A V Rajwade: China's capital market charge

WORLD MONEY

China had the largest issues of fresh equity in the year, exceeding even the issues in the US last year.

The speed and scale at which China changes, and digests the changes, never ceases to amaze me "" from Mao's cultural revolution to Deng's capitalistic revolution is less than five years; from Asia's worst infrastructure in the early 1990s to perhaps the best in a decade; from the mess in the banking space to the world's largest ever IPO and second largest bank by market capitalisation in five years. Reforms have been instituted in totality in the financial sector. One manifestation of this is that more than $100 billion of corporate funding (a fifth), came through sources other than bank loans. Not all of this can be characterised as capital market activity in the traditional sense, as there seem to be some instruments peculiar to China.

More than half the amount raised from non-bank sources was in the form of IPOs, making China the largest issuer of fresh equity in the world. This is remarkable considering that, after new issues had been suspended by the authorities for a year, issuance resumed only in the middle of last year. A recent issue by the China Life Insurance Company attracted subscriptions totaling $100 billion! (Paralleling the Industrial and Commercial Bank of China, China Life is now the world's second largest insurance company by market cap.) The secondary market in equity warrants is the largest in the world even when there are just 20 issues, and the market did not even exist 18 months back. The bond market is also getting sophisticated: there was an issue of dollar-denominated Chinese Residential Mortgage Backed Securities in Singapore and Hong Kong a few months back.

The enthusiasm of the investor for equities is understandable given the extremely low interest rates (banks pay just 2 per cent to depositors), the fast growing economy and the fact that the index has gone up 130 per cent last year "" ironically, it had fallen sharply over the previous four years despite the economic boom. The recently reconstituted regulatory regime is cleaning up the secondary market practices and making it more transparent. Earlier, given the ban on domestic IPOs, several Chinese companies listed only in Hong Kong. After the ban was lifted, major issues are now being floated in both Hong Kong and the Shanghai/Shenzen stock markets. IPOs by Chinese companies on global market totalled $45 billion in 2006.

Another major reform has been the abolition of the "non-tradable" category of shares "" these were actually state holdings, and comprised two-thirds of the total share capital of the listed companies. While such non-tradability no longer exists, it is not clear whether the shares would actually come in the market, as part of the privatisation of the state sector. Remarkably, the rise in equity prices last year took place in the face of the possibility of the huge amount of hitherto non-traded stock coming in the market. Including the capitalisation of the companies listed only in Hong Kong, the market capitalisation of Chinese-listed companies now comes to around $1,600 billion. Mergers and acquisitions in China (including Hong Kong) totalled $350 billion last year. Like the economy and banking, Chinese capital market activity has overtaken its Indian counterpart in many areas.

The mutual fund sector is also growing rapidly. While money market funds have dropped in assets as the stock market boomed, the aggregate mutual fund assets are in excess of $100 billion. India's, on the other hand, are about $80 billion. As part of the financial market reform, pension fund management regulations have been introduced. These envisage a small proportion of the funds to be invested in the stock market. The insurance sector has also been reformed with foreign companies allowed a majority holding in both life and general insurance companies. Clearly, the Chinese are well ahead of us in some of the areas which we keep debating.

While, in general, China continues to welcome foreign direct investments without too many reservations, including in the retail sector, some backlash is developing in respect of the takeover of existing domestic companies by foreigners. It took a Citibank-led consortium one year to get approvals to take over a relatively small Chinese bank. Carlyle, the private equity fund, has also faced problems and opposition to a takeover bid. On this issue as well, the contrast with us is interesting. We seem to be much more wary of fresh investment proposals, than takeovers or other private equity investments!

Meanwhile, commercial banks' reserve requirements have been increased to 9.5 per cent to cool the economy and the yuan continues its gradual appreciation against the dollar. A Shanghai Interbank Offered Rate (SHIBOR) market in the domestic currency has started in Shanghai.