Journal of International Affairs

Securities Markets and China's International Economic Integration

By Solomon M. Karmel *

In 1995, China was ranked by the World Economic Forum's Competitiveness Report for the first time. The report found that China was second in capital formation, behind only the United States, and that China's growth in gross domestic product (both overall and per capita) was highest in the world. Nevertheless, with its large state sector and arcane, protectionist regulatory structures at every level of government, China finished 34th out of 48 ranked nations in overall competitiveness. With respect to its underdeveloped financial markets, the subject of this paper, China ranked 46th out of 48 and last in terms of stock capitalization. 1

Throughout Asia, the corporate sector relies more heavily on bank finance and on internally generated funds and less on equity than in Western markets. Still, China's inexperience with corporate equity is extreme, and far more than elsewhere the result is that firms are weakened by a dependence upon banks (in this case officially sponsored banks) and fragmented, inefficiently utilized domestic markets for capital. According to a study by the World Bank, in terms of its value in the overall gdp of the national economy, stock market equity is less important in China than in the economies of every other major East Asian emerging market (Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore, Thailand). 2

As if this were not bad enough, the equity markets that now serve Chinese companies are awash in problems. The Chinese government, in its winding, long march from socialism, began permitting state-owned enterprises to issue stocks in the second half of the 1980s. Yet a decade later, foreign commentators describe the exchanges as plagued by "volatility, scandals, regulatory weaknesses, a limited choice of listed firms and a void of reliable information." 3

After a brief period of securities experimentation resulting in depressed markets and some justifiably negative press, can the government claim any successes in its new securities markets?

It is true that China's securities markets are nascent, poorly regulated and plagued by irregularities, some of which will be outlined here. However, a close look at the markets suggest the serious attention they are given by China's top leaders, by Chinese managers and by millions of domestic investors. 4

This article argues that despite significant problems, there is one other group -- beyond the government, the state enterprise managers and the 10 million Chinese investing in the most prominent markets for equities -- that should take a more serious look at China's securities markets: international analysts of China's political economy. If one includes China's securities issued and traded outside  of the officially sanctioned exchanges in Shanghai and Shenzhen, the securities markets are large, and their precipitous rate of growth is helping to fuel the Chinese economy. This article argues, moreover, that these markets are a significant force pushing China's integration into the world economy.

Some background information on China's securities reforms is provided below, followed by an outline of the problems that the Chinese government must face in order to enhance the viability of its markets. Next, the article examines, despite the peculiarities of "capitalism with Chinese characteristics," the growing importance of Chinese securities markets. Finally, it focuses on how, as the Chinese government struggles to reform the weaknesses of equities markets, it is being pushed slowly into further economic integration with international capital. The conclusion attempts to assess the consequences of this "peaceful evolution" and the increasing international economic interdependence between China and its trading partners.

Background to the Chinese Securities Markets 

China possessed small stock markets for Chinese stocks from 1911 to 1949, but Mao Zedong shut down all of them (outside of Hong Kong) by 1952. Mao permitted some national domestic bond issues in the first decade of his rule, but he considered corporate ownership through equities to be anathema to the Communist program. He essentially ended all private ownership of means of production by the Great Leap Forward (1959 to 1961). Encouraging profit earned against the government, through bonds issued by state corporations or the treasury, similarly was regarded as counterrevolutionary by the Cultural Revolution. Hence, through much of Mao's reign (the mid-1960s to 1976), for ideological reasons no stocks or bonds were issued by the central government, its bureaus or government-controlled work units.

Under Deng Xiaoping, the government hesitantly promoted new securities markets, first as a modern means to provide domestic and international loans to the treasury, and then in order to revitalize ailing state industries. The State Council issued National Treasury Bonds (guokuzhai) in 1981 and continuously thereafter. Several other kinds of national bonds followed, including bonds issued by the Ministry of Finance (bonds for key construction projects and finance bonds starting in 1987 and 1988 respectively) and bonds issued by several other national bureaus and organizations. 5

The value of bonds now fluctuates according to supply and demand, and interest rates (both on bonds and at the banks) are regulated, but at least partly driven by market forces.

When the futures trade in treasury bonds was introduced by the Shanghai Stock Exchange from late 1992, several domestic exchanges throughout China traded in "T"-bond (treasury) futures. However, while some would argue that China's interest rates are overregulated , the T-bond futures markets clearly were underregulated . Due to several associated problems (overspeculation, heavy losses for some companies and government bureaus, misuse of government funds), the government closed down T-bond futures trades in May 1995. 6

Without government sanction, isolated enterprises started to issue securities -- at first all bonds, although not always named as such -- as early as 1981. At the beginning of 1987, the public market for enterprise securities exploded. Organization representatives and even some ordinary investors began trading these securities in greater numbers, often outside of government regulations and without an officially approved exchange floor.

At the end of 1990 and the beginning of 1991, the Shanghai and Shenzhen Stock Exchanges opened, with official approval. Of the two exchanges, the Shanghai Exchange is by far the largest. It trades more than 200 treasury bonds, stocks and funds, with nearly 600 members and a trade network covering perhaps 300 mainland cities. In 1996, it plans to move its trading floor to Pudong, a business district of Shanghai, and the new trading floor will be twice the size of that of the Tokyo Stock Exchange. The Shanghai and Shenzhen markets together listed a combined total of over 300 companies by the end of 1995, with almost two-thirds listed in Shanghai. 7 In addition to the growing volume of legal trading since 1991 in other approved investment houses that report transactions to Shanghai and Shenzhen and illegal trading (in unsanctioned street markets) has also grown all over China.

In the official markets, China offers three types of shares. "A" share listings are for Chinese investors; companies that are joint ventures are allowed to sell "B" shares to foreigners, and these are also traded on the exchange. B share prices are quoted in yuan, but transactions are settled in U.S. dollars in Shanghai and Hong Kong dollars in Shenzhen. (Some Shanghai officials have campaigned to abolish all residency and passport restrictions on A and B shares, but central authorities are unlikely to permit changes until the yuan is fully convertible.) Next, "H" shares are mainland company listings in overseas markets. Chinese enterprises have listed H shares in Hong Kong and foreign markets. 8

In addition to A, B and H shares, three other stock classifications (or complications) are created based upon type of ownership. First, all of the equity on the Shanghai and Shenzhen Stock Exchanges (both A and B stocks) is theoretically traded by and issued to "individuals," and millions of individuals have legally traded these publicly-issued stocks. Outside of these exchanges, individuals can also trade stocks, legally and illegally (on informal street markets), that are issued privately to employees, as rights and bonuses. Second, state shares owned by the "central government" are theoretically not legally tradeable under any circumstances. Third and finally, "legal person shares" -- also known as "institutional shares," owned by public and private economic organizations -- increasingly are openly traded, in formal and informal markets, despite frequent efforts to ban various kinds of transactions. For example, in December of 1990, China launched a Securities Trading Automatic Quotations System (STAQ) in Beijing. In China's tiny STAQ market, by the end of 1995, the institutional stock of 10 companies was traded openly and legally by computer. By the end of 1995, an even smaller National Electronic Trading System (nets) also permitted open trading of the "legal person" shares of seven companies. 9

In Chinese, touzi  (to invest) can be translated literally as "to toss capital," and this captures the seemingly wanton way that money has recently been thrown in and out of China's securities markets. China's stock indices reveal that the prices of securities have fluctuated wildly since the opening of the Shanghai and Shenzhen exchanges, as government organizations and citizens move billions of yuan in and out of these two flagship exchanges, sometimes on a daily or even hourly basis. In Shanghai, the index shot up dramatically in 1992, only to lose more than three-fourths of its value. The index then surged again in the first months of 1993, only to lose one-third of its value in May. After another peak in February 1994, the stock market index lost two-thirds of its value in only three months, and then remained comparatively depressed for over a year. 10 The index in Shenzhen represents smaller volumes of trade and equity, but the wild roller-coaster ride tends to follow Shanghai's, and, at the time of writing, has led to an even more debilitating slump. Neither market is for the faint-hearted.

Changes in recent years are designed to shore up the officially sanctioned stock markets and increase investors' (shaken) confidence in them.

China's first investment fund was born in 1991. These funds provide essential services for investors, many of whom are inexperienced and uneducated. Moreover, as in the West, many funds are required to hedge their bets and make investments in more stable securities (e.g., government bonds). They therefore help to add some stability to unstable markets. China's regulatory authorities are hoping to greatly expand the number and size of investment funds in the coming years. 11

China set up its securities administration in 1992 to monitor and control the securities industry and protect the interests of investors. In 1993, the administration was further vested with the power to supervise the futures trading markets, and in 1995 it supervised their closure. 12 Most recently, the status of the Beijing-based China Securities Regulatory Commission (CSRC) has been

upgraded. Previously, responsibilities of CSRC organization were shared between the Ministry of Finance, the People's Bank of China and the State Committee for Restructuring the Economy. The commission now is directly under the control of the State Council, the Chinese government's highest-ranking decision-making authority. 13

Since its inception, the CSRC has struggled to improve the management, accounting and disclosure of listed companies. By the end of 1995, the regulatory body had authorized 74 accounting firms, 172 law firms and 82 capital assessment firms to work for listed companies, standardizing their books and annual reports and helping to provide information to investors. 14

The trial listings of companies overseas began early in 1993. The first group of nine H stocks were all listed in Hong Kong. Of a second group of 22 enterprises selected for listing in early 1994, eight have been listed in Hong Kong at the time of writing, and, by the third quarter of 1995, three had raised cash abroad: Yizheng Chemical Fiber, Jilin Chemical and Northeast Electric Transmission and Transformation Equipment. Altogether, the companies have managed to raise several billions of U.S. dollars in capital. 15

The number of candidates earmarked for overseas listings is strictly controlled by the central government. The CSRC has so far assigned three batches of companies (38 in all) for direct listing on overseas exchanges, yet many have not yet been listed, due in part to a bear market for Chinese stock.

In the future, authorities hope to abandon the "short list" (which previously favored large state-owned enterprises) and focus more even-handedly on companies with healthy profit and loss accounts that fulfill a standardized set of requirements. 16 Yet already, listed enterprises are serving as important guinea pigs for China's international integration. Foreigners and overseas Chinese can assess domestic companies in order to invest in a portion of them, with shares purchased on world markets. In turn, China can gain more knowledge of international financing, accounting standards and disclosure rules through its overseas listings. By issuing stocks rather than simply borrowing money, Chinese corporate heads learn to raise money more competitively, and they gain skills which, generally, are at the heart of capitalism.

While it is hard to explain fluctuations (especially wild fluctuations) in any market, some explanations of the rise and fall of China's securities exchanges suggest a close link between the domestic stock indices and how China fares in deflecting international criticism on trade and other issues. Specifically, interest in Chinese B and H stocks tends to coincide with the direction of China's relations with the United States. Shares spiked higher early in 1993 in anticipation of the U.S. renewal of China's most favored nation trade status. They fell early in 1995 during a dispute over intellectual property rights and then briefly rose again after an agreement was reached; they fell once more after disputes over an American visit by Taiwan's president and the jailing of Harry Wu further upset bilateral relations. 17

Records in 1993 and 1994 also suggest a close, perhaps predictable link between the B share market and China's macroeconomic fundamentals, including the performance of the yuan and the retail-price growth rate. 18 Hence, China's ability or inability to promote healthy international relations and a healthy base for economic growth affects foreigners' willingness to seek a profit there through corporate securities. To the extent that China cares about these foreign investments, it is forced to acknowledge that domestic politics and international affairs are linked, whether officials like it or not.

Much of this historic outline focuses on the most publicized, sanctioned experiments in securities. Yet, the discussion below demonstrates that the most publicized developments in China's securities markets are just the tip of the iceberg, as millions of rural enterprises, Chinese-foreign joint ventures and private enterprises are also participating in stock reforms and "joint-stock" incorporation, often without the support of the central government and far from the public eye.

Indeed, by the mid-1990s, the securities markets, broadly defined, can be said to include (1) securities listed in centrally-backed securities markets, meaning the Shanghai and Shenzhen Securities Exchanges and the more obscure (but still centrally backed) bond and futures markets; (2) the securities of other state-owned companies that raise money outside of Shanghai and Shenzhen by issuing stocks; (3) the securities of rural, "joint-stock" enterprises that raise money, again outside of Shanghai and Shenzhen markets, by issuing stocks; and finally (4) the securities of private companies (divided up by two or more individuals based upon the percentages of capital and services provided). Hence, China's stock market reforms proceed both from the top down, with the government struggling to expand and regulate its flagship exchanges, and from the bottom up, with savvy individuals and local wheelers and dealers struggling to expand their business operations through bold, unsanctioned, and often successful experiments.

The more publicized reforms, from the top down, are beset by a litany of problems; the less-publicized reforms, from the bottom up, have been far more extensive and significant.

A Litany of Problems 

Foreign investors in China face problems typical of emerging markets: Foreign exchange is difficult to convert, political stability is uncertain, the government approval process for projects is slow and the regulatory environment is not transparent. 19

Another central problem affecting all financial economic reforms is that reform of interest rates lags behind other market reforms, and interest rates at banks do not reflect their true market value. Prices of most commodities have been freed and the yuan can be exchanged conditionally, but interest rates are still determined by the state. This means that the black markets that were once prevalent for currency exchange now dominate the capital market. To crackdown on borrowing, to cool off an overheated economy and to draw capital to the central government, Beijing's primary modus operandi is to raise interest rates forcibly throughout China; yet many domestic organizations can still borrow money at home and abroad at market or below market rates. Hence, Chinese financial institutions can earn an extra five percent interest by borrowing U.S. dollars from abroad and depositing them in Chinese banks, and many do so, legally and illegally. State-run or state-subsidised enterprises and banks also can obtain capital at low cost to spend on speculative bets. Even state organs such as the New China News Agency (Xinhua) have used loans given for other purposes to gamble in futures markets, and the possibility that such organizations will abuse market insider information is obvious. 20

Speculation with foreign capital combined with artificially high interest rates (set by the government) may be aggravating hidden balance-of-payment problems. China's foreign currency reserves increased by $30.4 billion last year, but only $5.3 billion was the result of a trade surplus. Much of the rest was capital, borrowed for infrastructural improvements and construction projects, that will have to be paid back. 21 Some recent figures suggest that China's total debt may have risen past $115 billion by the second quarter of 1995. This is largely because banks, provinces, municipalities and non-financial institutions have bypassed Beijing and raised long or medium-term international loans, often through bonds, often without approval. They issue securities such as commercial bills for a term of less than a year in overseas markets, and raise foreign funds at costs exceeding the benchmarks set in Shanghai. This enables them to fund projects stopped by the State Planning Commission. Hence, by using foreign capital (especially borrowing it) to fund domestic ventures, China may also compound its already troubling problems with deficits and inflation. 22

Foreigners and overseas Chinese who plunge into Chinese securities markets despite the macroeconomic problems face daily illegal and flagrant speculation. One new term associated with stock trading is you zhi  ("hot money"), which refers to speculative funds rushed in and out of securities, futures and commodities markets, sometimes only in a few hours, to seek high, short-term yields on wild fluctuations in daily trading. Much of this money is said to be illegal credit, but it is not clear what percentage of these transactions are entirely legal. "Stir frying" is the process of rapidly buying and selling, or simply speculating, often with hot money. These speculative activities have poisoned whole markets of the securities exchanges. For example, it was wild stir frying of hot money which prompted Zhu Rongji to temporarily suspend treasury bond futures trading in February 1995, and then to ban all trade in treasury bond futures for an indefinite period, starting 17 May 1995. Since then, China's "hot" stock exchanges have turned rather frigid, and weeks have gone by with little to report of national and international interest on the exchanges.

No one is sure how much hot money there is, but an estimate by the Chinese Academy of Social Sciences places it at 150 billion to 400 billion yuan ($17 billion to $46 billion). One Western source estimates that about 250 million yuan of the hot money rapidly circulates through the market on ordinary trading days. 23 The speculative money is said to originate mainly from state-owned enterprises, banks and foreign enterprises. State enterprises are apparently using bank loans designed for other purposes to play in stock and futures markets for high returns.

The CSRC has blamed hot money and "a string of serious treasury bond violations in just several months" in 1995 on lax supervision, makeshift rules, and inadequate risk forecasting on the part of the Shanghai Stock Exchange. 24 In general, the CSRC has functioned as a relatively progressive regulatory body that hopes to expand the size of securities markets while improving oversight, largely for the benefit of (wary) investors. Yet the CSRC is but one anemic government organization, assigned to regulate the favored pet projects of comparatively large and powerful national, provincial, and municipal government bureaus. The securities law first drafted in 1992 was never passed, and the CSRC must struggle to enforce many regulations which are merely "provisional." 25 Local governments in particular still have enough political clout to block actions against the companies in their cities that have violated "provisional" statutes.

Moreover, as a result of the "democratic centralism" that China's Communist party borrowed from Leninism, there are no checks and balances, and every bureau is supposed to engage in a little self regulation. Hence, it is often difficult to know who has responsibility for regulating particular aspects of the securities markets and why. While the highest regulatory authority is theoretically the CSRC, the most important regulations on stock exchanges often descend from Shanghai. The Shanghai municipal government has promulgated several laws and regulations, and the Shanghai branch of the People's Bank of China also appears to possess important regulatory authority, even though the CSRC no longer reports to the bank. For example, in August 1995, the Shanghai branch of the central bank closed 14 offices of out-of-town brokerages for violating rules on operations of financial institutions. The offices were said to be little more than shell offices that operated on an occasional basis to speculate in the local stock market. Yet, it is strange that the local municipal branch of the central bank wielded a heavy hand against the organizations of outside localities. Indeed, it is  strange that the enforcement of any national securities laws would be a legal responsibility of any regional government or financial institution. 26

The Shanghai Municipal government itself is heavily involved in the buying and selling of the securities of local companies, and therefore serves as a not-too-objective arbiter for regulations, listings and investment practices. For example, the Shanghai International Securities Company (SISCO), the largest securities trading house in China before the T-bond futures trading scandal in May 1995, was built up with strong support from Shanghai's local government. Shanghai International Securities became technically insolvent on 23 February 1995 when it lost more than $100 million speculating in bond futures, and its violations of rules in May were a repeat performance, leading it to sink further down a hole. These grave mistakes destroyed China's T-bond futures market. However, since the scandal the municipal government has sought to merge SISCO with another local firm, a firm which might also be linked directly or indirectly with the municipality's government. There have been limited criminal proceedings against former SISCO officials, but as usual "reorganization" serves as a substitute for bankruptcy. 27

Turning to Shenzhen, officials in that city are hoping to revitalize the local securities regulatory bodies. It is not clear if "reforms" in this direction would create more binding regulatory controls on China's second bourse, or if they would further undermine the national regulatory authority, the CSRC, in its competition with local organizations. Since the July 1994 arrest of the head of the Shenzhen Securities Regulatory Office apparently caught at the Hong Kong border, fleeing corruption investigations it is an understatement to say that the local regulatory authorities lack credibility. Shenzhen's government also hopes to revitalize the local exchange by buying local securities firms and expanding their operations. While this might work, it would aggravate conflict-of-interest problems like those outlined in the case of Shanghai. 28

Throughout China, an atmosphere of almost no clear divisions of power also permits insider trading information to be opened to a host of government officials. This is illustrated by the recently uncovered case of a high-ranking official, Chen Shuiwen, in central China's Hubei province, who was dismissed from his posts for illegal stock-trading and accepting large sums of money. In 1992, Chen used public funds to purchase stocks under his own name, and then took more money from public coffers and listed it as personal profit worth tens of thousands of yuan. The diverse sources from which he could have taken money, picked up information to engage in insider trading or protected himself from investigation demonstrates part of the problem of regulating a one-party dictatorship. Chen was concurrently a director of the provincial financial office, its Party group secretary, a provincial Party standing committee member, provincial government Party group member and vice-governor. In any one of his posts, he could have secured insider knowledge about the financial plans of the government and its companies, passed the knowledge onto a connection, used insider knowledge himself or "stir-fried" public money and publicly-owned and managed stocks under his name or someone else's for personal profit. The fact that this particular case was brought to light and publicized is not even a comfort to honest investors. The sums involved were petty, and it is clear that the use of hot money for speculation frequently involves hundreds of millions of yuan rather than thousands. 29 Was Chen singled out because his crime was significant, because, as a Hubei official, he was an outsider looking in or for other reasons wholly unrelated to the securities markets (e.g., a local power struggle that he lost to an informer)?

The Liberation Daily has reported that corrupt government officials regularly  launder money in the Shanghai Stock Market, and that these corrupt officials may be a central source of hot money. 30

After the trading scandals of February and May 1995, Shanghai's brokerage houses owe triangular debts to each other of billions of U.S. dollars. One Shanghai paper suggested that the suspension of trading in treasury bond futures, and the suspension of the largest and most overextended brokerage house (Shanghai International) from underwriting contracts, may in fact have been a means to protect and regroup mismanaged companies, while shutting others out of the market and limiting the Chinese reform process. Asked the Business News Daily  of Shanghai, in a direct criticism of the government after the scandals of 1995: "Frequent use of administrative means to interfere in the market is really not good policy. Why shouldn't administrative measures be replaced by strict laws and rules?" The paper goes on to argue that China decided to close bond futures trading completely simply because some (public) organizations made miserable investments; this pun those who played by the rules, who faced extraordinary market risks, and who still survived intact. 31

Chinese state companies are slowly reforming, but those foreigners who invest in corporate bonds and stocks face a host of problems particular to Chinese companies and their highly unusual, "separate but equal" (A, B and H; individual, institutional and state) securities.

One article in a Hong Kong paper discusses the baffling divergence in the price of A shares and H shares issued initially for the same value by the same company. It may be explained largely by the fact that foreign investors have a variety of investments to choose from, and even in Hong Kong, H shares from the mainland form a minimal segment of most public and private investment portfolios. By contrast, Chinese investors have fewer legal opportunities to invest their savings, and the scarce A shares can therefore sail past the value of their H share equivalents listed in Hong Kong and abroad. 32 Similarly, the prices of B shares used to be higher than those of H shares, but are now lower. They are likely to rise when A and B shares are combined, but at present they are trading well below their renminbi counterparts. This is true despite the fact that some domestic investors with dollars are already buying B stocks in violation of the "separate but equal" rules. 33

Again, most "individual" stocks can be traded freely; "legal person" shares (owned by institutions such as companies and local government organizations) sometimes can, and sometimes cannot, be legally traded; 34 state shares (owned by the central government) are not supposed to be tradeable, but the bureaus that "own" the stocks ultimately report to the same leaders who regulate the markets. With large quantities of hot money trading hands on a daily or even hourly basis, it is not clear whether regulatory authorities have the skill, the will or the strength to monitor who is buying shares and how and where various kinds of shares took off and landed.

Dai Xianlong, governor of the People's Bank of China, stated in 1995 that the full convertibility of the yuan might occur around 1997 or 1998, which might permit the entry of foreign capital into the A share market and the replacement of A and B shares with a one-domestic share system. 35 For the moment, though, the restrictions on currency conversion and the curious divisions on shares lead to market irregularities found nowhere else in the world.

Other problems plague Chinese companies. Despite accounting reforms in Chinese companies, Chinese accountants tend to change standard cost structures only every two or three years in an environment of rapid inflation. Hence, the costs of production tend to be substantially underestimated. Also, depreciation and obsolescence are often not acknowledged, and with high inflation this problem is compounded. Finally, the ownership of property is not well defined, and any property (e.g., schools and apartments that cannot be sold and make no profit or moribund machinery) can be listed as an asset, even if it is essentially a liability. 36

Even many "reformed" companies that are selling stocks to domestic and foreign investors are insolvent and unable to pay their bills. Indeed, at least 10 of the 34 companies selling B shares in Shanghai in the spring of 1995 were said to be technically bankrupt. 37 Meanwhile, China's big four commercial policy banks are now top-heavy with bad or non-performing debts because they have been used for years as a lending arm of the government, providing credit to bankrupt state enterprises. 38

One Chinese financial newspaper, the Financial News , has criticized Beijing for its "Great Leap Forward" approach to expanding the stock markets, and makes the point that expansion for the sake of expansion is not necessarily a market reform. The paper charges that there are no uniform standards applied for a stock market listing. Some companies are huge, while others have only a few million outstanding shares. More importantly, there is a large discrepancy in the quality of listed companies. 39

In the most publicized stock experiments in Shanghai, Shenzhen and abroad, questions such as who can list stocks, where the stocks will be floated, what shares will be issued and how much money can be raised still are decided not by the companies but by government leaders. Hence, these market reforms still proceed to some extent through guanxi  (connections), and not as a result of the objective strengths of companies.

On many days, the unhealthy investment environment creates a painfully dull market at the stock exchanges, in which wild speculation is replaced by paralysis. About one-third to one-half of the dollar-denominated stocks in Shanghai do not trade on any given day. 40 This unbelievably "low liquidity" is reflected in new, comic rules, unveiled on 19 June 1995 by the Shanghai Stock Exchange, which ban brokers from drinking, smoking, gambling, knitting sweaters and sleeping on trading floors. 41

Beijing is not ready to permit "hostile" takeovers of domestic firms by foreign companies, and even some "friendly" takeovers of high-profile, non-state enterprises have been blocked by the authorities. For example, China Strategic, a Hong Kong-based firm headed by an Indonesian businessman, offered to give $46.5 million in shares to the Stone Group of China in exchange for a 57 percent stake, then valued at only $40.5 million, in a major Stone subsidiary (Stone Electronic Technology). The government in Beijing blocked the sale. 42 Government shares (owned by central and local government organizations) account for at least 60 percent of the shareholding in most companies listed in Shanghai and Shenzhen. For the moment, then, these corporate reforms stop short of complete privatization. 43 Hence, while China is ready to permit "denationalization" of state enterprises, their total privatization, and outright sale to foreigners, is often still blocked by a nationalist and protectionist government, which is still the majority owner of most listed enterprises.

Disclosure in Chinese companies is said to be minimal, even with respect to a crucial question for any capitalist investor: How will capital be used? Tsingtao Brewery received a great deal of bad press when it failed to disclose that it diverted funds from a recent public offer to third-party loans. Similarly, Shanghai Petrochemical used $265 million in securities to repay bank loans denominated in foreign currency, and only $25 million for capital expenditures emphasized in the issue. As a result of the lack of disclosure and many unpopular investment decisions, H shares have lost favor with many fund managers in Hong Kong, and their performance has been poor. 44

As if all of this were not damning enough, foreigners who still hope to buy stock in the "flagship" exchanges of Shanghai and Shenzhen may face excessive red tape. One reporter visiting a Chinese investment house discovered that there was a maze of forms, fees and hidden barricades one had to traverse to buy B stock. Stops in the maze included a $24 fee to open an account and a $20 minimum commission on every trade. Four other fees included a stamp tax and a stock exchange fee. The investment house provided no information on how portfolios were performing; there also appeared to be an unspoken, minimum investment exceeding $1,000, with smaller orders not processed.

The B share markets for foreigners in Shanghai and Shenzhen had raised only $3.5 billion by the third quarter of 1995. This represents only seven percent of the two markets' total stock capitalization ($47 billion, including both A and B shares), and is a mere 1/50th the size of the comparatively open, $280 billion "emerging" market in Hong Kong.

So why keep an eye on the market?

The Actual Size and Potential Size of the Markets  

The debilitating problems of China's markets for government and corporate securities have received enough bad press to quash interest from all but the most comfortable and courageous outsiders. Yet the perpetual news about market problems often obscures the fact that these markets, despite their flaws, have attracted millions of increasingly cash-rich domestic investors who are the market's primary source of strength. More importantly, if one studies all  securities experiments in China, including those that fall outside the markets for state bonds and corporations listed in Shanghai and Shenzhen, one discovers that securities markets in China, broadly defined, are huge and growing yearly. Unapproved securities and securities in non-state enterprises are often ignored in articles on China's securities markets, 45 but in many ways they provide the most dramatic histories of reform.

Even at the top, overall sales in treasury bonds have grown fivefold in two years, from 30 billion yuan ($3.5 billion) in 1993 to 150 billion yuan ($17.4 billion) by the spring of 1995. 46 Foreigners are underwriting and buying many of these bonds.

National treasury bonds are now only the most prominent part of the increasingly diverse bond market. Government bond sales are also conducted by local governments, especially rich governments such as those in Shanghai and Guangdong, where China's stock markets and investment houses have set up shop. Shanghai has revived its reputation as a major financial center as its municipal GDP has exploded. The financial sector in the municipality grew at an annual average rate of 18.1 percent from 1992 to 1994, accounting for almost 11 percent of Shanghai's gross domestic product in 1994. Much of this growth was fueled directly through the issuance of bonds and stock. From 1992 to 1994, by issuing various securities, Shanghai raised $5 billion in bank loans. More than 120 foreign financial institutions in Shanghai introduced $3 billion in foreign funds in 1994 alone, a figure roughly on par with the amount of foreign funds that all of Russia attracted the same year. In all, by the third quarter of 1995, China had issued bonds of all kinds worth 780 billion yuan ($90.26 billion).

Again, the Shanghai and Shenzhen securities exchanges together have a combined capitalization of about $47 billion, on par with older markets in Argentina and Indonesia. 47 These markets are growing much more slowly in the mid-1990s than in the early 1990s, yet this is in part the result of depressed prices for stocks in a bear market, not conservative predilections of leaders.

More dramatic changes are taking place at a distance more remote from the public eye. Aside from the national bonds and the approximately 200 state enterprises that have been permitted to list stocks on the prominent domestic exchanges, by 1994 sources claimed that (1) 11,560, (2) 13,000 or (3) over 13,000 state enterprises had conducted shareholding experiments, with perhaps 25 million shareholders. 48 Many of these non-listed companies have issued stocks to investors without approval from the CSRC and without the involvement of China's two official securities exchanges. Domestic organizations, domestic private investors and foreigners invest in many of these firms by forming joint ventures. Many investors, especially from Hong Kong, buy up a percentage of state enterprises through agreements negotiated outside the stock markets. Agreements arranged outside the stock markets may contain strict clauses on the trading of shares, but many are similar to ordinary stock sales and transactions.

Far more state enterprises are likely to become joint-stock companies in the coming years, because Beijing's cash-strapped government will be forced to accept new funding methods for bankrupt firms. China's economic czar Zhu Rongji is reportedly considering auctioning off tens of thousands of medium- and small-sized state-owned enterprises when the price is right. This would enable a majority of them to be sold as joint-stock companies to the highest bidders. 49 In those state companies that already have become joint-stock joint ventures, the state's share of control over the firms is slipping, as companies issue new stocks that the government cannot afford to buy. In listed companies, the decline in the percentage of shares owned by the state often exceeds 10 percent per year. 50 Hence, the influence of outside investors (foreign and domestic) on state firms is likely to continue to increase in the coming years.

Some 13,000 state enterprises, moreover, are still not near the bottom of the iceberg. State enterprise reform is proceeding much more slowly than the reform of village and township enterprises. These "rural" enterprises (begun in areas officially classified as rural, but now located in both rural and urban areas) were created at local levels as a means to tap the enormous labor market and increasingly large capital reserves of rural and suburban China. They have been essentially free from most central government control (and support) since the beginning of Deng's reign, and as a result they are among the most efficient industrial organizations in China. Moreover, village and township enterprises are now responsible for the majority of the industrial production in China. Perhaps it should be no surpise that the most wealthy and technically advanced among them are conducting joint-stock experiments.

By 1993, there were over two million joint-stock village and township enterprises, and one politburo member would permit all  of the 19 million township enterprises to issue securities in the coming years. 51

In developed, rural regions, joint-stock enterprises have replaced more traditionally run collectives as the mainstay of the industrial economy. For example, 1,071 joint-stock companies had been established in Shenzhen's rural areas by the end of 1993, with a total capitalization of 1.1 billion yuan. 52

It is also fair to label these advanced shareholding experiments as "privatization." In the Shanghai municipality, private shareholders are the largest creditors in af2,993 joint-stock "rural" cooperatives. Of a total of 1.46 billion yuan in shares that had been issued by rural collectives by the end of 1993, 68 percent were held by individuals, including the 115,000 employees of these organizations. 53

Often by buying and selling shares, rural enterprises are quietly buying up state-owned industries. This enables the rural enterprises to gain economies of scale and connections and leads to the further spread of reform into state industries. "Legal persons" (any officially sanctioned national, local, industrial or corporate intitution, including foreign-invested ventures) now own an average of 45 percent of joint-stock companies that are nominally owned by the central government, and many of these "legal persons" are village and township enterprises, with limited ties to national or local government bureaus. This 45 percent is often listed as "government-owned," with the government broadly defined to include rural organizations; but de facto this means that 45 percent often the largest piece of the pie is no longer controlled by the center.

Similarly, foreign-funded joint-venture projects help to modernize rural industrial zones and make "rural" industries not only national, but also international. By 1994, 4,900 village and township enterprises in rich Suzhou had attracted foreign investment. Half a billion U.S. dollars in investment were promised to rural industries in the municipality in the first three quarters of 1994 alone. 54 According to one study, the townships in the most developed regions of southern Jiangsu have an average of ten foreign-funded enterprises each. 55 The foreign funds are sometimes delivered in the form of loans by foreign firms or bonds offered to foreigners, but they are often administered through stock-sharing agreements that provide foreigners with 50 percent ownership or more in joint-venture projects. Again, as local organizations struggle to compete for overseas capital, they are drawn closer to foreign accounting and managerial standards; they begin to resemble more closely foreign firms; and they grow more distant from the organizational structures of the most inefficient and unreformed central government "work units."

Finally, in some rapidly changing cities and towns of coastal China, private enterprises have begun to dominate local industrial production. Many of these business are "mom and pop" companies with few international connections, but others are seeking foreign funds and foreign partners for joint-venture projects through their own stock experiments, with primary owners generally determined by who invested the most money in the start-up project.

In Guangdong, China's richest province, the number of non-state enterprises (private, joint ventures and foreign funded) already far surpasses the number of collective and state enterprises. Partly with the help of a massive foreign infusion of capital into the most autonomous enterprises, the registered capital of all non-governmental businesses in Guangdong (private and foreign-funded) passed that of state and collective businesses in 1992. There were 1.2 million individual, commercial enterprises in the province in 1992, with a registered capital of 264.7 billion yuan and 6.3 million employees. 56 The private businesses still comprise less than half of total industrial production in the province, yet provincial leaders are hoping for 50 percent private production by the year 2000. Because 50 percent of registered capital is already at least partially in private hands, the goal seems quite likely to be achieved. Meanwhile, Guangdong already has 200 "millionaire" private businesses, and the owners of these businesses are themselves diversifying their capital holdings through national and local stock purchases. 57

While the size of China's securities markets is already substantial, proposed reforms, if carried out, would benefit both foreign and domestic investors and expand the markets further.

A new law on treasury bonds, to be submitted to the standing committee of the National People's Congress this year, will supposedly address problems in the trading of treasury bonds and treasury bond futures. 58 China's commodities futures exchanges will be required to stop making profits and to operate on a membership system, according to Xinhua news agency. For the present, most of China's 15 commodities futures exchanges are profit-making companies that allow brokers to flout standard practices and pursue their own interests at the expense of investment capital that they have not personally generated or saved. 59

The People's Bank of China is drafting two parallel regulations on the management of domestic securities and treasury bond funds. By the spring of 1995, China had more than 80 funds involving 6 billion yuan ($714 million), but with only four years of history behind the oldest funds, their investors and administrators lack experience. Moreover, only four of these funds had been approved by the central bank's head office. The regulations would concentrate on standardizing the funds and on clarifying the rights and responsibilities of fund sponsors, managers, custodians and investors. 60

Zhou Daojiong stressed in his first speech as China's top securities regulator, in the spring of 1995, that he would redouble efforts to implement securities regulations that are already in place but insufficiently enforced. He hoped to improve the quality of all listed companies, keep a closer eye on them after they reached the market and insist on better disclosure. 61

Some recent reforms, such as those lowering fees on stock purchases, are clearly designed to placate investors and make China's equity markets more attractive. For example, the Shenzhen Stock Exchange announced through Xinhua that it would sharply lower the charges of listing, trading, registration and service commissions as of 1 October 1995. Fees would be reduced by 60 percent, putting trading expenses more in line with Shanghai's exchange. 62 The Shenzhen Stock Exchange also merged with the city's registration company to reduce trading fees and make the market more competitive with that of Shanghai. Previously, investors, brokerages and listed companies had to go through a maze of procedures to register a company, gain rights to offer shares and transfer custody of shares.

China generally is encouraging more foreign investment through securities and is struggling to provide the consulting services to help inform foreigners about opportunities in the domestic market. For example, the Industrial Bank of the China International Trust and Investment Corporation (citic) hopes to develop an investment bank-style securities company. About 60 percent of the assets of citic are already in banking-related sectors. Yet, unlike ordinary consulting firms, the securities company would be involved specifically in working as an investment bank for overseas investors. 63

Mainland Chinese had saved around three trillion yuan (almost $350 billion) by the end of 1995, or 35 percent of GDP. The savings ratio is one of the highest in the world. 64 Official figures show that average savings of urban and rural households rose to 1,504 yuan in 1994 from 865 yuan in 1993. By the end of the first quarter of 1995, total urban and rural savings in state banks stood at 1.7 trillion yuan. 65 Savings per person in the increasingly wealthy cities are far higher than average; Guangzhou, for example, has a per capita bank savings of some 10,000 yuan. 66 And rich cities provide the primary private investors for China's capital markets in Shanghai and Shenzhen. Thus, while millions of investors have already placed their money in Chinese securities, the potential for expansion in demand for these securities is clear. 67

The Foreign Connection  

China's "joint-stock" experiments with private foreign investors, surprisingly, have extended into industries and bureaus that, even in capitalist countries, are often entirely controlled by the public sector. China's infrastructural projects, for example, are increasingly funded through the stock markets. The largest expressway company in Guangdong announced plans to "go public" in 1995 with two share issues designed to help raise funds for key highways. The Guangdong Expressway Shareholding Company will be the country's first publicly quoted highway firm, and it plans to seek international investors. 68

China seems ready to seek foreign assistance as it "incorporates," not just state "work units," but also whole experimental districts of major coastal cities. Both "finance and trade zones" and "export processing" zones have sold stock to shareholders in Shanghai and Shenzhen. In fact, the Shanghai Lujiazui Finance and Trade Zone and the Shanghai Jinqiao Export Processing Zone were among the top performers in the Shanghai stock market in 1994. Similarly, areas designated as "rural" also are developing whole industrial or technological zones that have broken away from their parent companies and districts to form independent, rural, joint-stock entities. The stock markets are helping these special districts promote the primary goal of incorporation as districts and as companies, that is, increased exports and international trade.
It would be a loss of face if central government planners were shut out of the more exciting and profitable experiments with securities. Perhaps as a result, while joint ventures are usually negotiated outside of the securities exchanges of Shanghai and Shenzhen, central government officials have begun to permit them to form directly through these exchanges. Isuzu Motors and Itochu of Japan agreed late in the summer of 1995 to buy 40 million "legal person shares," or 25 percent of Beijing Lightbus, 69 in China's securities exchanges. According to the agreement, Isuzu would take a 15 percent stake in the Chinese company, becoming the second-largest shareholder after Beijing Si Da Tour Bus Co., which holds 19 percent. Itochu would hold 10 percent. 70

The Ford Motor Company's buyout of 20 percent of a Chinese light truck manufacturer was similarly described by some watchers of China's financial reforms as groundbreaking. By securing 20 percent of of the truck company for $40 million through the purchase of 80 percent of the B shares, Ford "may have shown the way for other foreign companies" hoping to create joint ventures with Chinese firms without painstaking negotiations with a host of bureaus. Ford's agreement entitles it to three members out of nine on the truck company's board, and five senior managers, including an executive vice president. 71

Similar joint ventures have formed with approval at very high levels, in public trades outside of Shanghai and Shenzhen. Late in 1995, shareholders of Hainan Airlines approved a sell-off of 25 percent of the airline's stock (which is traded on China's new STAQ system) to an American Aviation Investment Fund backed by George Soros. 72

To respond to the demand of foreign investors who wish to increase their capital presence in China, in 1995, Morgan Stanley launched a joint venture bank, China International Capital. The bank will deal in treasury bonds, B shares, fund raising, and management. Bank authorities hope to eventually have access to business in A shares. 73 Many other international investment banks have set up branch offices in Shanghai, Shenzhen, and Beijing with similar hopes. Meanwhile, the Shanghai Stock Exchange hopes to spark more interest with ambitious plans for market expansion. Shanghai hopes to expand its foreign exchange trade at an impressive rate of 30 percent annually through the end of the 1990s. 74

Other investments in companies listed domestically or internationally are made indirectly, through an increasing number of overseas funds. At least seven mutual funds specializing in Chinese stock or companies are available to international investors. 75

In all, in 1994, foreign investors pumped about $35 billion into China, making it the world's second-largest recipient of foreign capital. 76

Partly with the goal of attracting foreign capital, China is increasingly struggling to match international corporate standards. Some reforms even create carbon-copy laws to those that exist in overseas markets. For example, the China Securities Regulatory Commission has based some of its most recent regulations for Mainland listings in Shanghai and Shenzhen on Hong Kong's regulations for Mainland shares (H shares) listed in Hong Kong. Now, as in Hong Kong, underwriters on the mainland will be responsible for helping companies to reorganize their assets and accounting standards, to draft their articles of association, and to produce annual financial statements. The sponsors essentially act as the companies' principal channel of communication with the exchange and the public. The regulations are designed in part to ensure that companies seeking listings understand fully the responsibilities of floating stocks. In 1995, China also signed similar, cooperative regulatory agreements with Singapore and the United States. 77

Other new reforms in mainland commercial banking laws are in line with U.S. banking laws. Under the new Commercial Banking Law, which came into effect on 1 July 1995, commercial banks must separate their core banking business from non-bank financial activities such as insurance, trust and investment funds and securities. The big four state banks -- the Industrial and Commercial Bank, the People's Construction Bank of China, the Bank of China and the Agricultural Bank of China -- have taken the lead in dismantling their trust and securities arms. Hopefully, this will serve to stabilize the markets for future investors by limiting the insider knowledge possessed by the organizations that control China's largest liquid asset reserves, and by preventing massive speculative shifts in bank investments. 78

China is seeking foreign partners for further instruction on how foreign securities markets work, to encourage the development of markets that are both more vibrant and more internationally compatible. The National Association of Securities Dealers (NASD) of the United States, the organization that runs NASDAQ, has signed an agreement with the Shanghai Stock Exchange to provide expertise and advanced technology for Shanghai's emerging securities market. According to the agreement, signed in Washington in July 1995, NASD will assist the Shanghai Stock Exchange to build a self-regulating mechanism, draft listing regulations, conduct investigations and enforce disciplinary procedures. It will also supply computer hardware and software and provide advice on market supervision and legal issues. 79

To placate the anxieties of foreign investors, China claims that quality and liquidity will be more important criteria in approving new issues of shares specifically designed for foreigners (B shares) than in the past. With many investors especially wary of Shenzhen's market as the smaller of China's two markets, the Shenzhen Securities and Exchange Commission must work that much harder to generate foreign interest. As a senior official at the exchange claims: "From now on we will stick to two directives, good quality and high liquidity, in allocating B share quotas." 80

At a conference in Paris in July 1995, China became the newest member of the International Securities Administration, and participation in this body may facilitate further awareness of international expectations and regulations, as well as further efforts to match these international standards. 81

Conclusion: Equities and China's Prospects for International Economic Integration  

Despite all the debilitating problems in China's securities markets, the background information above suggest that they are rapidly growing in importance. The government also accepts that many of the problems in China's markets hinder China's long-term growth prospects, and it is struggling to reform the markets from the top down. This struggle has led to important reforms and promises of more dramatic change. As it struggles to change and to appeal to the needs of foreign and domestic investors (i.e., investors China increasingly values), the government moves China further on a "peaceful evolution" toward more integrated capital markets.

Meanwhile, change proceeds more rapidly from the bottom up. The companies of China's thousands of villages and townships, along with China's burgeoning private companies, all struggle to meet the demands of investors, domestic and foreign, in an increasingly liquid, increasingly large market for capital. Eventually, unreformed state enterprises, relying upon a bankrupt government, will need to enter this market for capital. Even the more reformed state enterprises that successfully prove their mettle in the central government's flagship exchanges will ultimately need to compete, not just with foreign companies, but also with other types of domestic organizations, struggling for capital in their own "joint-stock" plans that fall outside of government control. The means to succeed in this competition for capital, regardless of the label placed on a firm (originally state-owned, village-owned or privately owned), will not change. They include, in China as elsewhere, accounting practices that outsiders can understand, some degree of disclosure, up-to-date managerial practices, technological innovation and convincing proof of profits and future "marketability."

The stock markets help to make the Chinese government responsive to the complaints of domestic and foreign investors. If investors are unsatisfied with the direction of the Chinese economy, then they will choose to place their money elsewhere. Foreign capital flight can occur almost immediately. Domestic capital flight would be more complex and less complete; yet even private, domestic investors can place their money in investments, such as conspicuous consumption items, which the Chinese government regards as less productive for the reform process and the economy as a whole, than in securities markets. 82 Increasingly autonomous domestic firms, and even those of state-owned industry, can invest their money abroad by buying foreign firms, opening overseas plants or starting legal or illegal offshore "shell" companies.

While international and domestic capital flight is the "stick" threatening Chinese economic organizations, cash is clearly the carrot. A successful securities issue in domestic and overseas markets means an immediate influx of credit. In the long term, it means improved credit ratings in the eyes of international and domestic banks and suppliers, which these days is increasingly important to Chinese companies. 83 Both the carrot and stick wielded by domestic and foreign capital help to pry open governmental organizations -- with better disclosure and more transparent regulatory structures -- and help to make the government more responsive to outside scrutiny.

In short, Chinese leaders acknowledge that "the stock market has changed people's attitudes towards such concepts as capital, profit, bonus, risk, speculation, and investment." 84 Nevertheless, they continue to wage blustering crusades against Westerners and "bourgeois liberalization." However, if Chinese leaders hope to attract outside investors to their rapidly-growing markets for debt and equity, they realize that their bottom line will need to be market reforms, corporate reforms, further disclosure, superior regulation and, above all, profits.

Note *: The author wishes to thank the Naval Postgraduate School and the Center for Chinese Studies at U.C. Berkeley for support during the completion of this article. The opinions expressed are those of the author alone. Back.

Note 1: Simon Fluendy, "Mainland Starts to Climb World Ladder," South China Morning Post , 6 September 1995, p. 12. Back.

Note 2: Peter Montagnon, "E. Asia Bond Market Set to Triple," Financial Times , 26 June 1995, p. 4. Back.

Note 3: Sheila Tefft, "The Spread of People's Capitalism," Christian Science Monitor , 5 July 1995. Back.

Note 4: See also Solomon M. Karmel, "Emerging Securities Markets in China: Capitalism with Chinese Characteristics," The China Quarterly , no. 140 (December, 1994), pp. 1105-20. Back.

Note 5: Short, historical reviews of the development of China's bond markets under Deng Xiaoping are contained in "Article Predicts Bright Future for Bond Market," Liaowang , 9 (28 February 1994), pp. 10-11, in Foreign Broadcast Information Service (FBIS), Daily Report: China , 30 March 1994, pp. 33-35; and Alan P.L. Liu, "The Emergence of Chinese Capital Markets," Asian Survey , 31, no. 5 (May 1991), pp. 409-21; see especially pp. 411-13. Back.

Note 6: Liu Weiling, "Rules Planned for T-Bond Futures Mart," China Daily Business Weekly, 20 June 1994, p. 1 Back.

Note 7: "Shanghai: China's Largest Financial Market," Xinhua, 10 November 1995; Kathy Chen, "China Province Cracks Down On Curb-Side Trading," The Wall Street Journal Europe , 30-31 July 1993, p. 22. Back.

Note 8: The Hong Kong exchange now permits primary listings for Mainland companies in yuan. Dividends are paid in foreign currency and, at the time of this writing, the exchange rate matches that in the Shenzhen swap center. "Beijing to Expand B-Share Issues," Xinhua, in FBIS, 12 May 1994, p. 36; Gareth Hewett, "Exchange Opens Door to Primary Listing in Yuan," South China Morning Post , 18 June 1993, Business, pp. 1-2. Back.

Note 9: For information on efforts to ban various kinds of institutional trades, see Xing Bao, "China: SSE Deal at Fault," Shanghai Star , 10 November 1995; for more on STAQ, nets, and other institutions and organizations that have begun to legally organize the trade in institutional shares, see Liu Weiling, "China: Stock Group Focuses on Fund-Raising," China Daily , 15 March 1994; "Unlisted Share Center Tipped for Take-Off," South China Morning Post , 1 May 1994, p. 8. Back.

Note 10: Nicholas B. Kristof, "Don't Joke About this Stock Market," New York Times , 9 May 1993, section 3, pp. 1,6; Securities Figure Discusses State of Stock Markets," Xinhua, 13 May 1994, in FBIS, 18 May 1994, p. 67. The index remained low at the end of the second quarter of 1994. China Daily Business Weekly,  20 June 1994, p. 3. Back.

Note 11: "Market Needs Group Investors," Xinhua, 30 November 1995. Back.

Note 12: "The International Club: China Admitted to the International Securities Administration," Xinhua, 13 July 1995. Back.

Note 13: The State Council's "Securities Policy Committee" works with the CSRC to issue national regulations on questions of securities. See "Market Needs Group Investors," Xinhua, 30 November 1995; Pete Engardio and Joyce Barnathan, "Take a Nap. Read a Book. It's the Shanghai Bourse," Business Week , 1 May 1995; Tone Shale, "Zhou's Burden," Euromoney, May 1995. Back.

Note 14: "Round-Up: Securities Market Growing in China," Xinhua, 20 December 1995. Back.

Note 15: The overseas- and foreign-listed companies had raised $3.67 billion in capital by the third quarter of 1995. "Round-Up: Securities Market Growing in China," Xinhua, 20 December 1995; "China to List Seven More Enterprises Abroad," Xinhua, 27 September 1995; Louise Lucas, "Survey of International Equities," Financial Times , 14 September 1995, p. 4

The companies listed on the Hong Kong stock exchange represent diverse sectors of Chinese industry, including machinery, telecommunication cables, electric machinery, shipbuilding and shipping, construction materials, steel production and vehicle manufacture. See Mrinalini Saran, "HK-Listed China Firms Fall Prey to Beijing and Bollworms," Japan Economic Newswire , 9 May 1995, p. 315.Back.

Note 16: Josephine Ma, "Short-lists for Foreign Listings to be Dropped," South China Morning Post,  29 August 1995 Back.

Note 17: Conrad de Aenlle, "The Enigma of China: Ever Promising, Ever Puzzling, Ever Unpredictable," International Herald Tribune , 29 July 1995. Back.

Note 18: Li Min, "China: B Share Market Will Soon Emerge from Doldrums," Business Week (China Daily  supplement), 11 June 1995. Back.

Note 19: See also Deidra D. Deamer, East Asian Executive Reports , 15 June 1995. Back.

Note 20: Jasper Becker, "Wild Gambling Fever Grips China's Futures Markets," South China Morning Post , 18 June 1995, p. 3. Back.

Note 21: Ded Nickerson, "China Warned about Looming Finance Crisis," South China Morning Post , 18 June 1995, p. 2. Back.

Note 22: Peter Seidlitz, "No More Easy Money in Shanghai," Business Times , 21 April 1995, p. 17. Back.

Note 23: "Regulators Desperate for Hot Money Solution; High-yield Seekers Wreak Havoc," South China Morning Post , 12 July 1995, p. 4; Jasper Becker, "Wild Gambling Fever Grips China's Futures Markets," South China Morning Post , 18 June 1995, p. 3. Back.

Note 24: Christine Chan, "Stock Market Under Fire," South China Morning Post , 21 September 1995, p. 6. Back.

Note 25: Ding Xuemei, China Daily , 29 April 1995. Back.

Note 26: "China: Sharehold Firms Show Great Gains," Shanghai Star , 5 September 1995; "Shanghai Closes 14 Out-of-Town Brokerages," Reuter Asia-Pacific Business Report , 4 August 1995. Back.

Note 27: Foo Choy Peng, "Bond Scandal Firm may Merge," South China Morning Post , 3 August 1995, p. 4; Pete Engardio and Joyce Barnathan, "Take a Nap. Read a book. It's the Shaghai Bourse," Business Week , 1 May 1995; Ryuji Sato, "China Investors Brave 'Wild East' Bourse," The Nikkei Weekly , 6 November 1995, p. 24. Back.

Note 28: Christine Chan, "Watchdog Set for Bigger Role," South China Morning Post , 6 November 1995; "City Government to Invest Capital," South China Morning Post , 3 October 1995; "China Finance: Future of Shenzhen Stock Exchange Looks Bleak," Economist Intelligence Unit  "ViewsWire," 2 November 1995. Back.

Note 29: "Discipline Commission Spokesman on Dismissal of Hubei Vice Governor," Xinhua, 2 August 1995, in BBC, 4 August 1995. Back.

Note 30: Corrupt Chinese officials are also said to be stashing their money offshore. "Corrupt Shanghai Officials Investing in Stocks," Reuters, 19 June 1995; Andrew Browne, "Shanghai Broker Arrested for Embezzlement," Reuters World Service , 21 June 1995. Back.

Note 31: "Shanghai Daily Blasts Stock Market for Incompetence," Reuter Asia-Pacific Business Report , 13 May 1995. Back.

Note 32: In the fall of 1994, Tianjin Bohai's A-shares, for example, traded at a 666 percent premium to its H shares traded in Hong Kong, where it was not regarded as a superior company. See Adela Ma, "A-Share Market a Risky Business," South China Morning Post, 24 September 1995. Back.

Note 33: Seth Faison, "Would-Be Investor's Journey into Shanghai Maze: Buying Stock is Easier Said than Done; a Guide," International Herald Tribune , 25 April 1995. Back.

Note 34: Andrew Browne, "Top Chinese Official Snared in Stock Market Scam," Reuter Asia-Pacific Business Report , 1 August 1995. Back.

Note 35: Adela Ma, "A-Share Market a Risky Business," South China Morning Post , 24 September 1995. Back.

Note 36: Tapen Sinha, "Why Western Accounting Methods are Needed in China Now," Management Accounting (London) , 73, no. 1 (May 1995), pp. 18-19. Back.

Note 37: Tony Shale, "Zhou's Burden: Challenges of China's SEC," Euromoney , 19 May 1995. Back.

Note 38: Only one Chinese bank, the Shenzhen Development Bank, is listed on a Chinese stock exchange, and further bank listings have not been permitted. Mark O'Neill, "New China Eyes Offshore Operation, Listing," Reuter Asia-Pacific Business Report , 18 August 1995. Back.

Note 39: In the Great Leap Forward (1959 to 1961), Mao attempted to massively increase the rate of production and consumption in ways that produced economic collapse and starvation. The Shanghai and Shenzhen stock exchanges do appear to have rises and falls dictated in large part by the pace of new listings, and the paper's criticism of an arbitrary attempt to steadily expand the size of the market through a financial "Great Leap Forward" may be valid. Indeed, a flood of new issues in late 1993 may have helped the market to crash to historic lows by July 1994. To take a more recent example, on 15 June 1995, the country's top securities regulatory official, Zhou Daojiong, announced a quota limiting new shares to 5.5 billion yuan, and vowed to strengthen supervision of the fledgling stock and futures market. The announced amount would be issued over a period of several years. The market demonstrated serious fear of new issues despite this reasonably cautious pace of growth, and went into a tailspin in Shanghai and Shenzhen the day following the announcement. With more capital in circulation nationally every year, the stock market should have room for significant expansion, but there does appear to be at least a psychological link for domestic investors between the expansion of the market and the fall of its stock index. The link is less pronounced or nonexistent in the B share market, probably because B shares are purchased on an international capital market that could not possibly be saturated by Chinese stock. See Andrew Browne, "Chinese Newspaper Chides Beijing over Stock Market," Reuter Asia-Pacific Business Report , 22 June 1995; Ren Kan, "China: Quota Set for New Shares," China Daily , 16 June 1995; Wei Ling, "China: Sluggish Marts Need Good News," China Daily (Business Week) , 3 December 1995. Back.

Note 40: Seth Faison, "Would-Be Investor's Journey into Shanghai Maze: Buying Stock is Easier Said than Done; a Guide," International Herald Tribune , 25 April 1995. Back.

Note 41: Andrew Browne, "Shanghai Broker Arrested for Embezzlement," Reuters World Service , 21 June 1995. Back.

Note 42: "Industry Monitor: Electronics in China," Business China (The Economist Intelligence Unit) , 10 July 1995. Back.

Note 43: Foo Choy Peng, "CSRC Searches for Way Forward," South China Morning Post , 18 August 1995, p. 4. Back.

Note 44: "Stability of SES Swayed Sinochem," Business Times , 16 June 1995, p. 20; "Investors Souring on Actions of China's Tsingtao Beer Managers," Los Angeles Times , 19 May 1995.< Back.

Note 45: Indeed, the first published article by this author on the Chinese securities markets also focused exclusively on centrally sanctioned markets and, to a limited extent, enterprises outside the markets that were still state-owned. See Solomon M. Karmel, "Emerging Securities Markets in China: Capitalism with Chinese Characteristics," The China Quarterly , no. 140 (December 1994), pp. 1105-20. Back.

Note 46: Kevin Murphy, "A Struggle to Make Securities Markets Meet International Standards," International Herald Tribune , 24 April 1995. Back.

Note 47: Almost three-fourths of this capitalisation is located in Shanghai. "Round-Up: Securities Market Growing in China," Xinhua, 20 December 1995; Sheila Tefft, "The Spread of People's Capitalism," Christian Science Monitor , 5 July 1995; Andrew Browne, "China's Top Stock Regulator Praises Shenzhen," Reuter Asia-Pacific Business Report , 9 August 1995. Back.

Note 48: Statistics quoted in (1) Wenhui Daily , Hong Kong, 31 March 1994, p. A3, cited in "Shareholding Reform Reviewed," China News Analysis , 1508 (15 April 1994), p. 4; (2) "Total of 13,000 Joint-Stock Enterprises Set Up," Zhongguo Tongxun She , 25 February 1994, in FBIS, 17 March 1994, p. 49; (3) "Joint-Stock Businesses Increase Throughout Nation," Xinhua, 28 February 1994, in FBIS, 28 February 1994, p. 54. Back.

Note 49: Li Fu-chung, "Third Plenary Session Likely to Discuss Enterprise Reform Plan," Lien Ho Pao , 18 October 1993, p. 7, in FBIS, 18 October 1993, p. 42. Back.

Note 50: China: State Shares Suffer Dilution," China Daily (Business Week) , 19 November 1995. Back.

Note 51: See "Tian Jiyun Calls for Township Enterprise Shareholding," Zhongguo Xinwen She , 16 September 1993, in FBIS, 20 September 1993, p. 52; and Wu Yunhe, "Rural Firms to Continue Rapid Development," China Daily , 20 September 1993, p. 1. Hong Hu, the vice-minister of the State Commission for Restructuring the Economy (SCRE), would permit all of China's state-owned enterprises to become joint-stock companies. See "Beijing to Increase Number of Shareholding Companies,"  Xinhua, 19 October 1993, in FBIS, 21 October 1993, pp. 43-44. Back.

Note 52: "Rural Areas in Shenzhen Prospering," Xinhua, 3 December 1994. Back.

Note 53: From 1995-1997, Shanghai plans to greatly accelerate the issuing of shares for rural industrial cooperatives, with perhaps one thousand firms issuing shares in 1995 alone. By 1997, it is hoped that shareholding cooperatives will account for 60 percent of all local rural enterprises. Hu Deqiao, "Breakthrough in China's Reform of the Property Rights System," Zhongguo Gaige , 3 (13 March, 1994), pp. 9-12, 26, in FBIS, 14 April 1994, pp. 18-22. Back.

Note 54: "Foreign Investment in Suzhou's Rural Industry $480 Million U.S. This year," Xinhua, 27 August 1994; "Overseas Investment Pours into Suzhou's Rural Industry," Xinhua, 27 August 1994. Back.

Note 55: South Jiangsu Speeds Up Industrial Relocation," Xinhua, 9 August 1994. Back.

Note 56: "Problems and Countermeasures of the Nation's Current Development of Individual and Private Enterprises," Economic Research and Reference  (Jingji Yanjiu Cankao) , no. 503 (5 July 1994), pp. 31-38. Back.

Note 57: ibid , p. 32. Back.

Note 58: "Treasury Bond Law Expected to be Submitted to NPC," Xinhua, 8 July 1995. Back.

Note 59: "China's Futures Exchanges Banned from Making Profit," Reuters, 19 June 1995. Back.

Note 60: The new laws would also require the investment funds to buy only a set limit of shares in one company in order to guarantee diversification. Penultimately, the regulations would require investment funds to invest a certain percentage of their managed assets in treasury bonds. Many existing funds are top-heavy in unstable corporate shares. Finally, the regulations would require funds to make public information disclosures. Ren Kan, "China: Investment Fund Area Targeted," Business Week  (China Daily Supplement), 23 April 1995. Back.

Note 61: China's Top Securities Regulator Stresses Law," Reuters, 30 April 1995. Back.

Note 62: "Shenzhen to Cut Stock-Trading Fees," Xinhua, 25 September 1995. Back.

Note 63: Xie Ren, "CITIC Plans to Extend Reach," Business Week (China Daily Supplement ), 28 May 1995. Back.

Note 64: Adela Ma,"A-Share Market a Risky Business," South China Morning Post , 24 September 1995. Back.

Note 65: Foo Choy Peng, "Novel Debt Route Opens," South China Morning Post , 16 June 1995. Back.

Note 66: "Guangzhou Residents' Favorite Investment," Xinhua, 6 June 1995; Li Wen, "China: Guangzhou for Greater Investments," Business Week (China Daily supplement) , 4 June 1995. Back.

Note 67: Adela Ma, "A-Share Market a Risky Business," South China Morning Post , 24 September 1995. Back.

Note 68: Li Wen, "China: Speeding Down," China Daily , 8 September 1995. Back.

Note 69: Tony Walker, "Ford Skates Around Chinese Freeze: Share-Buying Avoids the Joint Ventures Ban," Financial Times , 7 September 1995, p. 34. Back.

Note 70: Lu Ning, "A Cheaper Way to Invest in Chinese Firms?" Business Times , 12 August 1995, p. 7. The acquisition by the two Japanese companies of 25 percent of the outstanding shares of Shanghai-listed Beijing Lightbus Co. was made through a share "transfer" rather than a "sale" to get around legal restrictions on percentages of foreign ownership, but the result appears to be the same. See also Andrew Browne, "In China's Stock Markets, Anything is Possible," Reuter Asia-Pacific Business Report , 16 August 1995. Back.

Note 71: Jiangling Motors was a diversified company even before the sale to Ford. It is 51 percent controlled by the Jiangling Motors Corporation Group; 17 percent divided into A shares issued to local investors; 25 percent divided into B shares held primarily by Ford; and 7 percent "legal persons" shares owned largely by the Shanghai Automobile Industrial Corporation Tony Walker, "Ford Skates Around Chinese Freeze: Share-Buying Avoids the Joint Ventures Ban," Financial Times , 7 September 1995, p. 34. Back.

Note 72: Jane Macartney, "U.S. Firm in Landmark China Airline Share Purchase," Reuters, 13 November 1995. Back.

Note 73: Overseas Funds Venturing into China's Stock Market," Xinhua, 25 August 1995. Back.

Note 74: "Shanghai: China's Largest Financial Market," Xinhua, 10 November 1995. Back.

Note 75: Admittedly, these funds tend to be small, and at the time of this writing nearly all are depressed. See Laurence Zuckerman, "How to Invest in China Without Really Being There," New York Times , 23 April 1995, section 3, p. 7. In a 1995 survey by Credit Lyonnais Securities, company shares sold to foreigners (H and B shares) usually made up a minority, sometimes less than 10 percent, of the "China funds" of major investment houses. Many investors prefer to invest in companies that have formed foreign-owned subsidiaries or joint ventures on the Mainland. Alternately, many feel still safer investing in "red chips" of Hong Kong; that is, Hong Kong-based and registered companies with Chinese backing or substantial China involvement. These companies are likely to enjoy better management and tolerate greater transparency than Chinese-based firms listed at home or abroad. See Adela Ma, "A-Share Market a Risky Business," South China Morning Post , 24 September 1995; "Emerged or Emerging?" South China Morning Post , 17 September 1995, p. 8; Alison Leung, Hong Kong-listed China Shares Seen Under Pressure," Reuter Asia-Pacific Business Report , 16 September 1995. Back.

Note 76: Paul Ham, "Chinese Dragon Puts Fire into Investors," Times Newspapers, Ltd. , 28 May 1995. Back.

Note 77: The new regulatory practices, in line with those in Hong Kong and elsewhere, prevent companies from using the proceeds from stock flotation for expenses not stated in their prospectus; companies are also banned from granting improper right to shareholders or issuing "bonus" shares; also, regulatory bodies must be informed of various material transactions. All of this would provide important amendments to the Company Law and the Provisional Regulations on Stock Issuance and Trading, the primary laws by which companies must abide. Foo Choy Peng, "CSRC Gets Tough With New Listed Companies," South China Morning Post,  13 September 1995, p. 1; see also "China, Singapore Join in Regulating Securities Trading," Xinhua, 30 November 1995. Back.

Note 78: This reform is complicated because it involves the entire banking sector and 90,000 jobs, and almost every major bank in China has subsidiaries in every province and every big city trading in securities. The separation might check "over-speculation" in the stock market. Some brokerage houses set up by the commercial banks used to borrow large amounts of money from their parent banks to speculate in the stock market, with the result of greatly increasing stock volatility. Wu Jianguang, an official with the Bank of China's International Finance Institute, hoped that the move would help the central bank to better supervise the financial industry for honest investors, while ensuring the stability of the financial market. "China: Banks Must Detach from Trust Arms," China Daily , 4 August 1995; Christine Chan and Foo Choy Peng, "Bank Split Shakes up Brokerages," South China Morning Post , 14 September 1995. Back.

Note 79: "China: NASD to Help Upgrade SSE," Shanghai Star , 28 July 1995; "NASDQ, Shanghai Exchange Sign Cooperation Agreements, AP, 24 July 1995. Back.

Note 80: "China: Financial Focus Shenzhen Looks for Quality," Lloyds List (Reuters) , 1 August 1995. See also Christine Chan, "Shenzhen Plan for Default Fund," South China Morning Post , 6 December 1995, p. 5. Back.

Note 81: "The International Club: China Admitted to the International Securities Administration," Xinhua, 13 July 1995. Back.

Note 82: For example, China is currently the largest importer of gold, and most of this gold is consumed by individuals, many of whom see jewelry or gold bullion as a better investment than stocks and bank accounts at a time of high inflation. Some of the market is illegal, and the government has sought to limit it, with limited success. See, for example, Eiichiro Tokumoto, "Asia's Appetite for Gold to Grow in Late 1995," Reuter Asia-Pacific Business Report , 29 July 1995. Back.

Note 83: See also Quak Hiang Whai, "Beneath the Bruises of the H-Share Market Lies Much Potential," Business Times , 7 December 1995, p. 17. Back.

Note 84: "Economist on Breakthroughs of China's Securities Market," Xinhua, 26 November 1995. Back.