By Samuel Beatson.

After offering weak returns to investors for a long time, the Shanghai stock exchange index for all shares has seen a dramatic rise of almost 15% in the last forty five days. This seems to indicate that investors in the stocks of Chinese companies have keen expectations for mainland companies and following global equity portfolio flows to both Japan and Hong Kong, the Chinese stock market has offered its own short terms gains.

Hong Kong’s Hang Seng index has been climbing for three months which seems to support the phrase that “Hong Kong was, and continues to be at the centre of Chinese-led capitalism.” The short-term bullishness here demonstrates the institutional and local confidence in the Hong Kong market. The steadfast rise in Hong Kong stocks may also indirectly reflect the renewed global interest in the shares of Chinese mainland companies amongst foreign investors in addition to that of Chinese investors in Hong Kong and the mainland who possess Hong Kong stock trading accounts.

Moreover, in 2012, the Chinese regulatory authorities approved a record 72 new QFIIs (Qualified Foreign Institutional Investors) to be able to invest directly in the mainland, more than in 2009, 2010 and 2011 put together, taking the closed capital account another notch towards the optimistic vision of openness outside investors wish for. In addition to satisfying the foreign institutional hunger to be a “China player”, it may also signal that regulators have some confidence in the market offering stable returns in the mid-term.

The moves upwards in the Hong Kong and mainland Chinese equity markets reflect an internal investor confidence in China’s economy and an expectation that the valuation of its listed firms should move in line with those on the exchanges of developed financial markets in the region.

Another positive sign for the development of capital markets and the evolution of what were large, unprofitable listed firms are the 2011/12 global portfolio flows into China. These have finally surpassed cumulative portfolio investment inflows into the other BRICS economies apart from India, overtaking Brazil for the first time. Again this signals investor confidence that the new Chinese leadership might take a more pragmatic approach to financial markets and the performance of companies could improve mid-long term both in terms of productivity and standards of reporting and managerial integrity.

The evidence seems to send a clear message to the new Chinese political line up that further financial markets development is required in China to facilitate China’s competitiveness and attractiveness for outside capital in addition to the expectations of internal investors. The latter is necessary to curb investment outflows from within China, which have risen from US68 billion in 2008 to US190 billion in 2011. It also shows confidence in the contemporary image of the Party.

China can remain optimistic with the latest economic figures, but should not ignore the very real political risk of leaving financial markets under-developed. The issue of developing China’s capital markets should no longer remain a side-line issue– an opportunity cost of FDI that sits on the margin– let alone an opportunity cost of ideological rhetoric. Neither should it be left to internal investors to “follow” the developed economies in regions around mainland China and prop up China’s stocks. Focusing on continuing reform and development of China’s enterprise and financial markets could help solve the challenges and opportunities China faces and promote stable growth in these most exciting of times for China.

Samuel Beatson is a PhD candidate in the School of Contemporary Chinese Studies, University of Nottingham.

Opinions expressed in the CPI blog do not represent the views of the China Policy Institute or the School of Contemporary Chinese Studies at the University of Nottingham. They are the personal views of the bloggers/authors