HONG KONG/SHANGHAI -- China has taken a small but significant step toward opening its capital market with the long-awaited Shanghai-Hong Kong Stock Connect, which began trading on Nov. 17.
The so-called through-train mechanism makes it possible for foreigners to invest in stocks listed on the Shanghai Stock Exchange -- via Hong Kong.
But numerous restrictions remain, and the liberalization of capital transactions in China is still in its infancy. Moreover, the sharp divide between the onshore and offshore yuan, including their exchange rates and interest rates, means the Chinese currency is still a less-than-ideal choice for settling merchandise-trade accounts.
Listed only on the Shanghai exchange, Tasly Pharmaceutical Group has not felt the need for an English-speaking investor relations officer, but the company expects the through-train program to change that.
The Tianjin-based herbal medicine maker is drawing international attention because the clinical trial of its primary drug has reached the U.S. Food and Drug Administration's final Phase III stage.
"From now on, as more and more foreign investors enter the market, English-speaking staff will definitely be a necessity," said a public relations manager at Tasly.
"The Shanghai-Hong Kong Stock Connect will convert the yuan from a settlement currency into an investment currency," Charles Li Xiaojia, CEO of the Hong Kong Exchanges and Clearing, told the Nikkei Asian Review. "I can see a great potential for the yuan to become a truly globally relevant investment currency. Its significance is really historic."
Net purchases of trading until Dec. 2 under the cross-trading program totaled 53 billion yuan ($8.6 billion), just 19% of the cap set by the Chinese securities industry watchdog to prevent erratic flows of speculative money.
Although the stock market link got off to an unexpectedly sluggish start, Dong Tao, chief economist for Asia at Credit Suisse, said, "According to my conservative estimate, at least 700 billion yuan of funds will flow into the Chinese market."
Though overseas assessments of China's economy are growing more grim, Chinese stocks are expected to attract investors from abroad, as they currently account for just a fraction of Chinese companies' market capitalization. Overseas investors have a far smaller presence in China than in other markets due to the government's restrictions on stock trading by foreigners until now.
MSCI, which calculates the indexes, said in March that it would consider incorporating China into its emerging markets index but announced a delay in June on the grounds that investment opportunities for foreigners were limited in China. MSCI plans to study the issue again in 2015, and the chances that China will be included in an index are increasing now that foreign investors have freer access to Shanghai stocks under the new program.
Miles to go
China permitted the use of yuan to settle accounts for merchandise trade in 2009, following the Lehman shock, and has since been promoting such settlements to counter the dominance of the dollar.
In contrast to this liberalization, the Chinese government maintains strict controls on securities investment and other capital transactions in the currency. Companies must go through complicated procedures, submitting contracts, customs documents and other paperwork, to prove that the use of yuan in and outside China was for merchandise trade.
In addition, interest rates on yuan-denominated funds are lower outside China than on the mainland, and there is a gap between the yuan's onshore and offshore exchange rates against the dollar. It is also extremely difficult to take out loans or issue corporate bonds in yuan outside China because of strict restrictions imposed by Beijing.
Merchandise trade in yuan totaled 4.8 trillion yuan in the first nine months of 2014 and accounted for 25% of total trade in the period, down slightly from 27% in the January-March quarter and 26% in the first half of the year.
The ratio remains low because strict restrictions on capital transactions make it difficult for non-Chinese companies to put the yuan they receive through trade to effective use. The Shanghai-Hong Kong Stock Connect program gives them a new option for managing such funds, but the yuan still has many hurdles to overcome before it can pose a serious threat to the dollar.