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Securities Market 20 Years on> Archive
UPDATED: January 29, 2007 NO. 5 FEBRUARY 1, 2007
How Healthy Is China's Stock Market?

It seems that China is on a roll. The world's fourth largest economy now has a high flying stock market. According to Shang Fulin, Chairman of the China Securities Regulatory Commission, China's booming stock market, previously having a poor reputation, should be attributed to the almost concluded split share reform that requires the country's listed companies to convert their state holdings to tradable shares. Investors are now thrilled at soaring stock indexes.

China's stock market was established at the beginning of the 1990s. At that time, the majority of listed companies were state-owned enterprises, the mainstream of the national economy. To maintain economic stability, the regulator then allowed only one third of the shares of listed companies to be traded on the market. However, facts show that this system made it impossible for the establishment of a regular interest-sharing mechanism between majority and minority shareholders, which in turn hindered the development of the securities market. On April 29, 2005, the government launched the split share reform.

Based on the current situation, this reform, which is hailed as the fundamental turning point in the remaking of China's stock market, is a huge success. The benchmark Shanghai Composite Index had topped 2900 by mid-January 2007 from around 1000 in April 2005. The total value of the yuan-denominated A-share stock market had climbed to around 10 trillion yuan at the beginning of 2007 from 3.3 trillion yuan a year ago, instilling investor confidence, encouraging investment and again strengthening the stock market's ability to accumulate capital.

From all indications, it seems that China's stock market has entered a period of healthy development. There are four factors to support this. First, institutional deficiencies existing in the Chinese stock market at the initial stage of its development are no longer there, paving the way for sound growth in the future.

Second, the split share reform has rehabilitated the stock market's innate wealth. In 2006, stock and debenture sales contributed 20 percent of the total funds that Chinese enterprises managed to round up, a big step forward compared to several years before, when almost all of the enterprises' financing came from bank loans. Apart from listed companies, investors' wealth is also increasing. The prospects look good.

Third, the structure of the capital market and also the composition of investors are becoming increasingly rational. Before the split share reform, it is the minority shareholders that played the major role, but now shares held by mutual funds, securities firms and insurance institutions account for 40 percent of the country's total stock market capitalization.

Fourth, more blue-chip offerings are leading to a revolution in investment philosophy. The basic function of the stock market is the distribution and redistribution of resources. With increasing domestic listings of blue-chip companies, the securities market's role in optimizing and integrating resources will be given full play. This is expected to encourage people to make investments rather than speculating.

Nevertheless, China's stock market is only 17 years old and despite the establishment of certain systems, further development is urgently needed. The limited market scale makes it hard to predict to what extent the market is able to dissolve risks when big money floods in, so whether the Chinese stock market has really entered a period of sound development remains to be seen.  

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