Traffic jam on capitalist road: This week's riots in Shenzhen illustrate a share mania that has been building up in China for 18 months, Liane Evans reports

A dusty hotel in Shanghai is not the most likely place to find a stock exchange. But 15 Huangpu Road is home not only to the Pu Jiang Hotel, but also to the Shanghai Securities Exchange, one of two exchanges operating in China.

The setting is far from conventional. Guests still check into the other half of the building, and the market still bears more resemblance to the hotel it once was than to a normal stock exchange. Complete with net curtains, the trading floor is situated in what looks like a large dining hall. Twenty or so young men in red overalls sit quietly at computer screens as if they had been trading all their lives.

This is a far cry from the recent riots at China's other exchange, in Shenzhen, southern China. Coverage of the recent unrest outside the Shenzhen exchange has brought to the fore a 'share mania' that has been quietly brewing in China since the stock exchanges were first set up 18 months ago.

This passion for stocks and shares, described by an official of the People's Bank Of China as 'a blind craze', is the nearest mainland Chinese get to a punt on the horses at Hong Kong's Shatin course. The Chinese have a reputation as keen gamblers, so it is no surprise that they have taken to their new outlet with such enthusiasm. The Shenzhen index has shot up from 110 in February to 300, while the Shanghai index has gone from 300 to 1,100, having peaked at 1,500 in May.

Some foreign fund managers worry that a bubble is forming, and that it will inevitably burst. But there is a more fundamental concern too. How seriously should we be taking the advent of capitalist institutions in the heart of Communist China?

The Chinese have convinced themselves that there are no problems. 'You cannot separate market factors from socialism,' Wu Ya Lun, assistant general manager of the Shanghai exchange, said. Shen Rui King, senior publicity officer at the exchange, pointed to Russia's failed attempt to put Marxist theory into action and said: 'To ask whether the stock exchange belongs to capitalism or socialism is too fixed; we have to think what benefits the people and the nation.'

The exchanges were set up with the aim of channelling the estimated 1,000 billion yuan (about pounds 95bn) held in savings in Chinese banks into the economy. 'A securities market is one of the most important means of raising money for the economy,' Mr Wu said. In addition, foreign investors have been encouraged to put money into Chinese stocks, with a number of Hong Kong-based companies having funds that invest in them.

But the recent riots in Shenzhen raise the question of whether the chosen medium is a sensible one and just how prepared the Chinese are for such a capitalist experiment.

There is no doubt that, from the investor's point of view, returns can be high. Both 'A' and 'B' shares ('A' shares are only available to the Chinese and 'B' shares to foreigners) have been known to double or even quadruple in a day.

But as is often the case, high returns also mean high risk. Published Chinese accounts of listed companies have little in common with Western standards, for example. The emphasis is mainly on how much profit and tax an organisation can hand to the state. But Mr Shen said: 'We are making great efforts to meet the needs of international accounting standards. We are already asking for disclosure of financial statements in local papers twice yearly.' And some exchange employees are being trained by international accountancy firms.

Eoghan McMillan, managing partner of the accountants Arthur Andersen and auditor of the first two 'B' share listings, expressed little concern over the recent riots. 'They are simply a product of over-excitement heightened by demand being too great for supply.'

But China lacks a securities or company law and has no regulatory organisation to match the Securities and Investments Board in the UK. The People's Bank of China regulates the exchange and, in June, the beginnings of a new regulatory body, the Shanghai Municipality Securities Management Committee, was set up. It is too early to judge the extent to which this new body may improve the current system.

Nonetheless, the fact remains that the market is booming, and not all foreign investors are sceptical about it. 'China plays and China 'B' shares may not be the fool's gold we all thought,' Dudley Howard, director of Jardine Fleming Investment Services in Hong Kong, said. 'We are currently seeing the first inflow of foreign money, and this has been shown to be a success.'

Availability of shares to foreigners is limited. Only eight 'B' shares have so far been listed in Shenzhen and, of the 15 companies listed on the Shanghai exchange, only four have 'B' shares. But all of the 'B' shares so far listed have been eagerly snapped up. The companies include a television component maker, a chemical factory, a tyre and rubber firm, and the self-explanatory China Number One Pencil.

K C Leong, director of Roctec Securities in Hong Kong and chairman of the Hong Kong Futures Exchange, has invested in 'B' shares. He said they 'shot up initially although the market has been a bit quiet recently. We will be buying more.

'But when investing in any instrument you have to know the company and bear in mind it is a new and emerging market, the liquidity of which is never as good as a mature market,' he said.

Mr Howard said: 'China 'B' shares have to be viewed as long- term investments.' Because of the lack of transparency, they can only be bought 'with your eyes closed'.

The Chinese stock markets are exciting places, and with a total of 100 listings expected by the end of the year they cannot be ignored. But they require a considerable degree of caution.

(Photograph omitted)