IN EARLY November we argued it was time to buy Shanghai B shares. This conclusion was the result of a visit to Shanghai, culminating in a meeting with the People's Bank of China. Under discussion were ways to revive B share markets in advance of 1993's new issue programme. These measures, including allowing Chinese to buy B shares and changing the clearing system to permit American institutions also to buy B shares, were under serious and active consideration. But most investors had been burnt by Shanghai B share issues and were not keen to believe these suggested developments. The other side of the coin was that if Shanghai B shares rallied, A shares would suffer. Privately, the People's Bank of China admitted in October that A shares should fall as they were too high in price. For a while, this was the case and the discounts that Shanghai B shares sell to the A shares fell sharply to a low of 16 to 40 per cent in November. However, when the fall set in, some officials began to make soothing noises in order to stabilise the A share market by referring to the good profits outlook. Not until mid-January did we get the first good move in B share prices and even then discounts of the B shares to the A shares widened to 65 to 73 per cent as the A shares moved up even more strongly. So a massive gap exists to be closed, should there ever be real arbitrage between A shares and B shares. This is not a prediction; but, mathematically, if A shares are not to fall, then the B shares need to rise by 3.3 times before parity of As and Bs is reached. Analysts still did not ascribe January's startling rally to the prospect of locals buying. Instead there was talk of possible bonus issues in March and good annual profits announcements. Also possible in March is the setting up of a central clearing house in Shanghai. This would probably enable the Securities and Exchange Commission in Washington to sanction US institutional ownership of B shares. But the recent rally, while it has not taken the B shares up to the PER levels of Brilliance China, listed in New York, has nonetheless been strong. Any further advance will have to come from substantial switching from A shares to B shares. The B share market at this level should at least give some comfort to mainland underwriters and is likely to ensure a good reception for further new issues, as long as their price earnings ratios are kept modest. The new low level of the yuan, having weakened substantially, is hitting Shanghai B share price earnings ratios, driving them up, as yuan earnings per share are translated into US dollars and then divided into US dollar share price to obtain the PER. In other words, what with the Shanghai rally and the yuan weakness, B share ratings no longer look so cheap. Duncan Mount is managing director of CEF Investment Management which may have an interest in and/or hold positions in securities mentioned above.