In only 14 years, China's stock market has developed into Asia's third biggest market, with more than 1,300 listed companies, 4 trillion yuan (US$483 billion) of market capitalization and more than 70 million stock traders.

It has been estimated that the market might even become the world's second biggest, after the United States, in the next decade.

The pace of growth looks rosy, and the momentum of the Chinese economy seems to be able to drive that growth even further.

Yet growth rate is not all that we care about.

The quality and sustainability of the growth count for more for the future of the market.

Dreams of getting rich

For over a decade, listed companies have been the biggest beneficiaries from the fast expansion of the bourses, raising all together more than 800 billion yuan (US$96.6 billion) of funds.

Investors are certainly more concerned about another issue: Can they make money out of the investments?

The answer is not a simple "yes" or "no."

Among the 70 million traders, there have been some like Yang Huaiding, a former warehouse keeper in Shanghai who became a millionaire after making fortunes out of trading bonds and stocks in late 80s and early 90s.

Yang, later called Yang Million, harvested his first fortune one day in April 1988 by buying 20,000 yuan (US$2,415.5) treasury bonds and selling them a few hours later at a price that earned him 800 yuan (US$96.60).

At the time, most Chinese people were still not familiar with terms such as investment and trade, more willing to cling to their "iron ice-bowls," stable jobs and incomes in State-owned institutions.

Yang recalled that his decision to quit his job and become a professional trader was a surprise to many.

But the surprise soon turned into envy as Yang struck gold on the stock market, which was launched two years later.

After the Shanghai and Shenzhen stock exchanges started operations at the end of 1990 and the first batch of A share companies was listed that year, more people got to know the "magic" of stocks and more nouveau riche like Yang came into being during the stock trading boom in the next few years.

But many were disillusioned. Soon bad times arrived, as heavy speculation piled up bubbles and quickly pierced them. A slew of profit-taking scandals and frauds made the market a highly speculative and risky one and forced the authorities to take cleaning-up measures.

Similar ups and downs have repeated several times in the stock market over the past decade.

Today, traders have become more rational than before and more mature too, knowing that the stock market is not a place where they may just earn money but where they may sustain losses too.

Meanwhile, an increasing number of institutional investors is gradually changing the investor structure in China, which used to be dominated by retailers, and making value-oriented investment ideology more accepted.

Market repositioning

But weak fundamentals of the listed companies and the systematic flaws in the market do not change much. Minority investors are still calling for more transparency, fairness and chances of attaining returns in the bourses.

Often, the market is like an automatic teller machine for listed firms, many of which are controlled by the State, while many private companies are blocked out.

Statistics indicate that the stock market helped raise more than 800 billion yuan (US$96.6 billion) in funds for listed companies over the past 14 years and generated 173 billion yuan (US$20.9 billion) of stamp tax.

But the overall dividends the companies have paid their investors total only about 72.2 billion yuan (US$8.7 billion).

If investors cannot get returns, why should they stay?

As the market turned bearish a few years ago, there has never been sufficient energy for a strong recovery.

The Shanghai composite index fell below the psychologically important 1,300 level and touched a five-year low on September 9 this year.

And the chance for a magic recovery, such as the strong rebound on May 19, 1999, which was lit by warm State media remarks and a boom in tech stocks, is small.

This time, investor confidence is at the core of the issue.

Wu Xiaoqiu, director of the Finance and Securities Institute of the Renmin University of China, said that the wrong positioning of the stock market in China was a major trigger for the confidence crisis, though the problem can still be cured.

The fundamental problem for the bourses is lack of common interest between the major shareholders of the listed companies and the small shareholders, said Wu.

The present system, which allows a large ratio of untradable State and legal person shares, enables big shareholders to take their own profit and erode the interest of the minor shareholders easily. And that has hampered the investment initiative of new investors.

Weak corporate governance in many companies and low dividend payment further hurt investor confidence.

Experts urged that the authorities should take iron-fisted measures to fix the listed firms, improve their quality and put them in a market mechanism where they have to face competition.

It is not the first time that these questions have been raised. They had been put forward several years ago, when the market was still bullish, but speculation was already too strong.

In a debate fuelled by critical remarks of economist Wu Jinglian at the end of 2000, scholars, regulators and securities practitioners in China have been trying to find the answer to the questions: What is the function of the stock market? Is it to support State-owned enterprise reform? Is it just a place where listed companies can get endless funding? Or is it a casino where anyone can try their luck?

Wu made the criticism that speculation had been too strong in the bourses, which had become casinos and people had lost rationality.

Who said that everybody should learn to trade stocks? he asked.

The debate rang a warning bell for market participants about the bubbles. It also made people rethink investment ideology and to some extent helped push the bourses to adjust its direction to become more market and value oriented.

The exploration of the new path for the stock market has never stopped.

Still an emerging market now, China is already undergoing a transition towards a more globalized and developed market.

And as it further opens up to foreign investors, domestic institutions are also confronting mounting international competition.

Such external forces will ultimately drive local participants to change their way of thinking.

Foreign investors

Since China formally introduced the qualified foreign institutional investors (QFII) scheme in December 2002, 20 foreign institutions have acquired QFII licences, which enable them to invest in yuan-traded A shares, bonds and mutual funds within authorized investment quotas.

QFII has also created a new channel of foreign investment in China.

To foreign investors, the Chinese market is attractive largely because of the rosy economic outlook, the strong renminbi and the vast growing potential of the capital market, though presently, compared to the overseas markets, the A share market is still over-priced, while the quality of the listed firms and market fundamentals is still lagging behind.

But even with price gaps and flaws in the market system, a growing number of foreign investors are still heading on with capital market expansion plans in China.

The American International Group (AIG), which launched the first foreign insurance company in China in 1992, is now developing into the country's asset management business.

Its fund management joint venture with China's Huatai Securities, AIG-Huatai Fund Management Co, is expected to open for business soon, with each of the two sides holding 33 percent.

AIG intends to increase the ratio of stakes in the fund venture to 49 percent next year, also the maximum ratio China allows a foreign company to hold in such ventures, according to Joel Epstein, AIG Country Manager in China.

In only two years after China's entry to the World Trade Organization, the country already has more than a dozen fund management joint ventures in operation or preparation.

When asked if the timing of entering the securities business is appropriate as the stock market is weak, Epstein said the strategy was based on confidence in the Chinese economy and long-term prospects.

Similar expectations of good investment returns over the long term have also pushed QFIIs to apply for investment quotas including UBS, which quickly used up an initial US$600 million quota, the biggest granted by the Chinese authorities to a QFII.

Nicole Yuen, head of China equities at UBS, said that though the market is in a correction, the company does not intent to change the general investment direction and will continue to invest in stocks with good potential for growth.

Some QFIIs also said that as the Chinese economy is expected to maintain momentum, the long-term investment outlook remains solid.

Obviously, the market consolidation will further squeeze out bubbles and lower the price/earnings ratio, reducing the room for profit-taking.

As A share companies see their prices getting closer to that of H shares, they may find themselves more attractive to overseas investors.

Fred Hu, managing director of Goldman Sachs (Asia), said that in spite of the market corrections in China over the past few years, a few good-quality companies have managed stable performance.

Though indices have been moving down, the investment ideology in the Shanghai and Shenzhen bourses is apparently more rational.

And as long as the macro economy stays on a healthy growing track and listed companies can improve their management, results and information disclosure, investor confidence will recover gradually, Hu said.

Future trend

The quality of listed companies is a basic element to measure investor confidence, the basis for market development.

When many listed companies used to rely on government support for an entry ticket, it is no longer so now.

With a series of reform plans adopted by regulators, the overall listing, trading and supervision systems have been undergoing a reshuffle.

The cancellation of the listing quota, the introduction of the sponsor and initial public offering pricing systems, the launch of new standards for information disclosure and stronger protection of the civil rights of investors are driving China's stock market into the direction where market rules are in command.

And regulators are unlikely to always come to the rescue with policy boosts when the market is troubled.

An official with the China Securities Regulatory Commission said the commission would see to the fixing of existing problems in the market and combine it with market development during future regulatory work.

Instead of being a player itself, the watchdog will stick to its position as a referee to ensure order and fairness during the competition.

And more often, it is trying to cut out the roots of the problems from the very start.

The expected new IPO pricing system is an implementation of that ideology.

It is expected that companies launching IPOs will have to make inquiries about share prices among institutional investors, which will make prices more reasonable and let second market investors have more say in the price formation process.

As the sponsors and the listing applicants are to take more liability for the correctness of financial figures and listing qualifications, it may help block bad and disqualified ones from the beginning.

Meanwhile, investors are also offered a wider range of investment tools and products than before.

The mutual fund market, for example, has experienced fast expansion since the second half of last year. And apart from equity funds, more new products such as bond funds, index funds, guarantee funds and monetary market funds have entered the market.

The large savings pool in China still leaves more room for fund managers and securities houses to come up with more diversified investment products to meet growing demand.

And meanwhile, intermediaries such as the securities houses themselves are undergoing restructuring to improve efficiency.

As declining brokering fees and stocks investment failures have pushed many domestic securities firms to the wall, the expected arrival of a Goldman Sachs' joint venture investment bank is expected to inject fresh energy into the industry.

"We do not really have an investment banking culture in China," said an official with a securities company in Beijing.

What most securities companies are doing is focusing on brokering and proprietary investments, which are actually the source of losses when the market is low.

They should be exploring new profit resources and try to build up the strength of investment banking, experts say.

Many other transitions are also expected in the stock market. And similarly, none is easy because of the aftermath of the planned economy and the complicatedness of the Chinese market.

"It takes a whole generation of Chinese to have a better understanding of the stock market and rebuild it in some form of order," said Dong Chen, an analyst with China Securities Co, who has been witnessing the ups and downs of the bourses for more than a decade.

"We have experienced bad times and good times," he said.

"It is hard to predict when the next bullish run will start."

"But now that more new standards and rules are taking shape, hopefully the market will go forward on a healthy track and offer newcomers more things to enjoy."

(China Daily October 7, 2004)