China hints at move to rein in growth
By Olivia Chung
HONG KONG - China's recent decision to increase the number of domestic funds
that can invest in overseas securities may be a prelude to a tightening of
monetary policy for the fast-growing economy, while also signaling confidence
in the domestic share market, analysts said.
E Fund Management was granted a quota of US$1 billion and China Merchants Fund
Management a limit of $500 million under the Qualified Domestic Institutional
Investor (QDII) program by the State Administration of Foreign Exchange (SAFE)
last month.
This marks the first issuance of new investment quotas in the 17 months since
Bank of Communications (BoCom) Schroders Fund
Management received a quota of $2 billion in May 2008. The BoCom Schroders
Global Selection Fund subsequently launched in August that year.
The QDII program, launched in 2006, allows domestic lenders, fund houses,
securities brokers and insurers to trade stocks and bonds overseas through the
designated funds, offering an overseas outlet for domestic savings while the
country's currency, the yuan, remains not fully convertible. Each institution
must apply to the SAFE for a forex quota before investing abroad.
By May last year, 56 Chinese institutions had been granted a combined quota of
$55.95 billion under the program. More allocations may follow soon.
Zhang Howhow, an analyst at the Shanghai-based fund consultancy, Z-Ben
Advisors, said a few more domestic fund houses, including Changsheng Fund
Management Co, owned partly by Singapore-based DBS, Bosera Asset Management Co,
owned partly by Shenzhen-based Merchants Securities, and UBS SDIC Fund
Management Co, will receive investment quotas of $1 billion each before the end
of this year.
Jing Ulrich, China equities chairwoman at JP Morgan, said the resumption of the
quota-granting process signaled regulators' confidence in the outlook for the
domestic market.
"Quota approvals were previously suspended in part out of concern over
potential capital outflows during a period when the [yuan-denominated] A-share
market was undergoing a sharp correction," she wrote in a research note. "The
resumption of approvals also suggests that the authorities believe overseas
markets have stabilized sufficiently after the financial crisis of the past
year."
Morgan Stanley analysts, including Jerry Lou, said China's decision to resume
the issuance of QDII quotas was part of its strategy to encourage capital
outflows to help offset money flooding into the country and ease appreciation
pressure on the yuan.
China's foreign exchange reserves reached $2.27 trillion by September and "our
economists' 'hot money' proxy shows positive inflows in the third quarter
totaling $25.6 billion," Lou said in a report. "New loan creation also
rebounded to 517 billion yuan [US$75 billion] in September, up from 356 billion
yuan and 410 billion yuan in July and August."
China has reversed a slowdown in growth, as a 4 trillion yuan fiscal stimulus
package announced last November has worked its way into the economy and the
government has maintained a loose monetary policy. The economy grew 8.9% in the
third quarter, up from 7.9% in the three months through June and 6.1% in the
first quarter.
The economic rebound has sparked concern that the loose lending may have been
channeled into the securities and property markets, raising the risks of asset
bubbles.
The CSI 300 Index, which tracks representative A-share stocks listed on the
Shanghai or Shenzhen stock exchanges, has surged more than 100% this year. Yet
the combined net profit for the 1,600 listed companies in Shenzhen and Shanghai
stock exchanges that have filed first-half results plunged 15% from the same
period last year, to 482 billion yuan.
Luxury property market prices have surged more than 40% this year and
mass-market prices by about 30%.
"If the Chinese economy continues to accelerate to a 10% annual growth rate,
per our economists' forecast, China will most likely have an overheating
problem, given the high lending base in 2009, unless the government wants to
cut new loans creation aggressively by more than 50%," Lou said. "Guiding
liquidity offshore will likely be an intermediate step before China tightens
aggressively."
Industry players and some analysts expressed caution over the performance of
new QDII products.
Pauline Loong, senior vice president in charge of China policy and risk
research at CIMB-GK Securities (HK) Ltd, said the fast recovery in the Shanghai
A-share market in the first half of this year was driven by abundant liquidity
generated by the government's November stimulus package. Hot money, that is
funds looking for quick profits rather than long-term investment, moving around
global markets is adding to market volatility, she said.
Loong said gains in the domestic A-share market have been fueled by huge
amounts of money leaking from bank lending and stimulus spending rather than
earnings.
Over the past weeks, Chinese stocks have been extremely volatile on rumors of
impending monetary tightening. Loong argues that the market's real concern is
not that possible monetary tightening would derail economic recovery, but it
would dry up the liquidity that had fueled the until recently seemingly
unstoppable rally.
Share prices have shown strong declines and gains since a correction in August,
despite pledges by Premier Wen Jiabao that the government would maintain its
current macroeconomic policies to safeguard stable and fairly fast economic
growth.
The willingness of China's savers and institutions to divert funds overseas
rather than into the domestic market is not reflected so far by the size of the
allocated quotas. "How much money might actually flow into overseas markets ...
depends on domestic risk appetite," said Loong.
Only about half of the quotas approved previously, or $28.71 billion of the
$55.95 billion allocated, had flowed out of the country as at the end of August
this year, she said, citing data from SAFE.
Ulrich and Lou said the resumption of the QDII program would benefit Hong
Kong-listed China equities, especially those trading at a deep discount to
A-share counterparts and blue chips to which A-share investors do not have
access. The Shanghai-listed shares of companies that are listed both there and
in Hong Kong are trading at an average 15% premium to the Hong Kong shares, up
from a one-year low of 10.2% during the recent mainland October holiday.
On Tuesday, the H (or Hong Kong-listed) shares of China Aluminum Corporation of
China (Chinalco), were about 42% cheaper than the corresponding A shares, while
China Everbright Ltd, a Hong Kong-based investment holding company, trades at
about a 23% discount in the Hong Kong market.
"QDII licensees are authorized to invest in most major markets, including the
United States, United Kingdom, Germany, Japan, Hong Kong and Singapore. The
Hong Kong market is however considered the prime beneficiary of QDII fund
flows, considering the prevalence of China-concept funds and Chinese fund
managers' pre-existing familiarity with the Hong Kong-listed stock universe,"
Ulrich said.
A spokeswoman of E Fund said it will sell funds focusing on equities in Asia,
excluding Japan, with a launch date expected in December. China Merchants Fund
is expected to launch a similar mutual fund product to invest in global stocks.
Loong said the QDII move should be positive on stock market sentiment in Hong
Kong, particularly on the expectation that this would be the first of more such
approvals.
"But the market should be alert to sudden changes in liquidity flows. Compared
with 20 months ago, bank lending and hot money rather than the trade surplus
are behind the groundswell of liquidity. This could change rather quickly," she
said.
China's current account surplus may shrink to 5.5% of gross domestic product
this year from 9.8% in 2008, and continue to decline to 4.1% in 2010, on
strengthening demand for imports, according to the World Bank.
A fund manager in Shenzhen, who preferred to remain anonymous, expressed
caution over investors' response to future QDII products from Chinese fund
companies due to the low return of QDII funds in many investors' minds.
"QDII products were launched at the wrong time and loss-hit investors must
learn a hard lesson that the funds might not be a good place to make money,
which is likely to continue to slow demand for some time," he said.
The first batch of QDII products - Southern Global Enhanced Balanced Fund,
Huaxia Global Selected Stock Fund, Harvest Overseas Fund and JPMorgan Fund QDII
- were oversubscribed on the first day of issue in September 2007.
By the end of last month, the net value of all four stock-oriented QDII funds
was below 1 yuan - the value set for fund subscriptions - with last year's
global decline in stock markets causing many overseas investments to lose
value. More than half of the existing QDII funds were in negative territory at
the end of July, he said.
The fund manager blamed a lack of experience in overseas investment and a
string of negative reports over the losses for subscribers to the first batch
of QDII products on the possible low future demand for the products.
Olivia Chung is a senior Asia Times Online reporter.
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