Stock market maturity key to stable growth

As a barometer for economic soundness, the Chinese stock market has seen a continuous slump in recent years and a large group of investors suffered losses in their investing accounts. People cannot help asking whether such a slump suggests the economy is having problems.

It is true that the Chinese economy witnessed a high-speed boom for more than two decades and the Chinese stock market was also among the most active markets around the world last year. However, the economy and the stock market are both under intensive pressure from forces in and out of the country at this moment.

The economy is still following a traditional model of development popular in the economic takeoff in East Asian countries: an economy relying heavily upon the external demand. Under this mode, the government imposes heavy influences upon the prices of productive elements in order to lure direct foreign investment and keep the commodities competitive on the international market with low prices.

Currently, such a mode is challenged by both the shrinking demand and the rising prices of raw materials. The subprime crisis in the United States and its negative influences have directly reduced the traditional export market for China and other developing countries.

The price hike of crude oil and other industrial raw materials is a direct consequence of global excessive liquidity and the development of financial derivative products, which is much faster than the economy.

The emerging market economies, including China, are mostly export-orientated, so they are the primary victims of the shocks.

If the Chinese manufacturers still take the international market as their primary market and keep their current investment momentum, they might soon see their inventory raised and profit reduced or even go red when the overseas market is weak and the prices of imported raw materials rise.

That would be a typical "hard landing", a scenario that happens when the economy goes directly from a period of expansion to a recession.

Therefore, our target should be to slowdown the economic growth gradually and achieve a soft landing, avoiding inflation, high interest rates and a recession when the economy cools down.

To achieve this target, it is necessary for China to speed up restructuring the industry and developing a sound financial system that could resist external risks.

As to the stock market slump, it is partly a result of the changes in the economic outlook across the world. The profits of listed companies, many of which are export-orientated, are sure to dip because of the global economic slowdown.

Of course, other elements within the country were also adding pressure to the capital market.

The tight monetary policy, which could not be loosened because of the excessive liquidity, the high inflation pressure, the huge inflow of speculative money and many other reasons, is not going to be changed in the near future.

The stock market itself is also under reform for many of its long-term ills have not been eliminated. Facing so many negative influences, the stock market can easily fluctuate dramatically.

As a matter of fact, a mature stock market should not only be a place for corporations to get financing. More importantly, it should be a place to create wealth.

With trust, investors put their money in the listed companies they choose in the hope of sharing the companies' business returns as shareholders. If their investment could not bring them rewards, or their rights of benefiting from such investment could not be guaranteed, they would definitely quit the market. The stock market might not function well for financing listed companies.

The authorities should encourage more profitable enterprises to get listed in the market, including the private businesses. Meanwhile, those listed companies with poor performances should be kicked out of the stock market under prudent regulations.

Only when the stock market functions well, it would serve as a strong support for economic restructuring, which is necessary to upgrade China from an export-orientated trade power to an economy pillared by domestic demand with sound and fast growth.

Another important mission for the authorities is to enhance the regulation of all market players, including investors, listed companies and financial institutions, so that they could not manipulate the market to their own advantage.

All these measures are only part of the solutions to develop the stock market into a more mature system. They are indispensable though sometimes painful or time-consuming.

There were calls for the government to take measures and prop up the stock market. Such a "bail-out", effective in lifting the index points, may not last. And it could bear long-term negative influences to the market.

The investors might feel confused about their investment decisions when the government, instead of the market, tells them where the stock price should go or where the investment risks lie. And the investors might even drop their own judgment and try to follow the government in their investment. It may lead to a market failure, which is obviously dangerous for the capital market as well as for the economy.

Therefore, a mature internal system for the capital market involving market players is what we need most urgently to prepare for a new round of prosperity.

The author is a professor of finance at the School of Economics, Fudan University

(China Daily 07/10/2008 page8)