Over the last month, we heard numerous discussions about whether granting Permanent Normal Trading Relations (PNTR) to China, in preparation for its entry into the World Trade Organization (WTO), was a good thing or a bad thing. Most who opposed the bill suggested that enhanced trade with China would be positive for China’s economy and negative for the U.S. economy, while most of the bill’s supporters believed that it would be good for both. Adding it all up, it seems that both sides agreed the bill would be good for the Chinese economy.
As Alan Greenspan said on May 18,”The addition of the Chinese economy to the global marketplace will result in a more efficient worldwide allocation of resources, and will raise standards of living in China and its trading partners. Should China accept the challenge of international competition embodied in World Trade Organization membership, it will doubtless promote internal economic development, encourage the adoption of modern technologies, and contribute to lifting its citizens out of poverty.”
The most active and enthusiastic supporters of China’s WTO and PNTR status predicted even more positive results for China, including fairer government, greater legal transparency, and faster economic growth. However, I have noticed a serious disconnect between positive talk and positive action. While all of these positive comments and forecasts were coming out in seemingly endless supply in newspapers, magazines, and talk shows, foreign investors were still far from enthusiastic buyers of the most Chinese of Chinese stocks.
In China, companies can issue two different kinds of shares, “A” shares, available only to Chinese citizens, and “B” shares, available only to foreigners. Both shares trade on Chinese stock exchanges, although A-shares are traded in Chinese renimbi, while B-shares are traded in U.S. dollars in Shanghai, and Hong Kong dollars in Shenzhen.
While Chinese investors have been enthusiastic buyers of A-shares over the past few years, foreigners have been much less enthusiastic buyers of B-shares. Though A and B shares typically represent exactly the same economic claim on a company, and receive the same dividend, many B-shares trade at 50% to 80% discounts to A-shares. In other words, a piece of a company for which millions of Chinese citizens are willing to pay one dollar is only attracting foreign bids of twenty five cents. Further, since dividends paid are the same for A and B shares, Chinese investors may earn a 2% dividend yield from the same stock that generates an 8% dividend yield for a foreign investor.
The big discounts of B-shares to A-shares confirm that there’s a big gap between words and actions regarding China. Foreigners, especially American politicians and lobbyists have been saying all kinds of nice things about China’s prospects, but the wide discounts for B shares suggest that few foreign investors have been buying Chinese stocks (other than a few U.S. listed “dot-coms” and telecom companies). If everyone seems to agree that WTO is great for China’s economy, why don’t foreign investors start buying cheap B shares and narrow the valuation gap? Perhaps they are, just a little, but only very recently. In May, the Shanghai B share index was up over 30%, but even so, B-shares continue to trade at substantial discounts to A-shares. Interestingly, this move came amongst recent talk of reforms in the Chinese securities markets, sparking suspicions that A and B shares could be unified in coming years. Looking ahead, only time will tell whether investors or politicians are better forecasters of China’s future.
