Since the peak of 6,124 in October 2007, the market has dropped over 50%; briefly dipping under 3,000 in intraday trading. With the Olympics on the horizon, there has been a lot of discussion lately of whether the Chinese government would ‘let’ the Shanghai market fall. Although with the recent drop, it could be argued that it already has, many investors still believe that the government would support the market no matter what, even if it necessitated irrational things like propping up stock prices through government purchases, insider trading, etc..

It’s no surprise that the government would be interested in ensuring the success of the stock market as it helps promote social stability and ‘harmony’, but what is a surprise is how they are doing it. Three events in the past two weeks indicate that the government is watching the market very closely, but instead of implementing the irrational measures some suggest, it is actually taking some very sensible steps to help the market

• April 20th – The China Securities Regulatory Commission announced stricter rules on the sale of previously non-floating ‘bulk’ shares stating that any more than 1% of total equity coming out of a 2 year lock up must be executed via a block trade, as opposed to just coming onto the free market directly, and must not be sold within 30 days of annual/interim reports. In 2005, China started a program requiring listed firms to convert their previously non-tradable shares, largely held by state owned enterprises (SOEs), into free-floating entities which, at that point, was designed to help support market fundamentals. In practice, this ended up bringing too many shares onto the market in too short of a period and pulled the market down. Recently, nearly 6.6 trillion yuan (US$900 billion) worth of free-floating shares were trading on the open markets; indications are that this will be limited to 3 trillion yuan (US$430 billion) in 2008.

• April 22nd – China’s Ministry of Commerce announced that China will help/allow qualified foreign-invested companies to list on China’s domestic stock markets. Pushing this measure is an attempt to help remedy what has been a perennial issue in China – not enough investment options either on or off the markets. Part of the reason that the stock market was driven to such heights was the fact that only 860 companies were listed on the Shanghai market at the end of 2007 (by comparison, the NYSE alone has about 2,800). With fewer investment choices domestically, investors drove these limited shares to irrational levels. The listing of foreign companies will be a gradual process, but will help to alleviate some of that pressure by putting more investment choices on the table for investors. Details are fuzzy about how this will happen, but in all likelihood, the so called ‘red-chip’ companies, or those Chinese companies who have listed abroad, but not in China, will be the first to come onto the market.

• April 24th – The A-share stamp duty was lowered from 0.3% to 0.1% - The Chinese stock stamp duty was first introduced in July 1990 on the Shenzhen exchange and has since been implemented on the Shanghai market covering both purchases and sales. In the last 17 years, the stamp duty has fluctuated between 0.1% and 0.5% and, including the latest move, has been changed about 6 times, followed by a corresponding shift in market prices. This a relatively rudimentary tool, but has nevertheless increased investor confidence.

However, although they largely dodged the subprime bullet with only limited exposure to subprime instruments, the Chinese markets have some large fundamental issues looming. First and foremost is inflation, which has been increasing dramatically over the past few years and is really starting to affect the average Chinese consumer whose food bill is rapidly increasing. The increased spend on food will gradually limit the amount of money that the average Chinese consumer will spend on the products and services from many of the large listed companies which depend on these consumers for their seemingly endless growth. This coupled with the potential global slowdown, the strengthening yuan and the new employment laws are seriously challenging the competitiveness of China; we are constantly hearing of more companies choosing to shift their production outside of China.

None of these measures are the silver bullet to make the fundamental issues in the market go away, but taken together they point to some sensible measures that the government is putting in place to help the market in at least a technical sense and have indeed helped with short-term market gains, however, many investors are still looking for the long-term fundamentals before they come back in.