Horns of a dilemma
The good times are back with a vengeance in Hong Kong. Riding a wave of mainland company listings and rising fever, the Hang Seng Index has, in recent months, repeatedly reached new heights. Everyone seems to be day trading. And the property market has recovered its swagger after a long slump.
But, early this month, Premier Wen Jiabao poured cold water on the party. He announced that Beijing was not yet ready to give the green light to a much-hyped plan to let individual mainlanders invest in Hong Kong stocks.
A delay was necessary, he said, because of the need for, first, further consultation among relevant regulators; second, more study of the potential impact on Hong Kong; third, thorough education of mainland investors on the entailing risks; and fourth, contingency planning to minimise capital outflows from the mainland financial system.
Some observers believe Mr Wen's real intention was to prick Hong Kong's rapidly inflating share-price bubble. If so, it is probably a superfluous move, as the ripple effect from the US subprime-mortgage crisis will get the job done anyway.
Rather, one fear of Chinese authorities seems to be the possibility that mainland investors will lose their shirts to sophisticated Hong Kong speculators. But this is also an odd reason to derail the so-called 'through-train'. The essence of the scheme is to allow mainland retail investors to buy Hong Kong stocks directly through the Bank of China's Tianjin branch.
Since the State Administration of Foreign Exchange's initial announcement on August 20, it is true that investors' anticipation of massive capital inflows into the Hong Kong market had driven up the Hang Seng Index by almost 40 per cent at one point. Nevertheless, it is hard to argue that any mainland investor who would play this market would be ripe for exploitation. The average valuation of Hong Kong shares is only about one-third that of the mainland's A-shares. Clearly, mainland investors are already not very prudent. If anything, it is mainland companies listed in Hong Kong (the so-called H shares) which are looking to exploit such irrational exuberance of mainland investors through dual listings on the A-share market.
Even if the through-train goes forward, this gap in valuation between A shares and H shares is likely to persist. In the absence of perfect capital mobility, it is difficult for investors to fully realise arbitrage opportunities. In fact, there is not even a short-selling mechanism on the mainland because such transactions are banned.
Economists have also shown that investors exhibit a strong home-market bias. This makes sense. Most investors, rightly or wrongly, believe they have information advantages when they invest in local firms. That means most mainland punters will probably focus on trading mainland-related shares in Hong Kong if and when they are allowed to do so. What, then, is the point of educating these investors on something that they already feel confident about?
The most plausible reason for the abrupt halting of the through-train lies elsewhere. Chinese leaders are hoping against hope to let steam out gently from the sizzling A-share market, and they are worried that a sudden capital outflow to Hong Kong would end in a bust. But a soft landing of the stock market is simply not a credible policy. It would only encourage an even more thunderous bull stampede by feeding the speculation that the government would do whatever it takes to support share prices - at least until the Beijing Olympics next August.
What is more, financial authorities have limited their own options by repeatedly ruling out a large currency appreciation. As long as liquidity continues to surge in from the external sector, the A-share market will stay bubbly. In fact, this is precisely why Beijing should promptly push ahead with the through-train as an alternative solution to reducing domestic liquidity.
Unfortunately, Mr Wen's comments were also an admission that the various arms of the government have yet to forge a clear consensus. The key issue is how best to proceed in drastically relaxing the country's stringent capital controls.
There are at least five agencies with a loud voice in the matter: the China Securities Regulatory Commission (CSRC), the China Banking Regulatory Commission, the People's Bank of China (PBC), the finance ministry, and the National Development and Reform Commission.
Needless to say, these stakeholders all have different objectives (for example, the CSRC wants a booming but stable stock market, while the PBC is keen to maintain the price stability of the overall economy).
And policymakers, by nature, tend to be risk averse. For instance, some might conveniently argue against a meaningful relaxation of capital controls by invoking the 'moral hazard' of bailing out speculators who have pushed the Hang Seng Index into record territory.
But then, in a way, it may be a sign of progress that there is more than one voice within the government on such a sensitive matter. Unlike share prices, the more steam the policy debate generates, the better the final outcome will be.
Steven Sitao Xu is the Economist Intelligence Unit Corporate Network's director of advisory services in China