By Peter S. Goodman
Washington Post Foreign Service
Thursday, August 25, 2005
SHANGHAI, Aug. 24 -- China on Wednesday freed more than 1,300 largely state-owned companies to gradually sell shares of stock now controlled by the Communist Party government, putting nearly $270 billion worth of state assets on the trading block. This unprecedented wave of privatization is aimed at lifting domestic stock markets and furthering the country's transition toward capitalism.
The plan announced by the China Securities Regulatory Commission underscored how this land once ruled by Maoist ideology has in recent years cast its fortunes with free markets and private capital. It also highlighted the government's mounting concern with the sorry state of the Shanghai and Shenzhen stock markets, which have performed worse than any in the world over the past eight years, even as China's economy has grown by nearly 9 percent annually.
The move is "a huge deal," said Stephen Green, senior economist at Standard Chartered Bank in Shanghai and author of the book "Exit the Dragon?," which examines China's privatization. "The state-owned shares have been an albatross around the neck of the market. This is a pretty good sign that they're serious about reform."
Ever since China established its first stock exchange in 1990, Communist Party leaders have struggled to convince investors that they are running a real market as opposed to a capital-raising machine in which the government manipulates share prices to serve the interests of favored state firms. The disconnect between China's swift growth and its plunging stock markets has been traced to investor unease with the structure of the companies for sale: Roughly two-thirds of the shares of listed firms remain non-tradable, locked in the hands of state-owned parent companies that are impervious to the interests of minority shareholders.
The plan announced on Wednesday -- the most significant change to China's stock exchanges since their creation -- is aimed at convincing investors that state interference is a relic of the past, with stock prices reflective of real values in a more transparent marketplace.
The move sets in motion a gradual sell-off of non-tradable shares while seeking to assuage worries about a possible plunge in prices when these shares enter the market. It also triggers negotiations between existing shareholders and the managers of listed companies to set some form of compensation -- either cash or additional shares -- for investors who will see their holdings diluted. The shares made tradable would not necessarily be sold: The parent companies holding them could opt to keep them. Those shares that are sold would be released for purchase over time, typically over one to three years.
Analysts emphasized that the plan should not be construed as an indication that the government has embraced wholesale privatization. The majority of the companies that trade on the Shanghai and Shenzhen exchanges are small arms of giant firms that remain wholly controlled by the state, or inconsequential and poorly managed firms engaged in such enterprises as the cement business and bicycle manufacturing. The government's decision to put more of these shares into private hands does not signal an intent to relinquish control over the largest and most strategically important state-owned firms, which still dominate key sectors of the Chinese economy such as steel, auto-making, telecommunications and commercial aviation.
"This is basically a mechanism to get the stock market to function, which it has not done in four years," said Arthur Kroeber, managing editor of the China Economic Quarterly. "This is the state privatizing junk that it's not interested in but retaining control over the core companies."
China's bid to win investor confidence in its stock markets received another push Wednesday with a report carried by the official New China News Agency that the legislature plans to toughen securities laws, giving the regulatory commission the authority to freeze corporate and individual bank accounts in a bid to root out corrupt trading.
Analysts said the initiatives are aimed at making China's stock markets more attractive to investors, particularly foreign banks such as Morgan Stanley that collectively have qualified to buy up to $4 billion of stock on domestic exchanges. The control of listed firms by the state has fostered the sense that China's markets are beset by inside deals and shoddy corporate governance. And foreign investors have been reluctant to plunge in until after the resolution of the non-tradable shares conundrum -- a black cloud hovering over China's markets, which have seen half their value wiped out since 2001.
In the past month alone, as speculation has grown that a new plan was in the offing, the Shanghai and Shenzhen markets have each risen by more than 12 percent. Both markets were up again Wednesday.
The Wednesday action caps a long and frustrating effort by China's leaders to address the issue of continued state dominance of listed companies. Four years ago, the government announced plans to sell off state shares of listed companies to raise money for a pension system that would compensate workers who lost their benefits under China's pro-market reforms. But when stocks tanked in anticipation of such sales, the government scratched the plan.
China's leaders have searched for a way to unload the shares without decimating the markets. In May, they launched a pilot project, allowing 46 listed companies to make all of their shares tradable.
Since then, 45 of those companies have gained the regulatory approval needed to proceed with their plans, having won over existing shareholders with compensation schemes, according to Green.
The negotiations have brought controversy, with some accusing the state-owned companies of defrauding the public by giving away stock too generously. In a commentary published this month in Caijing, a Beijing-based financial magazine, Shan Weijian, an independent board member of Baoshan Iron & Steel Co., the country's largest steelmaker, criticized as unjustly generous the company's plans to hand out 2.2 new domestic shares for every 10 held. The non-tradable shares "belong to all the people in the country," Shan wrote.
Now, the other 1,300-plus companies that trade on China's stock markets are free to pursue such deals.
In seeking the assent of existing shareholders, the managers of listed companies will need to win over the country's domestic mutual funds, which have become the largest single owners of nearly every stock, together controlling some $46 billion worth of assets at the end of April, according to China Economic Quarterly. The total value of China's two stock exchanges was $525 billion at the end of 2004, according to state data.
Though these institutional investors are themselves controlled by state-owned companies, they have generally taken an aggressive line in negotiations for compensation, experts said. But in a clear sign that the government is still to a degree managing the rising and falling of China's stock markets, a senior executive at one of China's larger mutual funds said that in recent months regulators have pressured his firm not to sell off depressed stock holdings to help prop up the market.
Special correspondent Eva Woo contributed to this report.