Charting China's Capital Market: Evolution Through the New Nine Principles
China reveals it executed scientist for spying in 2016 in documentary about ‘shocking’ cases; Singapore’s Lee Hsien Loong will hand over power to deputy Lawrence Wong on May 15
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Charting China's Capital Market: Evolution Through the New Nine Principles
Li Weijun
Last Friday, on April 12, 2014, the Chinese State Council released a pivotal document concerning the capital market titled "Several Opinions of the State Council on Strengthening Regulation, Preventing Risks, and Promoting the High-Quality Development of the Capital Market." This document outlines nine guiding principles for the future evolution of the capital market. Intriguingly, since 2004, the Chinese central government has issued a guiding document on the capital market every ten years, each comprising nine principles. Consequently, these documents are colloquially known as the "State Nine Principles." Moreover, following the publication of the "State Nine Principles" in 2004 and 2014, China's stock market witnessed vigorous bull markets.
To comprehend the impact of the 2024 "State Nine Principles" on the capital market and the stock market, a succinct historical review is essential. In the early 1990s, the Shenzhen and Shanghai stock markets were sequentially established with the primary objective of facilitating equity financing for state-owned enterprises. At that time, listed company stocks were artificially categorized into non-tradable shares and tradable shares: the former constituted approximately 70%, usually held by the state or state-owned enterprises as legal person shares, and were non-negotiable on the stock market; the latter made up roughly 30%, representing stocks publicly issued and traded in Shanghai or Shenzhen. This arrangement, aimed at ensuring absolute state control over state-owned enterprises even after issuing capitalist stocks and becoming listed companies during the initial stages of stock market development, significantly impeded corporate governance. Decisions made by state-owned major shareholders could not be overridden, even if all tradable shareholders opposed them. Simultaneously, in the early 2000s, decision-makers realized that absolute control over listed companies did not necessarily require a 70% shareholding. For most listed companies, a 51% state ownership sufficed; for companies with more dispersed ownership, even less than 51% state ownership could establish the state as the largest shareholder and actual controller. Against this backdrop, allowing non-tradable shares to be traded on the stock market could enhance corporate governance and enable the state to divest non-tradable shares for substantial funds. However, the issue arose that non-tradable shares outnumbered tradable shares on the market. Hastily introducing non-tradable shares to trading would instantly flood the market with stocks from all listed companies, inevitably resulting in a stock market collapse.
Indeed, since the early 2000s, when the central government first broached the topic of trading non-tradable shares, this issue has loomed over the Chinese capital market, causing continuous declines. It was against this backdrop that the first "State Nine Principles" emerged in 2004. The crux of this document was to initiate a bull market, during which each non-tradable shareholder of listed companies would gradually compromise with tradable shareholders, exchanging the right to convert non-tradable shares into tradable ones. Understandably, during a sustained market rise, removing the looming threat became easier, and tradable shareholders became more amenable to compromise. This bull market commenced in June 2005 and concluded when the subprime mortgage crisis erupted at the end of 2007. To address this crisis, the Chinese central government introduced the renowned "Four Trillion" investment plan, channeling substantial bank credit funds into real estate, infrastructure, and related industries. China's macro leverage ratio (debt/GDP) soared rapidly, setting the stage for the 2014 "State Nine Principles."
In 2014, the central government faced a scenario of slowing economic growth, with the old economic growth drivers propelled by a substantial amount of debt (real estate, infrastructure, exports) gradually losing momentum. Continuing to stimulate the economy through bank credit would undoubtedly bolster short-term economic growth but further elevate the macro leverage ratio, potentially triggering a financial crisis. In this context, in May 2014, the State Council reintroduced the "State Nine Principles," aiming to launch a bull market and direct residents' savings into the stock market (direct financing) instead of through banks (indirect financing) to provide financing for enterprises. This approach could not only foster economic growth without increasing debt but also provide financing for more small and medium-sized (private) enterprises through the newly established ChiNext board. Unfortunately, a substantial influx of funds from banks and shadow banks entered the bull market that commenced in July 2014, rapidly escalating the leverage of stock market funds (i.e., many investors borrowing money to speculate in stocks), thereby increasing the fragility of the stock market and the sustainability of the bull market. To illustrate, suppose an individual has 1 million RMB of personal funds and borrows 9 million RMB, totaling 10 million RMB invested in the stock market. A 10% market downturn would bankrupt this individual, necessitating the sale of 9 million RMB worth of stocks to repay debts. Borrowing to invest in stocks evidently accelerates market ascent, while selling stocks to repay debts accelerates market descent. Thus, a highly leveraged stock market is susceptible to sharp fluctuations. This bull market lasted less than a year, and the stock market commenced its decline on June 15, 2015, Xi Jinping's birthday, with the Shanghai Composite Index halving from over 5000 points in a short period. Since then, the index has fluctuated around 3000 points.
A decade later, the third "State Nine Principles" is launched amid: 1) Numerous Chinese banks still grappling with the aftermath of the 2008 economic stimulus, ensnared in the current real estate and local government debt crises. Until banks' balance sheets are fully rectified, bank credit's efficacy in propelling economic growth remains limited, and macroeconomic growth is elusive; 2) To counter various high-tech restrictions from Western nations, China requires independent innovation and robust development of so-called "new productive forces." Compared with real estate and infrastructure projects, innovative enterprises entail significantly greater risks, as investments may yield no returns or limited returns regardless of the amount invested. Financing methods such as bank loans, the simplest and most primitive form of "principal and interest guaranteed," evidently cannot accommodate such risks. Historical and international experiences indicate that financing for innovative enterprises relies more on equity financing.
In summary, with impaired bank balance sheets and many enterprises reliant on equity financing, the Chinese economy urgently needs to establish an "off-balance-sheet fund circulation" outside the banking system to channel residents' savings to enterprises, supporting the development of China's new productive forces. This implies that the Chinese government is poised to initiate another bull market, the true purpose of this year's "State Nine Principles."
It is noteworthy that the new bull market will also aid in resolving the current local government debt and real estate crises in the Chinese economy because: 1) A substantial portion of tradable shares on the stock market are state-owned. As the stock market surges, the market value of state-owned shares will rise, allowing the government to generate substantial funds by reducing its market holdings, selling state-owned shares to private enterprises, or pledging them as collateral to banks, thereby alleviating the current debt crisis; 2) The essence of the real estate bubble lies in the excessively high ratio of housing prices to household income, which is unsustainable. China's stock market comprises a large number of retail and fund investors. During a bull market, many investors realize investment gains, leading to an increase in household income and a reduction in the ratio of housing prices to household income, thereby mitigating the real estate bubble.
Unlike the previous two iterations of the "State Nine Principles," this year's version not only aims to kickstart a bull market but also contains substantial content regarding the regulation of participants and regulators in the Chinese capital market. These recommendations will have profound implications for the market. Historically, the Chinese stock market, established in the early 1990s, primarily aimed to facilitate financing for state-owned enterprises. The 2004 "State Nine Principles" addressed the issue of trading non-tradable shares, a legacy problem as China transitioned from a planned to a market economy. In 2014, the "State Nine Principles" aimed to expand direct financing, especially for small and medium-sized private enterprises, with non-tradable shares and ownership ceasing to be issues. In 2024, the focus shifts to transforming the Chinese capital market from a financing-centric entity into a modern market that also prioritizes investment. Notably, the capital markets of Western countries underwent a similar evolution, starting from chaos and gradually improving over time.
Although I have mentioned the impending arrival of a new bull market several times in this article, I believe investors still need to exercise patience. The onset of a bull market requires ample market liquidity, along with relative stability in macroeconomic conditions and expectations, which are not yet evident. China's stock market has just emerged from a crash and needs time to recover. Perhaps, in the near future, improvements in macroeconomic data, the convening of significant meetings, the introduction of unexpectedly positive reform plans, or the implementation of stimulus policies will herald the long-awaited bull market.
China reveals it executed scientist for spying in 2016 in documentary about ‘shocking’ cases
South China Morning Post
A Chinese scientist, Huang Yu, who was convicted in 2015 of selling state secrets to foreign spy agencies, was executed in 2016, according to a new documentary produced by the Ministry of State Security. The documentary also revealed new details about a former researcher from Taiwan who had been stealing secrets from mainland China while based in the Czech Republic.
Singapore’s Lee Hsien Loong will hand over power to deputy Lawrence Wong on May 15
South China Morning Post
Singapore's Prime Minister Lee Hsien Loong is set to hand over power to his deputy Lawrence Wong on May 15, marking the country's third leadership transition since gaining independence in 1965. Wong, who became deputy prime minister in 2022, was not the original choice to succeed Lee, but gained popularity as co-leader of the government's Covid-19 pandemic task force. Wong, who is also finance minister, will be sworn in on May 15 and is expected to lead the ruling People's Action Party (PAP) into elections due to be held by November 2025. The transition has been marked by unexpected twists, including the ruling out of another deputy prime minister, Heng Swee Keat, for the position. Wong's tenure as anointed successor has been relatively short compared to previous leaders. Wong and his team will face a tough electoral season, as there is a growing appetite for political opposition in Singapore. Wong will also face challenges on the foreign front, as he does not have extensive connections with emerging Chinese leaders or other global heads.
Apple announces investment in Vietnam as Tim Cook visits Hanoi
Al Jazeera
Apple CEO Tim Cook has announced plans to increase spending in Vietnam during his two-day visit to the country. The tech giant already has a significant presence in Vietnam, with suppliers such as Luxshare, Foxconn, Compal, and GoerTek operating factories there. Apple has spent nearly $16 billion through supply chains in Vietnam since 2019 and has more than doubled its annual spending in the country during that time. Cook's visit comes as the US seeks to boost Vietnam's position in the global tech supply chain as part of efforts to reduce dependence on China.
South China Morning Post
A student from China, Cheng Yixuan, was killed in a knife attack at a shopping centre in Sydney, Australia. Cheng was chatting happily on the phone with her fiancé just moments before she was stabbed. Five other people were killed in the attack and eight others were injured, including a nine-month-old baby. The attacker, Joel Cauchi, suffered from mental illness and was shot dead by police. An investigation is being conducted to determine why all of the victims were women.
U.S.-China fight over manufacturing subsidies just getting started
Nikkei Asia
US Treasury Secretary Janet Yellen’s recent visit to China highlighted the impending clash over China’s surplus industrial production. China’s policymakers are using massive state subsidisation to boost the manufacturing sector, however, this excess production will inevitably impact the global market through artificially low prices. The US is becoming increasingly aware of the negative effects of cheap imports from China, and both President Joe Biden and former President Donald Trump would be inclined to respond with retaliatory tariffs. An escalation of the US-China trade war is likely, irrespective of the US presidential election outcome.
U.S. urges transparency over China-backed canal in Cambodia
Japan Times
The US is calling for greater transparency from Cambodia over a proposed $1.7bn canal project funded by China. The Techo Funan Canal, which will stretch 180km from Phnom Penh to the province of Kep, has raised concerns that it could be used to bolster China's military presence in the region, posing a potential security threat to neighbouring countries such as Vietnam. Construction on the canal is due to begin later this year after China Bridge and Road Corporation won the contract to develop it during a Belt and Road initiative summit in October 2019.
Solomon Islands’ elections could impact China’s influence in the South Pacific
Associated Press
The Solomon Islands will hold its national election on Wednesday, with current Prime Minister Manasseh Sogavare seeking an unprecedented second consecutive term in office. Sogavare previously switched allegiance from Taiwan to Beijing, leading to fears of China gaining a naval foothold in the South Pacific. There are concerns that the electoral process could ignite violence in a nation affected by ethnic tensions, poverty, and youth unemployment. Observers suspect that China will back more than one pro-Beijing candidate in an effort to solidify its growing influence in the region.
Scholz welcomes Chinese cars but asks 'fair' competition
Deutsche Welle
German Chancellor Olaf Scholz has said that Chinese cars would be welcome on the German market. However, he warned against the use of unfair trade practices and called for competition to be fair, with no dumping, overproduction or copyright infringement. Scholz’s comments came during a three-day visit to China, during which he is accompanied by executives from German firms including BASF, BMW and Mercedes-Benz. Scholz’s visit comes as the European Union considers punitive tariffs on Chinese electric cars.
China Vanke says well prepared to resolve liquidity problems, denies travel ban imposed on officials
South China Morning Post
China Vanke has denied allegations that the company's majority shareholders were diverting assets amid concerns about its liquidity. The company also denied travel restrictions had been placed on key managerial staff. At a meeting on Sunday, the developer told investors it had plans to stabilise operations and cut its debt load, and would "properly resolve these short-term pressures". The company's chairman and president said it was confident about its plan to reduce debt by CNY100bn ($13.8bn) by next year.
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