All eyes on China as MSCI considers inclusion for Beijing

World's second-biggest economy's market may be accepted by New York index, spurring a flood of billions of dollars in foreign investment.

Powered by automated translation

Beijing // Chinese companies and the stock market are eagerly awaiting a review of listings by the New York-based index maker MSCI which will consider whether to including Chinese shares in its indices at a meeting on Tuesday.

If successful, it could drive huge amounts of international investment into Chinese stocks, and may seriously hit markets in other Asian countries as their stocks will lose weighting with the entrance of the mammoth player in MSCI’s Emerging Markets Index.

"Inclusion in the MSCI would certainly be a positive for China's equity markets," Chang Liu, China Economist for Capital Economics told The National. "Inclusion in the index will almost certainly lead to a pick up foreign investment in Chinese stocks".

MSCI said recently it was considering listing China’s A shares as local regulators have addressed some of the issues it had flagged earlier, and tried to overcome investor concerns.

It estimated that inclusion in its Emerging Markets Index could draw US$400 billion into Chinese shares in the next decade. But some analysts believe this kind of inflow is possible in as little as five years because a large number of Chinese companies are planning to list in exchanges in New York, London and Hong Kong.

A shares are stocks of Chinese companies that are off limits to overseas investors and can only be purchased through a specially regulated programme known as Qualified Foreign Institutional Investor (QFII) scheme. An MSCI listing is expected to not just enlarge the scope of QFII programme but also lead to relaxation in controls on foreign investments.

The recent MSCI statement caused a surge in the Shanghai stock exchange and some of the top investment bankers expressed strong optimism. Goldman Sachs said there is a 70 per cent chance that Chinese shares would enter the MSCI index.

Views differ. Some analysts said there are seriously regulatory issues in the Chinese market which might persuade MSCI to withhold listing by another year. It had rejected China’s case after a stock market crisis last year.

One of the issues concerns indefinite voluntary suspension of stocks, which is being used as a ploy by some listed companies to avoid price crashes or regulatory action. The China Securities Regulatory Commission (CSRC), China’s market regulator, is trying to control such suspensions and limit trading halts to maximum of three months.

“Widespread suspension has been a key hurdle for MSCI A-share inclusion, per MSCI. We now view this issue as 100 per cent resolved, reinforcing our 51 per cent probability – ie yes, but with high uncertainty – for MSCI to approve the inclusion,” said Jason Sun, the chief China strategist at Citi Securities.

Undervalued blue chips, particularly financial stocks, are likely to attract the most overseas capital allocation as they fit into the investment preference of foreign institutional investors, according to Tu Jun, an analyst at Shanghai Securities.

“Based on our estimation, financial stocks will make up 40 per cent of the A shares even with their initial 5 per cent weighting in the MSCI indexes, which will translate into roughly 60bn yuan (Dh 33.58bn) into the financial stocks,” Mr Tu said.

The push for MSCI listing ties with China’s desire to become a influential player in the international financial markets after establishing itself as a major manufacturer and exporter.

China has crossed two significant milestones in the world of finance over the past year as the IMF agreed to admit the yuan as one of the covered currencies in its basket for Sovereign Drawing Rights, and Beijing become the head quarters of the newly formed Asian Infrastructure Investment Bank.

In addition, the recently established New Development Bank launched by Brics countries has made Shanghai its head quarters.

The MSCI tracks $1.5 trillion worth of assets globally. Having its shares listed would enhance China’s influence in the world financial markets, and also help Beijing’s efforts to further internationalize the Yuan, analysts said.

The CSRC chairman Liu Shiyu has made it clear the regulator would focus on reforms to overcome probelms that led to past market crises. Getting Chinese stocks accepted is expected to help in the reform effort as Chinese companies would be pushed into the international buyer spotlight.

A CSRC spokesman went a step further describing the absence of Chinese shares in MSCI Emerging Markets Index was a “shortcoming”, which is why the regulator would be happy to see them included.

“As further reforms are pushed through in coming years and China’s financials markets are opened up further, the regulatory structure will have to be updated too,” Mr Chang said.

Analysts differ on the chances of MSCI including Chinese shares in the index, and whether such a listing would immediately open up floodgates of foreign funds flowing into Chinese markets.

Some expect the MSCI to move cautiously by including just 5 per cent of China A shares at this juncture, if it agrees to go ahead with the listing on Tuesday. This measure itself would result in an inflow of US$15bn to $20bn of foreign funds into Chinese stocks.

“Although the short-term impact isn’t likely to be very big – if the weighting of China’s stocks is increased over time [which is the plan according to the roadmap published by MSCI last year] it could have a significant impact on both China’s equity markets and even on the renminbi exchange rate,” Mr Chang said.

It is a good time for Chinese stocks which have remained more or less stable for the past four months after going through two major crises in 2015 and early this year resulting in a $600bn erosion in market value.

“The government has made progress in recent years in financial reforms, which is partly why investors are optimistic that the MSCI will decide to include China’s A-shares this time around,” Mr Chang said adding, “I think the government recognises that it made missteps in their heavy-handed response last year and has become better at communicating their policy responses in recent months”.

China has been the world’s second-biggest magnet for attracting foreign direct investments (FDI) after the United States for several years. FDI receipts in China now total some $2.6tn.

But the country has attracted very little portfolio investments partly because of the very nature of Chinese corporate ownership, and the government’s strict controls on foreign funds. The government has been concerned with “hot money”entering equities because they can cause shockwaves if and when they exit the market suddenly.

business@thenational.ae

Follow The National's Business section on Twitter