Quotes of the Day

The day-trading room at Huaxia Securities, one of mainland China's three biggest brokerage houses, is a place where Beijing residents gather to monitor the stock ticker and hunch over computer keyboards while they buy and sell shares of 1,378 listed Chinese companies. Like casinos, Huaxia supplies VIP rooms to high-stakes customers. After the central government's disclosure last week that China's surging economy registered unexpectedly rapid GDP growth of 9.5% in the fourth quarter of 2004, the VIP rooms should have been buzzing. But they were empty, while the atmosphere in the main room was morose and lethargic. A group of elderly men pried open sunflower seeds and dealt cards without glancing at the ticker. Most trading terminals were off. One gray head quipped that, like the market itself, "even the computers have no energy."

How can the world's most dynamic economy have Asia's most catatonic stock markets? That's a conundrum China's financial regulators have tried but failed to address since 2001, when an ebullient market bubble burst and local investors headed for the exits. In the latest effort to revive deflated stock prices and boost trading volume, the government last week announced that stock-transaction taxes would be cut by 50% for the second time in three years, and that initial public offerings would be resumed after a five-month suspension while other new rules designed to attract investors were implemented. At the same time, the China Securities Regulatory Commission revealed its latest attempt to clean up shaky brokerage houses. (More than a third of the 57 Chinese brokerages that have published 2004 annual results posted losses last year, according to the China Securities Journal.)

Similar moves in the past have done little to rekindle trading. The combined index for China's two bourses, in Shanghai and Shenzhen, is down 46% from its 2001 peak. Last year, the bourses lost 15% of their combined value, one of the worst stock-market performances in the world; they are currently trading near six-year lows. Meanwhile, the weekly trading volume on the Shanghai exchange has plummeted nearly sixfold, from a high of 178 billion yuan during the week ending Feb. 18, 2000, to 31 billion yuan last week.

Incremental regulatory improvements have failed to reverse the slide because they are Band-Aid solutions to wide-ranging, well-known problems. China's stock markets are afflicted by poor regulatory supervision, rampant insider trading, lack of corporate transparency, shady stockbrokers, and frequent government intervention. Investors dislike uncertainty, and in China, risk takes many surprising forms. In November, for example, the government suddenly rotated the top executives of its four listed, state-owned telephone companies, sending them to work for former competitors. Corporate corruption is commonplace—police have confirmed criminal investigations at eight listed companies so far this year, according to the Shanghai Securities Daily. The newspaper has reported that executives under investigation include the chairman of Shanghai-listed jewelry seller Diamond Co., who vanished after allegedly transferring $10 million in company funds to private overseas bank accounts.

Reports of such egregious abuses make trading on the Shanghai and Shenzhen bourses seem more perilous than gambling. But there's an even more fundamental problem: China's most promising companies tend to raise capital by going public in Hong Kong or New York, where tougher listing and reporting requirements make markets more trustworthy. But the majority of companies' hitting China's bourses are command-economy-era, state-owned enterprises (SOEs): many of them have limited growth prospects, while others, hopelessly uncompetitive, may be destined to fail.

To forestall massive layoffs and keep a lid on civil unrest, the government has in the past propped up struggling SOEs with loans from state banks. But China's banking system is awash in bad loans, so now Beijing prefers companies to raise capital by going public. "Stock markets should be a vigorous entrepreneurial way to promote capitalism, but China uses them to manage the slow decline of state companies," says Matthew Rudolph, a fellow at the Institute of Current World Affairs in Hanover, New Hampshire, who is writing a book on China's markets. Investors "are just helping the government manage domestic politics," he adds.

Punters who believe they can find gemstones in the scrap heap face one other glass shard. When SOEs go public, government entities continue to hold up to 70% of the shares. Bejing in effect banned the sale of these shares, so the state would maintain corporate control. But in June 2001, at the height of the market bubble, the government announced that it would allow the sale of some "nontradable" shares and use the proceeds to fund a national pension scheme. Investors panicked, fearing a flood of new shares would drive down prices. Although the government quickly reversed its decision, the markets lost a quarter of their value in three months, and they have kept falling ever since. "Everybody still worries that some day the state will sell those shares," says Fraser Howie, co-author of the book Privatizing China, a history of corporate reform. Little wonder the sunflower-seed eaters at Huaxia Securities find dealing cards more diverting than dealing in shares.

• Matthew Forney | Beijing
• Despite a roaring economy, mainland stocks are in the dumps, and Beijing's remedies aren't working