China nears moment of truth on IPO reform: Crash or recovery?

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SummaryChina's plan to turn around their reputation as financial casinos, will depend on a regulatory gamble paying off next year.

China's plan to build confidence in domestic stock markets, and turn around their reputation as financial casinos, will depend on a regulatory gamble paying off next year.

Authorities have decided to lift a ban on new stock listings from as early as next month, wagering that a series of confidence-building measures announced recently will ensure healthy demand for the tide of new shares expected in 2014.

But if they are wrong, a flood of new listings could not only sink China's already-struggling bourses but also jeopardise a bigger reform goal: to ensure more money flows to where it is needed in the world's second-largest economy.

Early signs are not encouraging.

Chinese investors appear far from persuaded that their stock markets are on the threshold of a transformation into investment destinations that are worthy alternatives to bank deposits, property and other preferred homes for their long-term savings.

“We stock investors are all idiots! Idiots!” said a middle-aged man, who gave his surname as Li, speaking in a retail stock-trading room at a brokerage in downtown Shanghai. “Why do we buy these things? The US market is at an all-time high and the Chinese markets are down. When the US market dives, we dive even further. As for the impact of the resumption of IPOs, my attitude is extremely pessimistic.”

Though a market cannot thrive for long without new listings, China's freeze helped trigger a strong rally in early 2013 by choking the supply of new paper. The CSI300 index, made up of 300 stocks on the Shanghai and Shenzhen exchanges, gained over 30% in the first two months after the freeze.

The index has held onto some of its gains — it is now up 12% since the IPO ban — but its rally cannot disguise the fact that China's stock markets remain among the world's worst-performing bourses over the past two years.

With more than 800 new companies queued to tap the market — and with Ernst & Young estimating that 200 billion yuan ($33 billion) will be raised in 2014 — there are concerns investors will simply sell shares in existing firms to fund their IPO purchases, a zero-sum scenario for the overall market.

“I think in the short term the IPO resumption is negative — in terms of sentiment at least — and also you will see some capital drain because of the new listings,” said Richard Gao, lead portfolio manager at Matthews China Fund.

Gao, though, believes

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