Robust stock market key to supporting economy

SMEs deserve further attention amid ongoing regulatory reform efforts

After rising more than 50 percent last year, the Shanghai Composite Index ranked as one of the world's top performing equity benchmarks in 2014. Such gains mark a stunning reversal from previous years, when the index consistently lagged its peers in other major world markets.

Recent stock gains can inject fresh vitality into the real economy, while also soothing investors burnt by past downturns. Such outcomes will help ease pressure caused by slowing GDP growth, overcapacity in traditional sectors as well as mounting local debt levels.

Recent years have seen China's economy descend into a vicious cycle, one where growth has been fueled by continued commitments of State investment. Now, the government has to confront the twin necessities of controlling debt expansion without sabotaging demand.

With the Shanghai Composite now above the 3,000-point mark, China's broader economy may be entering a new stage of development. Over the year ahead, the state of the real economy will largely hinge on the strength or weakness of the local capital market, of which China's A-share market is an essential component.

What sort of impact will rising stock prices have on the economy? Song Guoqing, an academic member of the People's Bank of China's monetary policy advisory committee, explained at a forum recently that stock price run-ups will raise the value of listed companies' assets. In turn, corporate liabilities will fall. Such market-driven balance sheet improvements will enhance the creditworthiness of listed borrowers, allowing for easier access to financing and reduced borrowing costs.

What's more, elevated stock prices can also lead to more equity financing within - as well as outside of - the capital market.

According to Song, under such circumstances total social financing - a broad measure of liquidity that includes some categories of borrowing outside of the commercial banking sector - could grow by 14.8 percent this year. Meanwhile, Song also foresees the domestic economy growing by 7.3 percent in 2015, while consumer inflation may increase by 1.6 percent.

Song's views are relatively optimistic, considering that some experts predict GDP expansion of as little as 7 percent this year in the face of rising headwinds.

In response to slowing growth, some companies may have to deleverage. According to a speech made at an industry conference by Song Liping, president and CEO of the Shenzhen Stock Exchange, some listed Chinese companies reported debt-to-asset ratios above 60 percent. For some businesses in traditional sectors, this rate could be as high as 80 percent. China's capital market will play a vital role in helping businesses reduce their debt exposure. Fortunately, current market conditions mean equity financing is now a practical option for filling holes left by deleveraging.

Despite recent run-ups though, many listed small and medium-sized enterprises (SMEs) have yet to reap the benefits of China's ebullient market. The bulk of last year's stock gains were absorbed by blue-chip companies, including central government-led enterprises, financial-sector companies and businesses involved in real estate.

In 2015, the market should shift to focus more on SMEs. The development and promotion of a registration-based IPO system can support such a transition and also result in more market-based allocation of resources. Indeed, reforming China's IPO mechanism is a large-scale, systematic project involving all market participants. As Xiao Gang, chairman of the China Securities Regulatory Commission (CSRC), said during the 2015 National Securities and Futures Supervision Conference, the completion of such a mechanism would mark an important breakthrough in the administrative reform process.

After the completion of such reforms, issuers will be given ultimate responsibility over the pricing of their shares. Without the CSRC putting its stamp of approval on the terms of every offering, investors will be forced to make their own decisions based on available information and their tolerance for risk.

Of course, even after these reforms are finalized and fully implemented, many other problems still exist in the way financing is obtained in China's stock market. Authorities and market regulators still have much to do over the coming months as they work to support the real economy.