Ultimately, capital markets need to be deregulated and the exchange rate has to be allowed to float freely if Shanghai wants to become a financial hot spot. “Capital flows have a significant influence on trends in exchange rates,” says Christina Chung, a senior portfolio manager at RCM, whose responsibilities include a $1 billion China-related fund for Allianz Global Investors. For that reason, opening the capital market could be better facilitated if the yuan (also known as the renminbi) is allowed to float.

THE NEED FOR ACTION IN REGARD TO capital market-related issues is revealed by looking at the domestic stock markets. “More than 95% of the money invested there originates domestically,” says Chung. Accordingly, it comes from investors who are new to the capital market and have little experience with it. “For that reason, they behave in a very uniform manner, which intensifies the price movements both upward and downward,” she adds.

This explains why, over the past several years, China’s domestic markets alternated between overheating and massive price slumps in quick succession, which is not a desirable trend at all. As a result, China’s government took initial steps in 2003 to open the capital market, including implementation of the Qualified Foreign Institutional Investor (QFII) Act. This status entitles foreign investors, under certain conditions, to invest directly in Chinese Class A shares that had originally been reserved solely for native Chinese investors.

The move was intended to draw foreign capital in the form of money from investors who wish to make long-term investments and so stabilize share price trends in China’s domestic markets. However, it really only was one small step. Ultimately, meeting the QFII requirements was not enough. “When it comes down to it, the China Securities Regulatory Commission (CSRC) decides whether and how much investors can invest in China,” Chung explains. In addition, a QFII’s investment amount is limited to $1 billion, with the total sum from the QFII program restricted to $30 billion.

“Despite the QFII, the capital market is in a very early stage,” says Chung. There is still a long way to go and the path could be better paved if a floating exchange rate goes hand in hand with it.

FROM AN INVESTOR’S PERSPECTIVE it is worth monitoring developments given that a lot of things will change on the road to Shanghai potentially becoming a financial market where capital is free to move.

China’s stock market could actually stabilize if it pulls in more investors with a long-term view, which might then allow for greater emphasis on basic factors. For example, shareholder value could become an important issue for Chinese companies and a topic that they would integrate into their corporate strategies. The business culture could change, while a corporate governance system that is aligned with international standards could play a more significant role.  

Should the doors to this market open, and the exchange rate along with it, Chinese markets will be able to offer entirely new prospects, in particular the possibility of participating in the country’s rapid economic growth.

Published by PROJECT M in April 2010

(Photo: Alessandro Digaetano)