China’s hunger for cap­i­tal spurring mar­kets

DNA (Daily News & Analysis) Mumbai Edition - - FRONT PAGE - Christo­pher Bald­ing —Bloomberg

Bei­jing is sell­ing its re­lax­ation of in­ward for­eign in­vest­ment lim­its as a nat­u­ral open­ing of fi­nan­cial mar­kets. The re­al­ity is that China needs the cap­i­tal to keep the econ­omy go­ing, and the ques­tion is whether in­vestors will buy the hype.

Au­thor­i­ties dou­bled to $300 bil­lion the quota for stocks, bonds and other fi­nan­cial prod­ucts un­der the Qual­i­fied For­eign In­sti­tu­tional In­vestor, or QFII, pro­gramme, the State Ad­min­is­tra­tion of For­eign Ex­change an­nounced last month. China has re­sisted for years open­ing its fi­nan­cial mar­kets, so the changes – com­bined with a broad­en­ing of the scope of the QFII pro­gram un­veiled at the end of Jan­uary – rep­re­sent a sig­nif­i­cant step.

The trou­ble is that China is no longer an at­trac­tive in­vest­ment story.

Only about $101 bil­lion of the pre­vi­ous $150 bil­lion quota, or about two-thirds, is in use by over­seas in­sti­tu­tions, ac­cord­ing to data com­piled by Bloomberg.

The fun­da­men­tal prob­lem is that China no longer has a large sur­plus in­flows. The cur­rent ac­count was of­fi­cially in a small deficit of $5 bil­lion through Septem­ber 2018 and bank­ing data in­di­cate net cur­rent ac­count out­flows of $32 bil­lion. The coun­try is starved for cap­i­tal.

The govern­ment has been push­ing to get into pas­sive in­vest­ment in­dexes such as those com­piled by MSCI Inc, which could re­sult in hun­dreds of bil­lions of dol­lars in in­flows.

Bei­jing has said it will open the bank­ing and se­cu­ri­ties mar­kets, hop­ing to en­tice for­eign in­vestors. It also needs to at­tract for­eign cap­i­tal to buy bond is­sues that do­mes­tic in­vestors and banks are strug­gling to ab­sorb.

When an en­tire eco­nomic model de­pends on cap­i­tal ac­cu­mu­la­tion, a flat­ten­ing of net in­flows crimps growth prospects. This open­ing has less to do with some new-found be­lief in the or­tho­dox ben­e­fits of for­eign in­vest­ment and knowl­edge spillover ef­fects and is more to do with their abil­ity to keep cap­i­tal flow­ing.

It might seem coun­ter­in­tu­itive for an econ­omy that was grow­ing strongly

un­til re­cently, but China is in­creas­ingly cap­i­tal­con­strained be­cause of poor re­turns on his­tor­i­cal in­vest­ments.

Bei­jing has been low­er­ing re­serve ra­tios to keep banks lend­ing and then hav­ing the Peo­ple’s Bank of China buy their fundrais­ing of­fer­ings when they run short of cap­i­tal. In con­trast

to its rep­u­ta­tion as a high­sav­ings, cap­i­tal-abun­dant econ­omy, China in­creas­ingly faces real con­straints.

The pas­sive man­date money that will flow in as for­eign fund man­agers match in­dex weight­ings will do lit­tle to boost Chi­nese fi­nances. The coun­try has hit the law of large num­bers hard. In 2007, the cur­rent ac­count sur­plus peaked at 10% of the gross do­mes­tic prod­uct (GDP), or $353 bil­lion.

In 2017, the sur­plus de­clined to $165 bil­lion – but that rep­re­sented a mere 1.35% of GDP. Even if net in­flows re­sume in sig­nif­i­cant amounts, they will rep­re­sent an ever smaller share of the econ­omy.

To make mat­ters worse, sav­ings rates are fall­ing as an age­ing pop­u­la­tion pays for its re­tire­ment, while for­eign in­vestors are be­com­ing less will­ing to dive into a slow­ing, over-lever­aged and state-con­trolled econ­omy that’s in the mid­dle of a trade war.

If China wants to rein­vig­o­rate its cap­i­tal and fi­nan­cial mar­kets, it needs more sub­stan­tial re­forms. Big­ger quo­tas make for nice head­lines but if con­fi­dence is lack­ing in the ac­cu­racy of fi­nan­cial state­ments and the strength of le­gal pro­tec­tions, over­seas as­set man­agers will re­main hes­i­tant. For­eign di­rect in­vest­ment, a good long-term in­di­ca­tor of con­fi­dence, is up only 3.5% since 2017. Treat­ing in­ter­na­tional in­vestors as a piggy bank isn’t go­ing to work any­more.

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