SCMP Wednesday, November 7, 2001

Pinning down a Shanghai bubble


The Shanghai-to-eclipse-Hong Kong story is hardly new but has reached giddy proportions in recent times. Barely a day goes by without some Nikita Khrushchev-like "we'll bury you" statement from up north. Protocol mitigates against explicit rudeness but the intent is clear and Hong Kong is feeling marginalised.
The Shanghai bandwagon has staggering momentum. Growth is higher, infrastructure is better, costs are lower, its hinterland is bigger and cultural life seems richer. The list goes on but condenses to the premise that Shanghai has recaptured its mantle as China's premier international commercial city.
The official Hong Kong refrain that there is room for both cities increasingly rings hollow as the biggest SAR firms re-direct investment towards Shanghai. Even as SAR stalwarts claim the primacy of their birthright in the rule of law and a fully convertible currency, no one seems interested.
Shanghai fever hit a new peak last week with a Shanghai Stock Exchange official arguing the SAR's open capital account was a relative disadvantage as Shanghai was the prime repository for China's enormous and crucially captive pool of savings.
Hong Kong is not unique in looking agog at its northern rival. Across Asia, fear and admiration of China's leading city is at record levels. Recession-scarred young Taiwanese are arriving with a suitcase and a resume in search of opportunity. They complement the flood of US-educated mainland returnees being snapped up, at almost any price, by multinational firms staffing operations ahead of China's World Trade Organisation (WTO) entry.
All are captivated by its stunning growth trends. Shanghai's economy expanded six times in the 1990s, it accounts for 23 per cent of China's foreign trade and per capita income has passed the US$4,000 (about HK$31,000) mark. Where Shanghai formerly relied on SAR-originated investment, foreign firms are going direct.
Yet the Shanghai allure is less about the city's achievements to date than its future prospects. That is inexorably linked to the huge optimism being invested in a post-WTO China. It is also the result of a staggering bull market in financial assets that hit a peak early this summer.
For two years, China offered local punters the world's best performing stock markets. State-directed mergers and commitment to industrial reform drove staggering wealth creation. As China's domestic capital market hub, Shanghai was the biggest beneficiary. With share valuations still at giddy levels, the underlying strength of the Shanghai bull market remains unproven.
What is certain is that periods of financial excess are fertile ground for wilder notions of future growth to take root. Any truly great bull market requires a number of critical ingredients. It needs a good story, supported by hard facts, that passes mustard with the normally sceptical captains of business. It also demands favourable monetary conditions.
Shanghai scores highly on all counts. The underlying growth of the Yangtze Delta region is undoubted. Central government support for the city has provided an apparent copper bottom to many investment schemes. In short, there has been a hypnotic plausibility to the notion of Shanghai eclipsing Hong Kong.
Above all, Shanghai has benefited from a government-sponsored equity investing culture that grew out of the late 1990s monetary deflation. By imposing withholding taxes on bank deposits, Beijing sought to rev up monetary circulation and ignite the domestic economy.
A closed capital account meant most domestic investors had little option but to park funds in the domestic stock market. The resulting price surge resembled the late 1980s Taiwan bull market, which ultimately collapsed in 1990. Whether China's stock markets will go the same way is unclear.
Shanghai's stock promoters have vast self-interest in maintaining the boom. China's capital account is not likely to be opened soon and the underlying growth of the city's real economy seems assured, with foreign direct investment flooding the city. Yet defending present asset valuations demands more than a steadily improving economy.
In this context the "we'll bury Hong Kong" sentiment fits neatly with the agenda of many in Shanghai. Bull markets mask a multitude of sins and it is the aftermath that reveals underlying failings. Unlike the fall-out from the 1996-97 boom in red-chip stocks, victims will be domestic rather than foreign investors.
They will have less recourse than foreign creditors who are still negotiating debt work-outs from failed provincial investment trust corporations. The result, however, will be financial distress in Shanghai and a higher cost of equity capital for mainland firms.
When that happens, the relative attractiveness of Hong Kong as a financing centre for mainland firms will increase. Until that point the SAR will remain stymied. Any firm will list its shares on a market where investors pay twice as much for the same asset.
Hong Kong is hardly a stranger to concept-driven booms fuelled by favourable monetary conditions. From past experience, it also knows that the most noise usually comes close to the top of the cycle. Despite Shanghai's stunning long-term prospects, its chief promoters look increasingly like late bull-market punters with a visible axe to grind.
Simon Pritchard ( ) is a staff writer for the Post's Business Desk.