KONGThe development of China’s stock markets has been dramatic, but
these emerging markets badly need a more rational structure, and more equal
valuations. Chinese stocks have outperformed most others in the past year, but
that has only exacerbated a situation in which Chinese pay several times more
than foreign investors for the same assets.
Since their start a decade ago, the
Shanghai and Shenzhen markets have grown to a combined market capitalization of
$350 billion. Last year they raised $18 billion from the Chinese public. Throw
in the H shares — Hong Kong-listed mainland companies — and ‘‘red chips’’ — Hong
Kong-incorporated mainland companies — and the total market value of listed
Chinese equities comes to more than $500 billion. This compares with a Hong Kong
market capitalization of around $520 billion, of which almost 30 percent is now
accounted for by mainland stocks, the most prominent of which is China Mobile
The biggest problem for China’s stock
market is its fragmentation. The mainland has two separate exchanges, Shanghai
and Shenzhen, listing and dealing in A-class shares — those which can only be
purchased by locals — and in B-class shares — those reserved for foreigners. The
A markets are supposed to merge, but the timetable is uncertain. Meanwhile,
Shenzhen in 2001 is to begin with a second board.
In addition to buying B shares,
foreigners wanting to invest in China can buy H-class shares, or the handful of
significant mainland companies with listings of their Hong Kong subsidiaries,
like China Mobile and China Resources (Holdings) Co. Several of these are also
listed in New York. B shares are quoted in U.S. dollars in Shanghai; in
Shenzhen, they are quoted in Hong Kong dollars.
However, the B markets are small and
almost moribund, having been overtaken by the larger H-share issues traded in
the liquid Hong Kong market.
The B shares trade at huge discounts to
their A counterparts, but the government is of two minds about what to do. The
preferred solution would be to merge the two, at the same time allowing
foreigners to buy A shares through institutional vehicles such as those Taiwan
used when it first opened to foreign portfolio investment. But Beijing is
reluctant about allowing trading in shares that could result in capital outflow.
As it stands, the types of stock that foreigners can buy are off-limits to
locals, in theory, so secondary market trading is in foreign currency and does
not affect the exchange rate.
Currency concerns are only half the
problem of bringing foreign and local investors to a single market. The other is
valuations. Telecommunications companies apart, international investors give low
ratings to mainland stocks. Most H shares trade at price-earnings multiples of
eight to 12, whereas A shares routinely trade at multiples of 30 to 40. The gap
is even wider after considering the superior accounting practices of
It makes limited sense for mainland
enterprises to raise money offshore when they can get it much cheaper from the
A-share market. Nor do companies need foreign exchange: China is awash with
reserves and there is no shortage of funds to import equipment. Baoshan Iron
& Steel Co. and China Minsheng Banking Corp., two recent A issuers, were
massively oversubscribed even though valuations were far above what they could
have expected offshore. But Petrochina, listed in Hong Kong and New York during
2000, trades at just eight times earnings and has a 4.2 percent dividend yield.
The foreign currency listings only make
sense from the point of view of prestige, of long-term capital needs, and in
terms of the positive impact that foreign listing is assumed to have on
corporate governance. The listings, of course, also are much promoted by Western
Under the pressure of this extreme
valuation divergence, the barrier between A and H shares has begun to break
down. H-share companies such as Huaneng Power International Inc., Tsingtao
Brewery Co., Yanzhou Coal Mining Co. and Zhejiang Expressway Co. have recently
been allowed to raise money through A-share offerings at prices several times
those of their existing H shares. That is beneficial for the holders of H shares
but puts the locals at a disadvantage. Meanwhile, the playing field is uneven
because A-share companies are not permitted to issue H shares.
The valuation gap has several causes. H
shares may well be underpriced, with foreigners overstating the country risk,
particularly for state enterprises enjoying protected franchises. A shares seem
overpriced partly because retail investors have as little concept of value as
U.S. investors did of dot-coms a year ago. Savers have few outlets other than
low-yielding bank deposits, and few institutional intermediaries are there to
make professional valuation judgments, so local markets are driven by retail
cash flow and sentiment.
The government is also to blame. It has
been anxious to induce a feel-good effect by limiting the supply of new stock.
Though more than 1,000 companies are now quoted, most are still controlled by
the state, whose shares are unlisted. The government ought to be raising more
money through asset sales, but it has given priority to bolstering stock prices.
This policy has long-term drawbacks. The government’s ability to use a public
offering to discipline state enterprises is reduced, and it becomes ever more
difficult for the government to allow prices to fall to rational levels without
upsetting investors’ confidence.
To bring China’s markets closer together,
it will not be enough to allow foreigners to buy A shares. They will not buy
them if they can get a good spread on H shares at one-third the price. Equally,
Chinese companies will not issue H shares if they can sell A shares at triple
the price. Market logic also demands that companies have a freer hand in
deciding when and where to issue stock.
Under this scenario, the H- and B-share
value gap will gradually wither and foreigners will buy mainland shares just as
they now buy, for example, Indian ones. The foreign price for investing in China
will rise, and the local investors will get a better deal.