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Moderating China's markets

By Kai Nargolwala (China Daily)
Updated: 2008-05-29 15:14

China's stock market has been on a roller-coaster ride, rising more than five-fold in two years, then precipitously dropping in late 2007 by half from its peak. Many are wondering - what sort of measures can be taken to lessen the volatility? The answer may well be more tradable stock in the market and a greater number of investors with a long-term perspective.

This year marks the 30th anniversary of China's open-ing-up policy. No area of the economy is more emblematic of China's transformation than its capital markets. From virtually nothing in 1990, China's stock market has grown into a global giant. Even after the recent decline, the combined value of the mainland's A shares and Hong Kong-listed mainland companies means the ratio of market capitalization to GDP is around 125 percent - similar to the United States. China, including Hong Kong, is now larger than Japan.

At Credit Suisse, we believe the greatest potential lies in China's domestic markets. This is not to say that markets abroad will cease to play an important role in the capital raising needs of the nation. But it is natural that local markets take the lead. As China has done so adeptly in many of its reforms, the future development of its markets will be determined in part by how China synthesizes global "best practices" into its own reality.

We see a number of things changing here, and as more foreign players take a role in the domestic markets there is a lot that can be shared in terms of technology, training of personnel, and the introduction of new financial products and concepts.

Looking at the recent ups and downs, it's clear China needs two things - deeper markets and more buy-and-hold investors.

These two objectives fit together nicely. In terms of market depth, China's A share market - and especially the biggest stocks - need to have a much higher free float, or the amount of freely tradable stock as a percentage of overall issued share capital.

At the moment, average free float is around 30 percent, far below that of other markets. In the case of some of China's largest banks, free float in the A share market is so small as to be almost insignificant. Because government holdings so dominate the shareholding structure of many companies, there is a large amount of stock whose future is an open question in the minds of investors. What will the major shareholder do, and when? This uncertainty breeds volatility.

China's markets are at a stage where a large part of those shareholdings could be divested. Naturally, the question is "into whose hands?" The answer should be into the growing institutional investor base in China.

Large investment pools for long-term capital appreciation and income are required here. These are the likes of pension and social security funds, which are growing rapidly as the social safety net expands and China's healthcare reforms unfold. On the retail side, creation of a tracker fund, as was done in Hong Kong some years ago, could be a good option, too. Exchange-traded funds are another way to go and something well known in other markets.

As free-float grows and more long-term institutions are active in China's markets, the peaks and valleys will be moderated. Of course, markets will continue to move up and down. A certain amount of fluctuation is desirable as capital seeks its most efficient outlets. However, a deeper, liquid market means that less needs to be done to manage market volatility. This is good for both large and small investors - and will result in fewer worries for market regulators.

The author is the Asia-Pacific CEO and member of the Executive Board of Credit Suisse Group.