China Opens New Stock Exchange

You wouldn't think that the worst economic downturn in 70 years would be a good time to open a new stock exchange. But the Chinese do. After a decade of delays, Beijing has decided to debut its Growth Enterprise Market (GEM)—China's very own version of New York's NASDAQ exchange. Under rules due to take effect this month, China's "second board," located in the southern city of Shenzhen, across the border from Hong Kong, will allow companies with just three years of operation, net assets of 20 million renminbi (just under $3 million U.S.) and combined profits of just 10 million renminbi to sell stock to the public.

The plan is going ahead even though China's main exchange in Shanghai has only partially recovered from its bottom late last year, when it was down by some two thirds. That says a lot about the economic competence—and the confidence—of the Chinese. Just as Beijing used the Asian financial crisis as a push to move ahead with trade reform, so leaders today see the global downturn as a chance for China to expand its reach in capital markets—to grow while others are faltering.

China recently announced plans to allow settlement in renminbi (RMB) for trades in Hong Kong—an important step on the road toward full convertibility of the Chinese currency. A flexible currency is a key part of making Shanghai a truly international financial center, another goal that the Chinese are now putting front and center. At a recent press conference, Liu Tienan, deputy director general of China's National Development and Reform Commission, gave a strong speech to that effect, proclaiming that the country's aim by 2020 is to build financial centers "appropriate to China's economic power and the international status of the RMB." Liu also stressed that China's financial sector should be not just "big, but strong."

A market like GEM, which targets small and midsize privately held businesses, will be a crucial step toward that goal. So far most of Beijing's $585 billion stimulus program has gone to state firms in industries like construction, real estate and transport. But about two thirds of China's GDP comes from the nonpublic sector—and small businesses create the majority of new jobs. In GEM, they'll have a new mechanism for raising sorely needed capital.

Some industry observers also see GEM as not only a step forward in China's move away from traditional communist ideology, but as part of a wider industrial transformation, as China seeks to promote innovation. "Supporting high-growth SMEs which have prestigious proprietary technology—and an element of sustainability beyond cheap labor—is now part of the central strategy as opposed to something on the periphery," says Robert L. Kuhn, a senior adviser to Citigroup Global Investment Banking, who has advised the Chinese government on reform. There is, he adds, "recognition that the Chinese financial system has not been conducive to these kinds of companies" and new measures are necessary.

The new market also addresses another problem—how to put China's pent-up capital to use. The Chinese have saved up some $2 trillion in foreign capital, yet as Yao Yang, deputy head of the China Center for Economic Research at Peking University, notes, "A lot of this has just been hoarded rather than invested—this shows we have big problems in our financial system. The money should be used in markets like GEM, something that would benefit the Chinese and the global economy."

There's no doubt that opening the new market at a time of economic instability is a risk. Just last month, Yao Gang, vice chairman of the China Securities Regu-Commission acknowledged that about half of the companies originally chosen as candidates for GEM listing are no longer qualified due to a slump in their performance. There's also the fear that if investors lose money on risky startups it could increase social instability—as Kuhn notes, Chinese investors still have the attitude that "if we make money it's ours—but if we lose money the government got us into this and so they have to support us!"

But the Chinese also have a history of making tough changes in tough times. Premier Wen Jiabao made a point of saying last month that the current situation demanded "more reform," not less. And in some ways, it may be easier to develop Chinese capital markets in a downturn, when the risk of overheating is less. "I think that China and its leaders feel that the relative position of China in all areas is now enhanced by recent economic events," says Kuhn. It's a moment the Chinese aim to exploit to the fullest.