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How far can cross-strait investment safely go?

Last Wednesday the Cabinet lifted a ban on investments in the Chinese stock market. Suddenly onshore funds and discretionary accounts managed by domestic securities investment trust companies can invest in stocks on the Chinese market, as well as in red-chip shares and H shares on the Hong Kong and Macau markets.

In the past, the government was unwilling to allow onshore funds to invest in the Chinese market because of worries that it would lead to an outflow of funds. There was also concern that the Chinese market was unstable and lacked corporate transparency.

Have all these concerns suddenly disappeared? Will Taiwan be called on to open its markets to Chinese investment?

First, Taiwanese capital is still flowing into China. According to official Chinese statistics, by the end of last year, Taiwanese investment in China totaled US$2.1 billion -- approximately NT$60 billion.

From January to June of this year, China-bound investments amounted to US$600 million, down 33 percent from a year earlier, but China is still Taiwan's top overseas investment destination. This proves that the capital outflow to China hasn't stopped yet.

Second, the Chinese investment market is still unstable. Manipulation of financial markets is still a serious issue in China. The average price-to-earnings (P/E) ratio on the Shanghai Stock Exchange Composite index is over 40, and the Shenzhen index P/E ratio is 60.

This is far higher than the P/E ratio of 17 of the Taiwan Stock Exchange. In addition, many listed companies in China are financially unsound, which means that these figures cannot be verified and that real P/E ratios could be higher still.

Third, risks increase as the Chinese and Hong Kong stock markets soar. This year both the Chinese and Hong Kong stock markets have seen a major surge, and this has increased investment risk.

The Cabinet lifted the restrictions on domestic funds investing in China with the hope that the relaxation would allow investment funds to carry out some asset allocation and enhance their risk management abilities. In my view, however, this will only increase future risk while promoting investment in the Chinese and Hong Kong markets.

Beyond these questions, there is the concern that the government will be trapped in a dispute over whether to allow Chinese investments in Taiwan. The Cabinet has long insisted that allowing Chinese investment in the Taiwanese stock market would pose a danger to the nation's economic safety.

How can it now justify lifting the ban on onshore funds investing in the Chinese stock market when financial circles, for example, demand that it allow Chinese investment in Taiwan based on the principle of reciprocity?

Policies should be consistent and predictable. On one hand, the government restricts Taiwanese capital flows to China, while on the other hand, it adopts a policy of deregulation.

On one hand, it cautions the public about investing in Chinese stock markets because of high risk, but on the other hand, it relaxes restrictions and allows mutual funds to invest in China because that will enhance their risk management capabilities.

Such contradictory policies are quite difficult for investors to predict, and they are unfair to law-abiding people. The government shouldn't pump out policies just because it wants to offer "a benefit of the week." What the government should focus on now is how to offer consistent and reasonable policies to increase public confidence in both the government and its policies.

Fung Kuo-hao is an associate professor and dean of the Department of Public Finance and Taxation at Hsing Kuo University of Management.

Translated by Ted Yang
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