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2015-Jul-6, 07:36

Chinese trade credit

Chinese economy is the world’s fastest growing economy. Its real GDP has grown by a factor of eight since 1991. And, according to IMF, China is now officially the largest economy in the world based on purchasing power parity.

In a recent paper, Franklin Allen, Jun Qian, Susan Shan and Julie Zhu contrast this impressive growth with poor performance of its stock markets. How could the world’s fastest growing economy have such a poorly performing stock market? The question is intriguing and fundamentally important for Chinese policymakers and regulators.

The underperformance of Chinese equities is phenomenal. If you invested $1 in a value-weighted Chinese stock portfolio in year 2000, that dollar would have become $0.62 by the end of 2012. Compare that to investing in a globally diversified world portfolio, where the same dollar would have become $1.67 by the end of 2012. In case you are wondering, Japan is the second worst performing country after China.

Several reasons are offered for such underwhelming performance of Chinese stock markets. The main reason appears to be the listing process that determines which firms get listed. The listed firms are doing poorly, and there is some evidence that unlisted private firms are actually doing quite well. Better firms are listing abroad instead of listing locally. One problem with listing is that firms have to go through an administrative process which works on a quota system. The listing process is also biased towards large firms with a track-record of profitability. These profit requirements distort the businesses of these firms. It is not surprising that many firms manage earnings prior to their listing to appear profitable. Moreover, the listing criteria also distorts the real operating decisions of these firms.

Chinese firms rarely delist because of poor performance. Very few Chinese firms have gone through a bankruptcy process – so the poorly performing firms continue to operate and exhibit further deterioration in performance over time. And by this way, we need more imformation to identify a firm, even about the chinese trade credit .

Many economists feel that much of the growth of Chinese firms is due to over-investment in fixed assets. So, while there is lots of growth (investment-financed), the profits aren't there. The return on invested capital of Chinese firms is surprisingly low compared to firms in other countries.

My view is that we are just scratching the surface of the problem. It will take a lot more work to understand what's causing the disconnect between the economy and the stock market. Clearly, regulations play a role, but also the growth oriented policies adopted by Chinese firms may be responsible for poor performance. There is too much speculation into the causes. So, I look forward to reading more research in this area.
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