Realizing the re-emergence of the Chinese stock market: fact or fiction?

• Author: Vandevelde, Ann P.

1. INTRODUCTION

   The People's Republic of China (PRC) is positioned to make significant future economic strides, including the re-emergence of an internationally recognized stock market, based on its impressive track record over the past decade. However, the actual realization of the stock market's re-emergence may be a product of fiction, unless Chinese leaders resolve the inherent conflict between state ownership and efficient markets for privately-owned stock.

   Section II gives a brief history of the recent development of the Chinese securities market. China entered the 1980s with a desperate need for capital to support the growth of its then anemic centrally planned industrial and agricultural economy. Following state-controlled experimentation with stock issuance and trading in the late 1980s, the Chinese stock market "re-emerged," after more than forty years in dormancy, in the early 1990s, when two stock markets sprang to life in Shanghai and Shenzhen.(1) As a result, individuals currently may purchase publicly-traded shares of joint-stock companies.(2) Despite the impressive development of the stock market since 1990,(3) the nascent Chinese stock market has not truly re-emerged due to the limited number of publicly traded shares.

   Section III examines the PRC's long-term commitment to resolving the ideological "counter-socialist dilemma" presented by capitalist reform and to developing an independent and internationally competitive stock market. While China has already made impressive strides in developing its socialist market economy, conservative Communist leaders have signaled their reservations about the pace of capitalist-laden reforms. Consequently, the PRC has enacted various regulations that effectively cabin the capitalist experimentation by limiting Chinese enterprises' access to the emerging stock market, restricting the flow of information to the stock market, and maintaining a high level of state ownership in publicly-traded stock companies. However, despite the ideological quagmire confronting Chinese leaders, evidence shows that they are committed to resolving the "counter-socialist dilemma," some more conservatively than others, in order to move China forward in the global marketplace. It is now a question of how to resolve this dilemma, rather than whether to resolve it.

   Assuming that the ideological barriers are not insurmountable and that Deng Xiaoping's successors will continue to implement economic reforms, China should take certain fundamental steps in the near future to realize the true re-emergence of its stock market in the twenty-first century. Section IV shows that in order to enable the Chinese stock market to attract the abundant personal savings of Chinese nationals.(4) as well as foreign investors. China must stabilize and improve the efficiency of its stock market through the enforcement of a comprehensive national securities law and the repeal of its censorship policy.

2. CAPITALISM IN CHINA? THE DEVELOPMENT OF THE CHINESE STOCK MARKET

   1. From Mao to Markets

      China has supported a stock market during several recent periods(5) in its long history,(6) but none has ever grown into an "independent institution"(7) strong enough to survive China's political turmoil. For instance, during the 1940s, the Shanghai Securities Exchange was the largest stock market in Asia and more influential and internationally supported than that of Hong Kong,(8) but the 1949 Communist takeover(9) caused its abrupt demise. Under the rule of Mao Zedong, the Communist Party believed that capitalist stock markets contributed to corruption, bureaucracy, and smuggling.(10) Once again, political forces in China effectively wiped out the securities market.(11)

      Although Chairman Mao and his supporters had used tightly centralized control with some degree of success in restoring China's ailing post-war economy in the 1950s and 1960s,(12) post-Mao leaders of the PRC realized that such strict Communist rule had stifled the country's economic development over time. Thus, in late 1978, under the leadership of Deng Xiaopeng,(13) the Communist Party of China (CPC) announced its "open door policy," under which the CPC would focus its attention on economic development, rather than class struggle.(14) The economic reforms sought three main objectives: (1) to decentralize the economy; (2) to bolster reliance on market forces and on material incentives as a means for achieving desired economic behavior and resource allocation, and (3) to encourage foreign investment.(15) Following decades of economic isolation, these pragmatic policy reforms created a literal "opening to the outside world" for China.(16)

      The Chinese government has gradually implemented economic reforms in the form of experiments at both local and national levels. China initially overhauled its financial sector by allowing the state-controlled banks to allocate financial resources more efficiently(17) and by creating non-bank financial institutions.(18) Prior to 1979, China's financial system had consisted of only a few specialized banks(19) which had acted merely as "the government's cashiers," while the state had controlled almost all resource allocations.(20) The later transformation of China's banking sector inevitably led to the re-emergence of its financial markets.(21)

      China represents the first known example of a centrally planned economy supporting a securities market.(22) China's financial markets re-emerged primarily as a result of the decentralization and rationalization of investment activities and the increase in the financial autonomy of enterprises.(23) Debt securities first appeared in 1981 when the PRC issued government bonds to finance its budget deficit.(24) In the latter half of the 1980s, the national economic policy reforms led to the emergence of joint-stock companies and stock issuance.(25) After the opening of the first over-the-counter (OTC) stock exchange in Shenzhen on August 5, 1986, other regional markets quickly developed in Beijing, Chongqing, Guangzhou, Shanghai,(26) Tianjin, and Wuhan.(27) During this same year, a reorganized state-owned enterprise publicly issued shares for the first time.(28) The subsequent emergence of the national securities exchanges in Shanghai and Shenzhen occurred on December 19, 1990.(29) and July 3, 1991,(30) respectively. As of December 31, 1996, 237 and 293 joint-stock companies had listed their A-Shares on the Shanghai and Shenzhen exchanges respectively.(31) Furthermore, a total of eighty-six companies had issued their B-Shares on the two exchanges.(32)

   2. Chinese Stock Market Participants

      On July 1, 1994, the 1993 Company Law of China,(33) which combines the Chinese socialist market economy with Western forms of capitalism, took effect, creating a law with distinct "Chinese characteristics."(34) The main goal of the Company Law is to provide a unified standard for more efficient and productive modern corporate organizations operating under non-state-controlled management.(35) In furtherance of this multi-faceted goal, the Company Law (as a supplement, modification.(36) and codification of prior regulations) regulates the public issuance of stock by any company organized as a "company limited by shares," commonly referred to as a "joint-stock company" (JSC).(37) Pursuant to the Company Law, a JSC can issue shares to the public only after obtaining permission from the State Council and meeting fairly strict requirements, such as having a minimum of fifty million yuan (approximately six million U.S. dollars) in capital, having at least 1,000 shareholders, and having earned profits during the preceding three years.(38) Due to the state's retention of majority ownership in JSCs,(39) the Company Law should be viewed as the catalyst for "corporatization" rather than "privatization."(40)

      Various types of business enterprises compose China's economic system. The non-stock business forms currently operating in China include state-owned enterprises (SOEs),(41) collectively owned enterprises (COEs),(42) private enterprises (PEs),(43) and foreign investment enterprises (FEEs).(44) Under China's Company Law, stock companies may exist in two forms: limited liability companies (LLCS)(45) and JSCs.(46) These stock companies are owned by stockholders,(47) managed under the direction of a board of directors, and characterized as limited liability enterprises. While LLCs may privately issue stock, only JSCs may access the stock markets,(48) assuming they meet the relevant national and local regulations in force at the time of the issue.(49) Non-stock enterprises, including SOEs, cannot issue stock, unless they do so through a stock-form holding company or reorganize into an LLC or JSC before such issuance.(50)

      Both national and foreign investors may participate in the Chinese stock markets, although they must purchase different types of shares. Chinese individuals can own the A-Shares of a company, while foreign investors(51) can purchase B-Shares. The first B-Shares, which are denominated in reminbi, but traded in foreign currency,(52) began trading on, the Shanghai and Shenzhen Exchanges in February of 1992.(53) A-Shares trade among domestic shareholders on various local or OTC markets as well as the national stock exchanges. B-Shares, on the other hand, trade only on the Shanghai and Shenzhen stock exchanges among foreign investors. Besides these differences, A and B shareholders enjoy the same rights.(54)

      Upon regulatory approval by the state, Chinese companies may also list their stock on foreign exchanges, such as in Hong Kong(55) or the United States.(56) For investors weary of the speculative Chinese stock markets, these investment alternatives are attractive because they provide the upside of China's strong economic growth without the unpredictability of its still emerging stock market. Section IV suggests some steps China should take to increase the efficiency and stability of the...