Though it could be viewed as too little too late, the decision by index compiler Morgan Stanley Capital International (MSCI) to add Chinese stocks to its benchmark index still matters to the world’s second-largest economy and the investment community globally.
The inclusion of domestically traded, yuan-denominated stocks, or the so-called A-shares listed on the Shanghai and Shenzhen stock exchanges, is another milestone towards China gaining full acceptance in the global economy.
It follows the International Monetary Fund’s decision last year to include the yuan in its basket of currencies that make up the Special Drawing Right, making the Chinese currency the fifth global reserve asset.
It is a welcome vote of confidence as China aims to make reforms that are amenable to international investors after three years of delays.
However, China’s 222 large-cap stocks that will be included in the MSCI Emerging Markets Index in May 2018 will account for only 0.73 per cent of the index. They will also be included in the MSCI All Country World Index (ACWI) with a 0.1 per cent weighting, and MSCI Asia ex-Japan Index with a 0.83 per cent weighting.
The MSCI index is tracked by more than US$1 trillion dollars of pension money and passive funds. At the initial stage, the weighting will roughly translate to US$17 billion of inflows into China, which means little in a market that is valued at US$8 trillion and last year had an average daily turnover of about US$70 billion.
Currently, foreign investors own less than 1.5 per cent of Chinese stocks, through a Hong Kong platform known as Stock Connect.
But in the long-term, the A-share’s market share could grow if China makes progress in market openness and governance. A MSCI road map suggests the ultimate weighting of A-shares could reach 18.8 per cent of the index. If it takes into account H-shares in Hong Kong and Chinese companies listed on the US stock exchanges and other regions, China would then have a nearly 40 per cent weighting in the index.
While green-lighting China’s long sought-after inclusion, the provider indicated China still has a long way to go to catch up.
For instance, the A-share’s disproportionate 0.73 per cent weighting in the index is tiny compared to South Korea’s 15.65 per cent, Taiwan’s 12.23 per cent, and India’s 8.92 per cent weights, respectively. The MSCI has just applied a 5 per cent “inclusion factor” to the A-share domestic universe, while other emerging markets such as Egypt, India, South Africa, and China’s regional peers, South Korea, Taiwan and Thailand all have markets that enjoy 100 per cent inclusion.
Currently, the Chinese exchanges are still among the most inaccessible markets to foreign investors. The stock exchanges are also known for their poor corporate governance as evidenced by widespread fake information, insider trading, corruption and heavy-handed government intervention. That is why MSCI has chosen a very cautious, calculated approach on the issue of China’s inclusion.
Both China and global capital markets will receive a big push as the world’s second-largest stock market opens up to international investors. It is hoped the inclusion will serve as a game-changer, bringing about fundamental revisions to the dynamics, demographics and sophistication of China’s capital markets.
And such progress will be crucial for Beijing’s effort to establish Shanghai and Shenzhen as regional or global financial centres, another milestone in China’s journey to fully embrace economic globalisation. ■
Cary Huang, a senior writer with the South China Morning Post, has been a China affairs columnist since the 1990s