcy (2007). This will have a great affect on SOEs in the long run and promote stronger entities that will make for better investments. Though if a lot of SOEs go bankrupt then several workers will be unemployed and angry (The Economist, 2007). This may benefit the SSE but be traumatic for Chinese society. June 4, 2007, the SSE had its largest single day lost in absolute amounts, (Zengxin, 2007). The index decreased by 8.26 percent which translates to 330.4 points; its questionable if the government intended such a large loss but from the looks of this it appears that the SSE is being slowed down by the stamp tax but its only been imposed for a short time; only more time
will tell what impact the stamp increase had. The central government raised interest rates twice this year and the end result was still a booming economy so the tax may not be enough to slow the SSE down. Another interesting event that occurred was the widening of the Yuan against the dollar from .3 percent to .5 percent. This shift shows a growing sign of flexibility in the Central Government for it means that the Yuan can appreciate faster (AP, 2007). If the currency could appreciate faster this would be of benefit to stockholders both foreign and domestic by increasing the value of their stock. Today, June 11, 2007, the SSE has rebounded and has been on the upward trend since ...