17 October 2018
Domestic investors are driving China's  A-share rally. In order to maintain the momentum, Beijing has announced an economic stimulus. Photo: Internet
Domestic investors are driving China's A-share rally. In order to maintain the momentum, Beijing has announced an economic stimulus. Photo: Internet

Why China is not rushing to open its capital account

Some people think June is a bad month for the Hong Kong stock market.

In fact, stocks have risen during June in seven of the past 10 years.

The Hang Seng China Enterprises Index (HSCEI) has traded mixed, gaining between 0.41 percent and 0.69 percent over that period.

By comparison, non-Chinese stocks in the benchmark Hang Seng Index (HSI) have been less volatile.

Government policy drives HSCEI, making stocks in this sub-index more unpredictable.

A-share spurt

In mainland China, domestic investors are mainly behind a rally in the A-share market.

In order to maintain the momentum, Beijing has announced an economic stimulus including cuts in interest rates and the reserve requirement ratio for commercial banks.

However, foreign investors have yet to fully embrace the mainland bull market.

As a result, they have been piling into Hong Kong, snapping up domestic shares in competition with mainland investors.

Stocks in which overseas funds have a large holding are facing a downside while HSCEI plays are grappling with a sell-off by foreign investors.

Also, there is increased uncertainty in the external environment including an impending rate hike in the United States and problems associated with deepening economic challenges in Greece.

In addition, growing tensions between the US and China over the South China Sea issue and a political standoff in Hong Kong over political reform are putting pressure on fund managers.

Good returns

Most funds have made good returns in the first half, taking profit and buying stocks during market corrections.

HSI is likely to trade between 27,000 and 28,500 points this month.

By contrast, HSCEI is expected to be more volatile. Speculators will focus on stocks that have asset injection potential given ample market liquidity.

A game charger could be the possible inclusion of A shares in MSCI. However, that is not likely to happen this month.

FTSE is set to include A shares in two new emerging market transitional indices, which might prompt MSCI to follow suit.

If that happens, the move could have huge implications for investors.

Opening up the A-share market is part of Beijing’s efforts to internationalize the Chinese currency.

Also, China is keen to see the renminbi in the SDR (special drawing rights) basket this year.

China could make changes to the currency settlement regime to pave the way for the entry of A shares to MSCI.

That is technically viable but it could lead to a runaway bull market and could get out of control.

Under control

At the moment, the bull market is manageable and regulators can simply open new financing channels to ease pressure on stock prices.

But any hasty move to liberalize A shares could open the floodgates for sophisticated foreign investors which might cause some negative short-term impact on the market.

About 80 percent of investors in China’s equity market are individuals.

Authorities may delay any decision to welcome foreign investors until they see significant progress in the ongoing economic restructuring and some clarity over local government debt.

That means China’s financial market will be liberalized in a gradual and orderly manner.

If A shares don’t make it to MSCI this year, the impact on the market will be little more than psychological.

If they do make it, they will initially involve no more than 50 billion (US$8 billion) to 60 billion yuan worth of shares, which is insignificant for a market with daily turnover above 2 trillion yuan.

This article appeared in the Hong Kong Economic Journal on June 2.

Translation by Julie Zhu

[Chinese version中文版]

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columnist at the Hong Kong Economic Journal

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