Capital gains?

China polices money flows

Archduke Franz Ferdinand made an unwitting contribution to world finance. His assassination sparked war in Europe in 1914, and with it the introduction by the belligerents of a new concept: capital controls. Most countries have long since dumped these measures. China remains a large and glaring exception.

So recent news that Beijing may be looking to ease current restrictions further got widespread attention.

The reason? The government wants to stimulate the ailing A-share market.

For five years, A-shares have been a constant disappointment. Since the SSE Composite Index in Shanghai collapsed after climbing above 5,900 points in October 2007, investors have been waiting for the  recovery that never came. Over the last 12 months, the A-share market has lost nearly a quarter of its value and is currently trading at around 2,300 points.

With domestic investors so unenthusiastic, the view seems to be that foreign money may offer the best hope of boosting stocks. So last week the CSRC, the securities regulator, announced plans to expand the scale of the Qualified Foreign Institutional Investor scheme (QFII), which allows foreign funds to invest in China’s capital markets.

The total quota for QFII will be increased by $50 billion. To put this in context, it is more than double the $24.55 billion of quota allocated to investors since the scheme was first introduced in 2002.

In addition, a separate programme that allows renminbi held offshore to be reinvested back into mainland China – Renminbi QFII – is to be extended by Rmb50 billion. RQFII was launched as a pilot late last year, with 21 institutions sharing an initial investment quota of Rmb20 billion.

The expanded RQFII quota will be heavily focused on the stock market, given it is no longer subject to rules that capped the proportion that could go into equities at 20%, reports Shanghai Securities Journal.

In particular, the securities regulator is hoping that the larger scheme will help promote the market for the exchange-traded funds that follow the A-share market.  The CSRC recently gave the green light for Hong Kong to list renminbi-denominated A-share ETFs too.

Despite the potential for a larger inflow of money from abroad, the impact on the market is uncertain. At the end of March, the value of the assets held in QFII accounts was Rmb265.6 billion, representing just 1.09% of the A-share market’s capitalisation. Even after the expansion of QFII and RQFII, foreign capital will account for a tiny part of the stock market.

In fact, some analysts believe that an expanded QFII is more important for the way it could encourage broader economic change. Bank of China’s chief economist, Cao Yuanzheng told Shanghai Securities News that an increase in the investment quota would be felt in other areas, such as reforms of the exchange rate mechanism and in bringing a greater level of transparency to China’s capital markets.

The expansion of QFII could also be part of a more general relaxation on capital controls, accompanying other signals that it could become easier for Chinese individuals to invest abroad.

Two weeks ago, WiC reported on a pilot scheme that would allow individuals in Wenzhou to invest up to $200 million abroad directly (WiC144) and the Economic Observer reports that Shanghai and Tianjin have also submitted requests for similar schemes to the State Council. The newspaper says that it is possible that all three cities will be given the go ahead at the same time, widening the two-way flow of capital across China’s border.

HSBC China strategist Steven Sun is bullish and reckons the latest reforms could see the SSE Composite Index hit 2,800 by year-end.

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