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China's stockmarket

A tiny leap forward

China's first cautious step towards an open capital account

JUST as China's leaders were gathering in Beijing last week for the 16th congress of the Communist Party, the country's securities and foreign-exchange regulators announced that, from December 1st, they would consider applications from some foreign investors to invest in the Chinese stockmarket. Whatever the cadres decide this week, the timing seemed to say, China will continue on its slow and cautious path towards an open capital market and, ultimately, a convertible yuan.

The new scheme—known as QFII, because it is aimed at the qualified foreign institutional investor—is an import from Taiwan. A decade ago Taiwan, just like the mainland today, badly wanted foreign capital to beef up its stockmarket. But it was cautious about encouraging volatility (for fear that the mainland would exploit it). So it added swathes of bureaucratic red tape, which were sufficiently obstructive to deter all but the most dedicated investors, and cumbersome enough to cool down most “hot money” long before it could exit from the market. QFII has worked for Taiwan, saving it from the worst of the Asian crisis in 1997-98. Today, foreigners own some 7% of Taiwan's stockmarket, and the government has said that it is ready to open up completely by 2004.

The mainland is hoping for a similarly slow evolution. Its entry conditions are onerous. To apply for the special yuan accounts, foreign investors must have at least $10 billion in assets under management (which rules out most investment boutiques). Banks must be “in the top 100” globally. Applications will take 30 days (in theory), and the QFII may buy at most 10% of any Chinese company listed on Shanghai's or Shenzhen's yuan-denominated stockmarkets (foreigners can already invest in China's tiny hard-currency stockmarket). And repatriation will be a nightmare: some types of funds may not take anything out for three years, others not for a year, and even then it will only be in small dollops.

The barriers are intentional, but that is only one reason why international fund managers were not exactly fighting in the queue for applications this week. The other is the peculiar nature of China's market. Capitalised at about $540 billion and consisting of 1,212 companies, it is now Asia's second-largest, after Japan's. But only 35% of this capitalisation is tradable, since the state—the owner of virtually all listed companies—sits on the rest. Corporate governance is widely acknowledged to be atrocious. And valuations are probably overdone, with an average price/earnings ratio of 40, compared with about 12 for mainland companies listed in Hong Kong. That is despite a fall in the market of some 30% over the past 17 months.

Chinese investors themselves seemed to acknowledge these shortcomings this week, by not anticipating a rush of foreign interest: the market barely moved. In time, China's leaders hope, foreigners will support the market and force managers and brokers to become cleaner and more transparent. Even in Taiwan, though, this did not happen overnight