Careful scrutiny is in order when it comes to examining recent changes in the regulations of China's capital market. As part of ongoing reform of the financial sector, China Securities Regulatory Commission (CSRC) announced that domestic residents with legally-held foreign currencies could open and trade on a stockmarket that was open only to foreign investors.
There has been much excitement about allowing expanded trading on this so-called B-share market. A superficial assessment of this move would suggest that Beijing is liberalizing the financial sector. However, these reforms provide a way to close a gap in its capital controls. With substantial increases in foreign currency savings held by domestic residents, domestic banks have been able to divert these savings overseas for investment. This move is also an admission of the wretched performance of a mutant market created with two heads to serve Beijing's capital control policy. The sad truth is that nothing of substance will change even with full consolidation of China's stockmarkets. In fact, things might become worse, at least for China's beleaguered and badly-served savers. This is because the state-owned banks have squandered much of the hard-earned savings of Chinese depositors by lending to poorly-run state-owned enterprises (SOEs). As it is, somewhere between 25 and 40 percent of those outstanding loans are non-performing.
Given that most of the listed companies are the same SOEs that are delinquent borrowers, this gives them another shot at high jacking China's domestic savings. It is no secret nor should it be a surprise that the central government will benefit mightily since it has majority interests in most of the listed companies.
And these funds at stake are not small potatoes. Foreign currency savings of Chinese residents are estimated to be as much as US$75 billion.
It would be bad enough if investors were simply at risk from the many irregularities in the share markets arising from insider trading and price manipulation schemes. Without transparency and shoddy accounting standards, it almost impossible to track the performance of listed enterprises in a reliable manner. Even so, risks of losses from these illegal acts are probably less than from what amounts to a cynical expropriation by the Chinese government.
If Beijing were acting in the best interests of individual savers, they would be allowed to place their hard-currency holdings anywhere in the world. Or if the funds must be kept captive in the domestic market, the overall economy would be better served if they went into the private sector since sustained growth will require allowing private entrepreneurs greater access to capital.
However, none of these funds will find their way to private enterprises that already have difficulty finding funds from the state-owned banks. Instead of promoting private sector growth, SOEs will be able to use the stock market to continue their inefficient operations. This is especially discouraging since no company has been delisted despite having broken the rules. Although delisting procedures are to be announced soon, the proof will be in the pudding. Under China's securities law and company law, a listed firm can be delisted from the stock market after three consecutive years of losses. Yet the regulations do not specify how soon loss-making firms will be removed under these conditions.
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