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Controlling capital market boom without hurting economy

By Robert Blohm (China Daily)
Updated: 2007-05-23 10:57

The market should reflect factors China does control. This includes increasing the supply of stock and a market-driven real economic policy (fiscal and industrial), not just monetary policy. The China stock market is a vote of confidence in the continuing stability of the RMB. Appreciation could crash China's stock market because of reduced earnings to the exporters accounting for 70 percent of the economy.

More stock issuance plus a market for government, bank and corporate bonds are needed just to replace dwindling growth in bank lending funded by dwindling growth in deposits.

Banks can get into the mutual fund business to recycle their customers' deposits into stocks and replace interest income by income from stock trading. But without release of more shares by the State, this is just more money chasing the same stocks, creating higher share prices.

The speed of bond market development depends on the development of a solid base of professional institutional investors, not just mutual funds. Last year's flood of new shares did have the immediate beneficial effect of shifting liquidity from retail to corporate investors. Those companies should only temporarily, not permanently, be managing cash liquidity raised from issuance of their stock.

Compared with Hong Kong, the rest of China still lacks a critical mass of sophisticated institutional investors. As a result Hong Kong's stock market correlates more closely with the New York Stock Exchange than Shanghai's stock market does. This makes day-trading far more reliable in Hong Kong.

The privatization process is creating a political conflict within one and the same Chinese citizen, in particular the one who risks loss of the State-enterprise job providing him or her money to invest in the stock market. There's a trade-off between job security and a stock market boom predicated on accelerated privatization. While politicians have timed privatization with the impact on jobs, they now have to increasingly consider the possible shock of widespread losses to investors from stock market collapses.

Another policy tool at the State's disposal is further decontrol of prices in strategic sectors of the economy. Historically these prices were too low. For example, the State needs to further bring the energy sector into market dynamics. It needs to abandon the idea that national energy security is a matter of administrative control over resources and national control over local resources.

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