China's Quirky Stock Market Finally Matters

An investor checks stock prices on a board in Shanghai on Friday, when the benchmark index gained 1.2 percent after significant losses early in the week.
An investor checks stock prices on a board in Shanghai on Friday, when the benchmark index gained 1.2 percent after significant losses early in the week. (By Eugene Hoshiko -- Associated Press)
By Ariana Eunjung Cha
Washington Post Foreign Service
Sunday, March 4, 2007

SHANGHAI -- Looking at the facts, the past year seems to have been disastrous for Worldbest Pharmaceutical. First, there were reports of accounting irregularities and exaggerated profit. Half the managers were fired. Then, in the summer, six people died and at least 80 fell ill after receiving an antibiotic injection manufactured by a subsidiary. Most recently, the company warned investors that it was likely to report its third consecutive year of losses.

None of that cooled the enthusiasm of investors on China's Shanghai Stock Exchange, who since the end of March 2006 have driven the value of Worldbest's shares up 44 percent.

The Shanghai exchange and its smaller counterpart in Shenzhen, near the country's extreme southern border, have long been viewed skeptically by global capitalists, even those enthusiastic about the broader Chinese economy. The markets were considered too new, too small, too closed and too quirky to matter.

That attitude was put to a test last week when, for the first time, a big drop in the Chinese markets helped spark a global stock sell-off. Suddenly, it seemed, the views of Chinese investors mattered to the rest of the world.

And as the Chinese government takes steps to clean up market practices and allow more foreign investments, the rest of the world's markets are likely to continue to feel its growing pains.

Though China's is one of the fastest-growing economies in the world, it remains heavily influenced by the Communist state. The stock markets are not the main source of capital in China -- that role is played by banks, all of them controlled or heavily influenced by the Chinese government. Many analysts also see the stock markets as subject to more government manipulation than is the norm in capitalist countries.

It remains murky exactly what role the Chinese government played last week, when the Shanghai composite index fell 9 percent, either in setting off the panic by talking about new regulations or in countering it after it started by buying securities.

"There were some reports of state buying -- I don't know how reliable those are. But it's also possible people may have decided 9 percent in one day was too much and they are still bullish on stocks," said Stephen Green, senior economist at Standard Chartered Bank in Shanghai. "I don't think anyone really knows where we go from here."

The Chinese markets made up half of Tuesday's losses in Wednesday's rebound. The Shanghai composite index ended the week down about 4 percent, at 2831.53. Global markets also stabilized after Tuesday's drop and then rose modestly. But the fall left investors wondering whether China's new influence over stock markets adds fresh risks to a global financial picture already plagued by huge trade imbalances and bubbles in the prices of many assets.

China's strict capital controls -- the fact that it is hard to convert the yuan into other currencies and vice versa -- for years insulated its stock markets from outside tremors. Concerns about transparency and corruption have also kept some investors away. Although foreign institutional investors have increased the number of shares of Chinese-listed companies they own in recent years, they still hold less than 4 percent in the Shanghai and Shenzhen markets.

"When you think of the Shanghai market, it's best to think of it as another continent or even another planet," said Jonathan Anderson, UBS chief economist for Asia.

Concerned that isolation would stall its economic transformation, China has introduced a number of reforms in recent years. As a result, China's equity market is becoming increasingly integrated into the rest of the world's. Dual listings of Chinese companies have meant that rumors that start on the mainland can jump to Hong Kong. London companies with large shares in public Chinese companies mean that their bottom line could fluctuate based on what happens in the Shanghai market. Hedge funds, lightly regulated investment pools that specialize in risky investments, hold stocks in China as well as New York. That has meant that an automatic sell-off of one fund could affect more than one market.

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