While undervaluation of the renminbi was a major factor causing the large imbalances in the past, our assessment now is that the substantial real effective appreciation over the past year has brought the exchange rate to a level that is no longer undervalued,” the IMF said in a statement last Tuesday.
While the language was unremarkable, the moment was significant. The world’s preeminent monetary authority was finally endorsing the view that China is not a currency manipulator.
Most analysts had been expecting the news for months. China’s current account surpluses have shrunk and its foreign reserves stopped ballooning at the same explosive rate. The yuan has been strengthening for years – including a 14% rise against a trade-weighted basket of currencies since the middle of 2014, according to the Bank for International Settlements.
Still, the IMF’s findings weren’t greeted with any enthusiasm at the US Treasury, which reiterated its view that China’s currency is still undervalued, according to an unidentified official who briefed the media just hours later.
Attention now turns to New York where MSCI Inc, the provider of the most widely tracked benchmarks of emerging markets stocks, is about to disclose whether it will add mainland Chinese stocks to its indices in the coming year.
Last month, FTSE Russell, another index provider, committed to launching two new products that will incorporate Chinese A-shares over the next three years. They will have an initial weighting of 5% Chinese equities, but the proportion will rise over time to close to a third. “Investors need to begin the transition and the planning for the inclusion of A-shares in their global portfolios now,” commented Mark Makepeace, chief executive of FTSE Russell.
If MSCI opts for a similar scheme it could prompt a surge in buying by global asset managers. Mere news of any changes are likely to supercharge sentiment in China, where the atmosphere is already frenetic. As of Tuesday this week the Shanghai index was up 49% year-to-date, with stocks in Shenzhen booming 107% over the same period.
MSCI has been studying whether to add A-shares since mid-2013 but pushed back the decision last year after hearing concerns from global investors that the Chinese market wasn’t open enough. Since then the Chinese authorities have permitted more of Shanghai’s stocks to be bought by Hong Kong-based investors (see WiC279) and expanded the quotas for qualified investors from other parts of the world through two further programmes.
For some, this still isn’t enough to warrant inclusion in the indices because foreign money is subject to daily and aggregate quotas. But there was anecdotal evidence last month that more international fund managers are ready to support the move, with five of nine global investors interviewed by Bloomberg agreeing that Chinese stocks should be added.
Mark Mobius from Templeton Emerging Markets was typical of the change of mood. “Every time MSCI came around, I said ‘Forget it. We can’t invest,’” he said. “Now we can, and I have no objection.”
The Chinese have been lobbying global funds to approve the move, because they see endorsement by MSCI as a way of professionalising the local stock market and boosting the yuan’s influence in global finance.
Certainly, some form of reweighting looks inevitable because China is so under-represented at the moment, despite producing 15% of global GDP.
The MSCI All Countries World Index – the widest benchmark, across hundreds of developed and emerging market companies – has half of its composition in US stocks, with Chinese shares taking up just 3% (that’s mostly mainland companies listed in Hong Kong). MSCI has already announced that it will include China stocks with American listings (companies like Alibaba and JD.com) from November this year.
But the same month holds another key date in the diary, with the International Monetary Fund set to decide whether the yuan should be included in its basket of reserve currencies, known as Special Drawing Rights.
Currently the basket is made up of the dollar, the euro, the pound and the yen. Adopting the renminbi too should prompt central banks into making matching investments for their sovereign reserves. And as much of this capital would flow into Chinese bonds, it could lead to a further flurry of yuan-denominated investment as the big benchmarks top up their indices again.
That makes it a hugely significant few months not just for the world’s financial markets, but also for China’s push for greater global acceptance of the renminbi.
And it ratchets up the pressure on MSCI too. Perhaps the tension was starting to tell on Monday, when executives at the index provider insisted that they don’t have to make their crucial call next week, despite typically deciding on the composition of the indices on a June-to-June schedule.
“We will stay as flexible as possible and are not rigidly bound to the year-to-year cycle,” said Chin Ping Chia, head of research for Asia-Pacific at MSCI during a media briefing in Hong Kong.
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