Yin Zhongli

 

In contrast with the mainland's yuan-denominated A-share market, which has been fluctuating drastically with its recent record highs, the foreign currency B-share market has been moving upward with a steady momentum.

 

With more investors opening accounts in B shares (US-dollar-denominated accounts on the Shanghai stock exchange and Hong-Kong-dollar-denominated accounts on the Shenzhen exchange), the market gains increasingly heavy leverage within the country's capital market.

 

It is, therefore, critical to clarify the exact role of the B-share market in the current financial situation.

 

Established in the early stage of China's economic reform, the B-share market was originally meant as a tool to assist domestic businesses in attracting overseas investors. It made a remarkable contribution to getting the foreign currency needed for economic development when China started to open up.

 

The economic situation has changed so radically in past decades that China has gone from a shortage in foreign currency to the national holding of the world's largest foreign exchange reserve as of last year

 

Since 1997, domestic businesses have been eligible to list on overseas stock markets as well as the Hong Kong stock exchange. The H-share stocks traded on the Hong Kong exchange and the "red-chip" shares of the mainland's leading companies traded on foreign markets have attracted large amounts of capital needed by mainland enterprises. As a result, the B-share market has been marginalized in the financing of mainland businesses.

 

Given the current situation, the B-share market should be repositioned as a market where domestic individuals and businesses can invest their foreign currency in mainland enterprises.

 

The B-share market will provide a good channel for Chinese to garner a sound return on their foreign currency.

 

The renminbi is facing heavy pressure to appreciate, not only because of the hot money flowing into the country but also because of the foreign currency and foreign assets held by Chinese individuals and businesses.

 

According to the statistics of the State Administration of Foreign Exchange, the foreign currency remitted into China has been rising dramatically since July 2005, yet bank deposits in foreign currencies have not been growing at the same pace.

 

It indicates that individuals and businesses owning the foreign currencies are selling them to buy renminbi.

 

The average price of stocks on the B-share market is about half the average price of A shares. Theoretically, B-shares could double in value once the B-share market is subject to the same policies as the A-share market.

 

When the B-share market is geared up, individuals and businesses will be more willing to invest their foreign currency rather than convert it into renminbi. This would ease pressure to revalue the renminbi.

 

At the same time, if domestic companies could get the foreign currency they need from listing in the B-share market, they would stop bringing in foreign currency pooled from overseas stock markets, further reducing the pressure for renminbi revaluation.

 

However, several arrangements must be made before revitalizing the B-share market.

 

Currently, individual mainland investors are the majority investors in the B-share market.

 

Before the B-share market was opened to domestic individual investors in February 2001, it was mainly composed of foreign investors. By the end of 2002, domestic investors held 82 percent of all B shares while foreign institutional investors accounted for 1.5 percent.

 

Mainland institutional investors are still not allowed in the B-share secondary market. This has made the B-share market a rare case in capital markets where individual investors dominate.

 

The ban on domestic institutional investors was imposed out of concern that the foreign currency pooled from the B-share market would flow into the pockets of institutional investors instead of the businesses in need of the assets. This concern was a result of the foreign currency shortage, which has long since vanished.

 

The time is now mature for lifting the ban and letting institutional investors into the secondary market of B-shares.

 

The authorities could allow institutional investors to establish funds invested in B shares. The funds invested in A shares now total more than 150 billion yuan (US$19.5 billion), while there is not a single B-share fund. It will inject vigor into the market and ease the tension in the currency market by providing an outlet for major investment with money collected from individuals.

 

While granting institutional investors access to the B-share market, the authorities should also try to boost the B-share market itself to balance supply and demand.

 

Currently there are only 111 companies issuing B shares in the Shanghai and Shenzhen stock exchanges with a total of 16.4 billion shares circulating. The market value of the shares stands at 100 billion yuan (US$12.9 billion) at the current exchange rate.

 

By May 18, the shares in circulation on the A-share market for Sinopec, the listed company with the largest market value in both stock exchanges in Shanghai and Shenzhen, were worth 43 billion yuan (US$5.51 billion), almost half the total value of the B shares in circulation.

 

With the growth of the B-share market urgently needed, a proper approach would be to start the public offerings of companies, especially those with excellent business records and prospects. Blue chips on the B-share market would help stabilize the market during the speedy swell of investment.

 

The author is a researcher with the Institute of Finance under the Chinese Academy of Social Sciences

 

(China Daily May 22, 2007)