China’s MSCI win may be a loss for some regional equity markets

Stocks fell in some Asian markets after MSCI said it would include A-shares in its benchmark emerging market index

PUBLISHED : Thursday, 22 June, 2017, 12:52pm
UPDATED : Thursday, 22 June, 2017, 10:46pm

China’s US$7 trillion domestic stock market has won a historic entry into MSCI’s key benchmark emerging markets index. But China’s gain could be a loss for some Asian economies as the inclusion is expected to siphon away capital from other regional markets as investors reshuffle portfolios to increase Chinese investment, according to analysts.

South Korea, Taiwan, and India could see the largest dilution in their stock weights in the MSCI Emerging Market Index (EM Index), translating into a combined US$4.2 billion worth of net selling by global investors, according to the latest projection by Goldman Sachs.

Credit Suisse also expects these three markets to see weightings drop as China’s proportion increases.

MSCI’s A-share nod brings Chinese stocks into the global mainstream

MSCI Inc, a global index compiler, said Wednesday that it will include 222 stocks of China’s onshore yuan-denominated shares, or so-called A shares, in its widely-followed MSCI EM Index. The index currently only includes shares of Chinese companies listed in Hong Kong or the US.

These A-share stocks only account for 0.73 per cent of the index’s weighting, based on a 5 per cent initial inclusion factor. That means MSCI will initially count 5 per cent of the free-float market cap of these selected stocks, but the weighting could increase in future if China implements more market reforms, MSCI said.

The change will take place in two steps: the first in May 2018, and the second three months later.

For China, the A-share inclusion is considered by many analysts as positive not only in bolstering its market sentiment and triggering global fund inflows, but also enhancing the yuan’s status as an international currency and boosting China’s credibility as a global economic power.

MSCI estimates initial inflows could reach US$17-18 billion following the partial inclusion. The amount could increase to US$340 billion if more A-shares are included in future.

However, it could spark capital outflows from other emerging markets in the EM Index, some worry.

Following the announcement from MSCI the South Korean stock market fell, with Seoul’s Kospi index closing down 0.5 per cent at 2,357.53. India’s Sensex index also closed slightly lower.

South Korea’s top financial regulator voiced concerns about possible capital outflows.

Jeong Eun-bo, vice chairman of the Financial Services Commission, said Wednesday at a policy meeting that South Korea’s weighting in the MSCI EM Index will shrink to 15.2 per cent as China’s total weight rises to 28.4 per cent.

Given the size of global funds tracking MSCI’s EM index, the outflow from South Korean equities could reach 600 billion won (US$528 million) to 4.3 trillion won, Jeong said.

Nonetheless, he added that the anticipated outflows will have limited impact on the country’s equities.

What is the MSCI index, and why does it matter so much to China?

The MSCI EM Index is tracked by US$1.6 trillion worth of assets and is used as a benchmark index by many emerging market mutual funds. It currently consists of indices from 23 emerging markets, including Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, South Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and the United Arab Emirates.

Hong Kong and US-listed Chinese stocks possess the biggest weight in the index — 27.66 per cent, according to the latest data from MSCI.

South Korea, Taiwan, and India follow with a 15.65 per cent, 12.23 per cent, and 8.75 per cent weight respectively.

Analysts anticipate South Korea, Taiwan, and India to see biggest capital outflows among markets covered by the index, as investors sell other stocks to make room for A shares in their portfolios.

Goldman Sachs analysts Kinger Lau and Timothy Moe predicted China’s total weight would reach 28.5 per cent after MSCI adds the 222 A-share stocks based on a 5 per cent initial inclusion factor.

As a consequence, South Korea’s weight will drop by 0.11 percentage point, while Taiwan and India will see a fall of 0.09 percentage point and 0.07 percentage point respectively.

That translates into US$1.8 billion, US$1.4 billion, and US$1 billion of net selling separately for three economies, Goldman analysts said.

If the inclusion factor increases from 5 per cent to 100 per cent in the future, China’s total weighting could rise to 37.2 per cent, with the A-shares’ weight at 12.9 per cent. In that situation, South Korea, Taiwan, and India’s proportions might decrease to 13.5 per cent, 10.7 per cent, and 7.8 per cent.

Other markets such as Brazil, South Africa, Russia, and Mexico will also see a dilution in weights.

However, Credit Suisse’ forecasts are a little bolder. Based on a 5 per cent initial inclusion factor, it says China’s total weight will reach 29.28 per cent by August 2018, when MSCI completes the addition of the 222 stocks.

South Korea’s stock weight will decline to 15.27 per cent, Taiwan’s weight will be diluted to 12.07 per cent, and India’s will drop to 8.75 per cent, according to Credit Suisse analysts.