Echo Boom

Amid the relentless mania for making money that defines 21st century China, it’s easy to forget that the country’s stock markets in Shanghai and Shenzhen are less than two decades old. They may be barely out of adolescence, but they are already among the largest in the world. According to a forecast this month from PricewaterhouseCoopers (PWC), a global consulting firm, Chinese companies will raise $52 billion this year through initial public stock offerings in Shanghai and Shenzhen, more than double the amount forecast at the start of the year. Remarkably, this makes it likely China will generate more IPO money in 2007 than any other major market in the world did in 2006. This year, says Richard Sun, a partner at PWC, only London is on a pace to outstrip the Chinese markets in total capital raised through IPOs.

This rapid rise testifies to the buoyancy of China’s equity markets. The relentless increase in stock prices in both Shanghai and Shenzhen—the former market has trebled in value in just the past 18 months—has triggered a stampede of Chinese companies eager to offer shares to a ravenous public. But is the IPO boom a historic milestone marking the permanent shift of China’s financial center of gravity from Hong Kong to the mainland? Or is it a temporary aberration that, for investors, will come to a tragic and costly end?

Many analysts believe China’s A-share market—stocks priced in renminbi that are available almost exclusively to mainland investors—is experiencing a classic bubble and is destined to crash. Certainly it isn’t hard to find evidence to support this conclusion. The 1990s U.S. technology and dotcom bubble saw an explosion of IPOs that peaked in 1999, when companies raised $63.1 billion (still a U.S. record). The bubble burst the following year. China’s shares, which now trade on average at about 45 times next year’s earnings estimates, are definitely expensive. But there are differences between China’s bourses now and the NASDAQ then. The companies offering shares to the public in China are not small, unprofitable start-ups—”no Pets.com.cn among them,” as PWC’s Sun puts it. They are mostly big corporations—energy giants, mining operations, banks and insurance companies—many of which have already gone public in Hong Kong and are now opportunistically selling additional shares in China. The largest China IPO this year, for example, came March 1 when Hong Kong-listed Ping An Insurance, China’s second largest insurance company, raised $5 billion on the Shanghai exchange.

The Chinese government views this blue-chip IPO parade as essential for economic modernization. “The government wants a healthy equity culture to gradually develop in China,” says Jing Ulrich, managing director of China equities at JPMorgan in Hong Kong, “because allocating capital more efficiently is central to the ongoing reform process.” The government has outsized influence over large Chinese corporations for a simple reason: most being brought to market are state owned. Encouraging big, well-known companies to make their shares available to domestic investors—who have very limited access to markets abroad—makes sense. China’s equity markets have a reputation for being poorly regulated casinos. Giving investors the opportunity to buy stakes in China’s leading corporations under a more robust regulatory regime (starting this year, companies listed in Shanghai and Shenzhen must meet internationally accepted accounting standards) is a significant upgrade for the country’s financial system, says PWC’s Sun.

By encouraging IPOs, the government is also trying to manage a troublesome side effect of the country’s rapid economic development. China’s citizens have few investment options. Interest rates on savings deposits don’t even keep pace with inflation. So many have dumped their growing savings into real estate, resulting in speculative property bubbles in major cities that have driven house prices beyond the reach of average people. The fact that property prices in places have declined while stock prices have soared is not an outcome that displeases the government. “If the new listings diverted some savings that were otherwise driving up the price of apartments in Shanghai—and they definitely did—that was fine [by Beijing],” Sun says.

But in trying to influence markets, policymakers must balance on a tightrope amid shifting financial winds. Some investors are already miffed at the government for allowing the IPO spigot to open wide, saying that the burgeoning supply of shares could push prices down. As far as the authorities are concerned, a bit of a correction is probably welcome. But they don’t want a bust. When the Shanghai Composite Index plunged 8.8% in February after analysts warned Beijing was about to impose a capital-gains tax, the government quickly backed off. Stocks resumed their rise, but dangers remain. As tech investors learned in 1999, corrections have a way of becoming something worse—and $52 billion plunked into IPOs can become a lot less in a hurry.