China’s welcome mat for foreign investors

HONG KONG (MarketWatch) � When China takes steps to open its closed capital account, it is always going to generate keen interest � as the world�s second largest economy.

Last week China more than doubled the amount of money foreign investors can invest in its domestic stock markets.

This initiative offers some encouragement that the recent crescendo of debate on reform will be matched with some action. Attention will also focus on what other steps might be taken apart from increasing the Qualified Foreign Investment Quota (QFII) from $30 billion to $80 billion.

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Yet, although more foreign investment is now welcome, there will be some skepticism on the timing and questions asked if this is more than a token gesture?

Hopefully, there are some contrarian investors waiting in the wings, as this move to expand QFII comes at a time private capital appears to be heading for the exits and fears over a potential hard landing loom as the property market corrects.

Since the beginning of the year there has been a notable reversal in fund flows. As well as slowing forex accumulation, foreign direct investment in China has been falling amid signs of hot money outflows.

Perhaps, QFII investors can take up the slack and provide some cushion to the economy?

Still, some analysts argue this move is less pragmatic and laud it as an important policy break-through. CSFB in a new note argue it shows there is now a broad policy consensus on opening the capital account and domestic capital markets in the coming few years. They add reforms and opening up is gaining momentum and this is a very encouraging sign.

Further, because China�s trade surplus is narrowing and market expectation of yuan USDCNY �appreciation is weakening, this is a good time to act.

Granted, not so long ago, the problem for Beijing was too much money inflows, which was adding to pressure on the yuan to rise at a time when the government was struggling to slow the economy.

CSFB also add the move shows the intention of the government is to boost sentiment in the A-share market.

Still, lifting investor spirits could prove a tall order. CLSA�s strategist says the muted A-share reaction in Shanghai to the QFII news announced last week is a sign of the bearishness of domestic investor sentiment.

Meanwhile, Capital Economics writes the move may help to lift equity prices in the short-term, but the wider impact will be limited without faster progress on reforming the currency regime and state-controlled banking system.

Looking past sentiment after all, QFII numbers are small. The overall value of approved QFII and RQFII funds is currently only 0.8% of total market capitalization. If fully used, the ratio would rise to 2.6% based on current data.

And this cannot be taken for granted say Capital Economics, given only $25 billion of the current $30 billion QFII quota has currently been taken up.