TAIPEI, Taiwan (TheStreet) -- China is in the paradoxical position of trying to cool down its stock market while at the same time attempting to heat up its economy.
Though the twin moves seem contradictory, they are intended to reduce stock market volatility while stoking economic growth -- both of which would be welcomed by foreign investors.
China's market regulators said on April 17 that they would curb over-the-counter margin trading, which may reduce somewhat the practice of borrowing by new investors to enter the market. At the same time, regulators increased the number of stocks permitted to be loaned for short-selling from 900 to 1,100. And in a separate move, on April 20, China's central bank began to trim the reserve requirement in an effort to stimulate a different kind of borrowing -- for private investment in enterprises.
The curb on margin trading could reduce the risk of stock market volatility resulting from newer Chinese investors rushing to borrow to participate in the stock market but then leaving en masse if prices fall. An increased reliance on short-selling would reduce market fluctuations and help investors find the "reasonable prices" of assets, the official Xinhua News Agency said, quoting the China Securities Regulatory Commission.
"Successful short-selling is a tough game and usually only the really smart investors can make a living at it," said Michael McGaughy, a money manager and consultant with Yuan Asset Management in Hong Kong.
Together, these measures are aimed at reducing stock market volatility over the long term -- a change that would probably be welcomed by foreign investors despite any immediate short-term market chaos, such as April 17's 5.5% fall in after-hours stock futures.
"By adding controls to borrowing on margin and allowing fund managers to lend shares to short-sellers, we anticipate Chinese equity markets will improve in both quality and efficiency in the long run," said Jay Jacobs, research analyst with Global X Management in New York.
Despite the price of Chinese A shares rising 47% last year, some foreign investors are worried about poor transparency, risks to minority shareholders and patchy regulations. Even so, as of December, the number of foreign institutions allowed to trade A shares rose to 261 and they have permission to trade as much as $67 billion, according to the State Administration of Foreign Exchange.
China-focused exchange-traded funds such as iShares MSCI China ETF (MCHI - Get Report) and the Deutsche X-trackers Harvest CSI 300 China A-Shares Fund (ASHR - Get Report) may then reflect long-term gains from reduced volatility.
Financial institutions that have obtained China's permission to trade A shares -- such as JPMorgan Chase (JPM and Nomura Holdings (NMR -- would also benefit from more market stability since the new rules bring the trading of Chinese stocks more in line with international norms. Neither investor would comment for this report.
The complementary move by the monetary authority, the People's Bank of China, to lower the reserve ratio requirement by 1 percentage point means that large Chinese banks must hold 18.5% of their deposits in reserve.
China's authorities are seeking to pump up domestic private enterprise beyond manufacturing to drive the growing yet slowing economy. The hope is that stronger private enterprise would in turn raise domestic consumption, which could benefit American companies such as Hewlett-Packard (HPQ and Wal-Mart Stores (WMT. It would also bolster domestic rivals of the American firms.
"China is now such a big part of the global economy that any abrupt changes in the economy, the stock market, regulations or other economic indicators tend to create confusion and doubt in the minds of investors," said Jack Perkowski, managing partner of merchant bank JPF Holdings in Beijing.