China Tries to Tame its Swinging Stock Market

Chinese investors are a brave bunch. The country's stock markets are notorious for their dizzying swings. After soaring in 2007, Chinese stocks suffered a sharp fall in 2008, with the benchmark Shanghai index losing two-thirds of its value. Last year, Chinese stocks again reversed course and increased 80%, thanks largely to $586 billion of stimulus spending by Beijing and $1.3 trillion in lending by state-owned banks. With China's economy now showing signs of overheating, officials are worried that the equities market may be poised for another sudden turn. Liu Mingkang, chairman of the China Banking Regulatory Commission, warned on Jan. 4 of hot money forming new "structural bubbles" in China's markets. That could be why Liu and his fellow regulators are rolling out a series of financial market reforms designed to reduce market volatility and make investing in Chinese stocks less of a thrill ride. The latest: a long-anticipated move to introduce trading in equity index futures, which would allow investors to hedge risk by profiting from falls in stock prices. Stock index futures trading could begin as early as March, says an official with knowledge of the matter. Index futures trading would be the most dramatic step yet by officials aiming to make China's markets more like the bourses of developed countries than those of emerging markets. As China closes in on Japan as the world's second-largest economy, the government wants Shanghai to be more New York and London and less Mumbai and Istanbul. Among reforms the government has launched in the past year is the debut in October of a Nasdaq-like market for younger companies, called Chinext. Regulators have also lifted restrictions that had kept prices artificially low on initial public offerings—almost ensuring a big jump on the first day of trading. The reforms are long overdue, say many analysts. The changes will help local investors become more sophisticated and make Chinese markets more palatable for investors from outside the country. "In other markets, IPO prices can go up and can go down, but in China they could only go up," says Thomas Deng, chief China strategist for Goldman Sachs (GS). Changes such as futures trading and IPO pricing reform make Chinese markets more mature and "give investors more tools to manage their risks," he says. slow reforms via central planningThere are still plenty of other changes on the to-do list. The biggest obstacle is the government's control of the IPO process, with regulators limiting the number of companies it allows to list on the main board in Shanghai. That prevents companies from swamping the market with new listings, but also leaves many companies—and investors—frustrated. "A more market-based stock market needs investors to decide whether a company will go public or not, not the regulator," says Zhang Xiang, a Beijing-based strategist for Guodu Securities. "The next step should be removing the restrictions on IPO approvals." Don't expect Chinese officials to heed that call soon. Despite a background in central planning, they can move quickly when they want; witness the government's swift implementation of the stimulus program after the Lehman Brothers bankruptcy in 2008. When it comes to the wild experiment in capitalism that characterizes the country's stock markets, however, Chinese officials typically move with great caution. The Chinext market in Shenzhen, for instance, was a decade in the making, and the March debut for futures trading follows years of anticipation. There are advantages to having less-advanced markets. That China doesn't yet allow margin trading, for example, has helped cushion the damage to many investors when markets fell. So regulators are likely to continue moving slowly. "The system itself is more in line with international practice," says Lu Yizhen, chief investment officer at Tianhong Asset Management in Beijing, which oversees the equivalent of $665 million in funds. "But the possibility of having it completely international-like isn't quite realistic." —With Zhao Yidi

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