By Hu Shaowei (China Daily)
Updated: 2008-04-21 07:21

International experiences over the past decades have proved that the stock market usually gains strong driving forces from continuous economic growth and the appreciation of the currency during a country's economic takeoff.

Nearly all researchers expressed their confidence in the Chinese economy for 2008 as the year started. Their optimism stemmed from two facts: the long-term elements promoting economic growth were considered unlikely to be reversed during the year; and the consumption demand was expected to remain active and investment in fixed assets strong.

However, a dramatic turbulence has hit the stock market since January despite the theories and the proven facts. While the US stock market was down by less than 20 percent as a consequence of the subprime crisis, the Shanghai Composite Index, the benchmark of the Chinese stock market, slipped by over 40 percent from its peak by mid April.

The fluctuations took place against the big picture that the economy remained sound, the government displayed firmness in maintaining the stability of the stock market and the listed companies reported lucrative profits.

During several trading days, the market benchmark dived to new lows because of various rumors. Worse still, it dipped further even after the rumors were proved false.

Some attribute the turbulence to widespread panic among investors. But the dramatic fluctuations were actually a result of the defects in schemes governing the stock market and related institutions. Without correcting these defects, the investors' confidence could not be recovered and the market could not resume its sustainable growth.

In recent years, the stock market of China has been swelling quickly and more and more individuals becoming market participants. Therefore, the stock market has occupied a position that cannot be ignored in economic and social terms.

Although many researchers are still debating whether it is theoretically valid for the State to stop the stock market index from slipping dramatically, most governments around the world choose to intervene in the market during such turbulences.

Given the immaturity of the Chinese stock market, it is less able to mirror the real situation of the economy and more susceptible to dramatic fluctuations. It is, therefore, even more necessary for the government to bear a sense of responsibility and develop mechanisms to watch over the market.

Since the authorities completed the colossal work of non-tradable share reform of most listed companies in 2006, they have eliminated a major obstacle for the development of the stock market in the long run. Justifiably, this was widely lauded as a remarkable accomplishment.

However, a policy has to be assessed in accordance with the real consequences of its implementation. Admittedly, the reform in non-tradable shares has sped up development of the stock market in recent years. But it has also created a problem, which, if not properly handled, might threaten the market's future.

The non-tradable shares, gained by their holders with nearly zero costs during the reform, have severely damaged the investor confidence when they have been sold at high prices after being unlocked and made legitimate for public deals.

There is a pressing need for the authorities to deal with the unlocked non-tradable shares. Otherwise, the non-tradable share reform might turn out to be a threat to its prosperity.

Another trigger for the stock slump was the refinancing plans of the listed companies. Almost all the listed companies planning to issue new shares wanted to raise huge sums of capital, which spread the fear that the market might be drained.

But none of the plans actually failed to be carried out despite the fear among common investors. In most cases, the plans were approved by the shareholders' congress because the mutual fund managers whose funds formed a large percentage in the companies' shares voted for the plans. They did so for many reasons, the most prominent one being that these managers have formed a de facto alliance with the company managements.

It is necessary to frame more specific rules about the issue of new shares. Terms should be laid down to specify the frequency of issuing new shares as well as to indicate how the newly-raised fund should be used. The rules should work in such a manner that the listed companies are able to raise the money they really need, while the investors' interest is safeguarded.

As mentioned above, the stock market benchmark dropped dramatically because of some rumors. Yet, no one responsible for fabricating or spreading them has been caught or punished. Some institutional investors also took advantage of the market's volatility and manipulated it with impunity.

Regulators of the market should ensure the enforcement of the current rules and regulations about maintaining transparency and fairness as well as about the release of information. They should also cooperate with the law enforcement departments and check violations of fair market practices.

When the market is relatively low, it is time for decision-makers to consider staging the long-brewed stock index futures. Under the current circumstances, the launch of the scheme would cause less shock to the market. In addition, it might even reduce panic and restore the normal market order. After all, the stock swap offered by the futures could check excessive market speculation.

The author is an economist with the State Information Center

(China Daily 04/21/2008 page4)