China's market bubble

Share ownership has become all the rage among China's growing middle classes, writes Clifford Coonan.

A frenzy of share-buying is the latest revolution to grip China, a country already more familiar with transformation than most. However, the revolution in China's share exchanges has global markets worried about the wider impact of wild volatility in this emerging power.

Once banned as an evil capitalist tool by the zealous Communist government of Mao Zedong, share ownership has become all the rage among the growing middle classes. Witness the staggering rise in the number of new accounts for investing in shares and mutual funds - more than 100 million by now, compared to 77 million six months ago.

This accounts for 17 per cent of China's urban population.

A one-day drop of nearly 9 per cent on February 27th prompted a sell-off on US and European exchanges. Analysts reckon the international downturn was an overreaction, as only 3 per cent of investment in China's capital markets comes from abroad. But it made the world sit up and take notice of the revolution in Chinese investment culture.

When the Shanghai index breached the 4,000-point threshold late last month, trading volume that day on the Shanghai composite index and China's second smaller exchange in the southern city of Shenzhen exceeded all other markets in Asia, including regional giant Tokyo.

The media are full of stories of people getting rich quick - wily pensioners and canny school kids making millions through lucky deals - prompting comparisons with the happy-go-lucky atmosphere in America before the Wall Street Crash in 1929. Taxi drivers, retirees from former state-owned enterprises and cash-rich students are all going share-crazy and retail investors now account for about 70 per cent of the stock markets' capitalisation.

In the first four months of this year, the capital markets siphoned more than 70 billion yuan (€7 billion) out of savings accounts in Shanghai alone, according to the People's Bank of China.

The share-buying frenzy drove the index up 50 per cent this year, prompting former US Federal Reserve chairman Alan Greenspan to warn the bubble might burst and spell disaster for millions of Chinese.

The markets fell sharply after his comments. Then came the news last week that the government planned a stamp duty hike to cool things down, which wiped another 15 per cent off the value of the market.

Yet even after recent fluctuations, the Shanghai index is still up 37 per cent this year, which comes after a 130 per cent increase in 2006.

The rollercoaster ride continues. This week the Shanghai composite index plunged more than 8 per cent on fears the government could impose a tax on stock-market gains. Day trading is not allowed in the world's fourth-largest economy, but it doesn't stop people engaging in quick turnaround buying and selling, hopeful of speedy gains. Increasingly they are doing this with borrowed money.

This week, market nerves were soothed by placatory comments by People's Bank of China Vice Governor Wu Xiaoling. "China's macroeconomic controls are aimed at promoting the healthy, stable development of the stock market," she said.

The next day there was more sentiment-boosting news, when a front-page report in the state-run Shanghai Securities News cited a nameless officials saying the government did not have a plan to impose a capital gains tax.

While China's national tax bureau declined to comment on the report, the markets drew breath and rose again.

"The report has greatly eased retail investors' concerns, as many of them were speculating the tax would be implemented in the wake of the duty hike," says Du Changjiang, an analyst at China Great Wall Securities.

This kind of volatility would have people jumping out of windows in more developed economies screaming "we're gonna crash", but the general view on the Chinese market is that these are teething troubles, bumps on the road, to a developed market.

Analysts reckon the global implications of stock market volatility in China are ultimately marginal. While the 8.8 per cent slide in late February triggered a global sell-off, recent declines in the Shanghai composite index have had only a slight impact, even within the region.

This is chiefly because of the relatively unimportant role China's share markets currently play in relation to the overall Chinese economy, which is growing by about 10 per cent every year.

At the same time, things change quickly in China and the importance of the stock market is certainly growing as millions of ordinary Chinese citizens rush to cash in on the biggest bull run in the country's short 17-year history of stock markets.

People are crowding into shares because there are few enough other vehicles around in which to invest your money.

The government has clamped down on speculation in the property market to stop housing costs soaring, interest on bonds is low and most individuals are not allowed to invest abroad. Even though the savings rate in Chinese families is high, at up to 40 per cent of incomes, bank accounts pay just 3 per cent interest on one-year deposits - less than the rate of inflation.

Though the market continues to rise, turnover has dropped alongside a decrease in the new stock accounts being opened daily - new brokerage accounts totalled 189,056 on Tuesday, the lowest since April 11th, according to the China Securities Depository and Clearing Corp.

That is down from 723,463 on May 30th when the stamp duty increase was imposed and a far cry from the peak of 1.08 million at the end of April.

Jonathan Anderson, chief economist for Asia at UBS in Hong Kong, reckons the Beijing government is close to intervening.

Optimists point out that the macroeconomic picture in China remains resolutely healthy. The country's massive trade surplus with the rest of the world has left it with plenty of cash. The economy is expected to expand by about 10 per cent during yet another year of huge economic expansion in 2007.

Share prices are trading at 30 to 40 times earnings, an unusually high ratio for many major markets, which some say makes them unrealistic, but earnings growth too is strong.

"It's true that 'traditional' macro-policy tools like base money constraints or interest-rate hikes don't have much impact on the equity market," Anderson says.

"However, unlike the US or other developed markets, the Chinese regulators have no qualms about using direct administrative tools to affect asset markets once they reach a consensus that something needs to be done. We believe that the recent A-share market gains have brought the authorities to that point."

He adds: "We already saw the full gamut brought to bear on the property sector and we expect further use of administrative restrictions on the equity side as well."

From the regulators you hear complaints that the quality of investor is not good enough.

Many new investors lack basic knowledge of the stock market and the China Securities Regulatory Commission has called on stock exchanges, securities dealers and other authorities to educate investors about the risks of investment.

Zhou Zhengqing, a top financial adviser on the National People's Congress standing committee and a former chairman of the regulation commission, says share- owning culture is developing well in China, but urges patience.

"Compared with mature markets, China's securities market is still in its infancy. The quality of investors is not high enough. The regulatory system is not mature enough. We must improve risk education for new investors and ensure they have a clear understanding of the risks ahead," Zhou told the People's Daily.

Fears of a stock-market frenzy have prompted Chinese government officials to warn against irrational exuberance. The prospect of millions of inexperienced retail investors losing everything if the stock market were to crash would have politically destabilising effects that the government, which keeps a tight grip on single-party rule, is not prepared to risk.