A-shares move will not solve China's capital flows problem
Beijing remains uncommitted to market reforms despite MSCI announcement
Henny Sender, Nikkei Asian Review columnist
When the global index provider MSCI announced that it had decided to include China's onshore A-share market in its emerging market indices, the widely tracked CSI 300 index of major Chinese shares rose sharply, hitting a 17-month high of 3,587.96 on June 21, the first trading day after the announcement.
The CSI index has remained strong, closing at 3,674.72 on June 27. But a more muted response might have been more appropriate. The announcement was replete with qualifications. Only 222 stocks are eligible for inclusion in the MSCI index, and even that involves a two-step process in May and August of 2018.
The amount of fresh money that will flow into Chinese stocks from abroad as a result of MSCI's move is underwhelming: UBS, a Swiss investment bank, put it at $10 billion, while ANZ, an Australian bank, estimated that inflows might reach $12 billion. That compares with total market capitalization of $8 trillion for the A-share market as a whole.
Beijing is keen to offset capital outflows -- potentially its biggest economic problem -- by encouraging inflows into its financial markets, or in the form of less transient direct foreign investment. But the MSCI announcement on emerging market indices will not solve China's capital outflow problem. In May, a moderate month, $27 billion left the country.
China's inclusion in the world's government bond market indices, which could happen soon, would be far more significant in inspiring inflows, potentially facilitating investment of $1 trillion over the next decade, according to Goldman Sachs, a U.S. bank. But even that is not enough for jittery politicians or regulators in Beijing, for whom capital flows are a challenge that has economic, financial and political dimensions.
High levels of capital outflows put downward pressure on the yuan, forcing the People's Bank of China, the central bank, to keep interest rates higher than they would otherwise be to encourage companies and individuals to keep money at home. The burden of leverage on state enterprises is heavy; reducing it by easing interest rates is a top priority for the central bank's political masters in the capital.
In some ways this is yesterday's story. Capital outflows are expected to amount to about $300 billion in 2017, less than half last year's $634 billion or 2015's record $674 billion, according to economists at JPMorgan, a U.S. bank. Some of the reduction is due to rigorous enforcement of capital controls; in particular, acquisitive privately held companies such as Anbang, Dalian Wanda, Fosun, and HNA have been told to stop making multi-billion dollar acquisitions outside China.
However, some of it reflects the repayment of foreign exchange denominated debt by state owned enterprises. "Corporate balance sheet adjustment is almost done," said JPMorgan. The rate of economic growth has also been higher than expected, buoyed by strong exports and consumption. And the quality of growth has also improved. Today, growth depends less on property and investment in heavy manufacturing and more on champions of the "new economy."
The PBOC reduced the gap between dollar interest rates and local rates ahead of a widely anticipated 25 basis point hike in U.S. interest rates in mid-June, reducing the incentive for savers to put their money outside the country. And the dollar has not strengthened despite the hardening of U.S. monetary policy; a less buoyant dollar means less downward pressure on the yuan. Several brokerages now predict that the Chinese currency will end the year close to its current level of about 6.81 to the dollar, erasing earlier prognostications that it could fall to below 7.00.
All these developments ease pressure on Beijing. But that is not to say that all is well. Too much capital continues to flow to the least productive state owned enterprises; 70% of corporate debt is held by large entities in minerals and mining. And it is these big, indebted companies that foreigners will be encouraged to buy into as a result of the MSCI decision.
It would be tempting to conclude that having satisfied the MSCI that capital will be allowed in (and more importantly out, though there will be limits on such repatriation), and agreed that shares that remain suspended will be excluded from the list, Beijing has committed itself to reform.
However, such a conclusion would be too optimistic, given Beijing's continuing interference in the operation of markets, and in the management and ownership of companies -- including seeking to stabilize share prices by making it harder for large shareholders to dispose of their holdings, which some companies agreed to without either a board or shareholder vote.
"China's regulatory tightening on the A-share market -- such as the restriction on major shareholder selling and the slowdown of the [initial public offering] approval process -- left questions on whether Chinese regulators are keen to loosen their grip on the onshore equity market," analysts at UBS noted.
Stock exchanges are a western capitalist invention, and China has never embraced the idea of shareholder democracy or of accountable corporate governance. Behind every board of directors is a Communist Party committee. The chief executive of any company may at any time be reassigned to a different company, even a direct rival of his previous business, or moved into a regulatory or political assignment.
Sadly the indications are that Beijing will continue to opt for the easier and short-term fixes -- at least for the moment.
Henny Sender is the Financial Times's Chief correspondent for international finance based in Hong Kong and contributes occasional columns to the Nikkei Asian Review. She has extensive experience covering international finance in the U.S. and Asia, including in Japan, Hong Kong and South Asia.