Set Chinese free to invest abroad
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China's policymakers want to recycle more capital abroad in order to reduce upward pressure on the yuan and slow official reserve accumulation.
Before they can achieve any meaningful results, however, they will have to twist a few arms among the country's different financial regulators in order to get the current rules changed. When they succeed, it will be good news for Hong Kong's stock market.
It is now a year since China announced its qualified domestic institutional investor, or QDII, initiative intended to allow mainland financial companies to invest abroad on behalf of their clients.
By any standards, the scheme has been a dismal failure. To date, domestic and international banks, insurance companies and a lone fund manager have been allotted quotas worth almost US$18.5 billion to invest in foreign markets. Estimates of how much money has actually been invested differ, but most analysts seem to agree the amount is somewhere between US$500 million and US$1 billion. In other words, in the year since the QDII scheme was introduced, only around one day's worth of China's foreign exchange inflows has been recycled abroad.
The reasons for this woeful lack of interest are simple enough. When the QDII scheme was first promulgated, the officials who drew up the rules erred deliberately on the side of caution.
The China Banking Regulatory Commission has so far restricted banks to offering bond investments. The mainland's insurance regulator has yet to approve any life insurance company investment beyond a couple of initial pilot schemes. And the China Securities Regulatory Commission has dragged its feet over allowing the fund managers and stock brokers it oversees to launch international investment products of their own.
As a result, the investment products on offer are desperately unexciting. By buying into a bank-run QDII product, clients of mainland banks can expect to earn a yield of about 5 per cent from its investments in US dollar-denominated bonds.
At first, that appears better than the 3 to 3.5 per cent they would get from Chinese government paper. But when you factor in the 3.6 per cent by which the US dollar has fallen against the yuan over the past 12 months, QDII investors would actually be losing money in yuan terms.
Compared with the A-share market that has risen over 100 per cent in the past 12 months, QDII products are deeply unattractive. It is small wonder that Bank of China scrapped its first QDII product in February in response to a lack of investor interest.
Spicing up the QDII scheme to make it more enticing to mainland investors would not be difficult. Banks are already experimenting with foreign exchange hedges and equity-linked notes. But if China's economic policymakers really want to ship more capital abroad, they will have to push the country's insurance and securities regulators into relaxing their rules to allow more investment in foreign currency stocks.
The China Insurance Regulatory Commission has been talking for months about letting insurance companies invest up to 15 per cent of their assets in overseas markets. It should now enact regulations allowing them to do so - complete with a generous allowance for investing in overseas equities.
Equally, the CSRC should stop trying to support the overblown A-share market and allow fund managers and securities companies greater freedom to invest abroad on behalf of their clients. With A shares trading at price to earnings valuations of around 40 times, compared with around 20 times for H shares, it is likely they will get plenty of takers despite the currency risk.
According to Stephen Green at Standard Chartered in Shanghai, simple rule changes could initiate outflows worth US$10 billion this year. That would do little to alleviate the upward pressure on the yuan, but over time the potential outflows would be many times greater.
And given that the first stop for many QDII investors would be H shares, any new rules would be good news for the Hong Kong stock market.