China allows nationals to buy Hong Kong shares

New SAFE regulations will turbo-charge Hong Kong H-shares. But the effect on renminbi revaluation is less clear, say commentators.
News that Chinese nationals will be able to buy and sell foreign shares privately caused a sensation in Hong Kong on Monday û and commentators estimate the reaction is justified.

Under the new regulations, Chinese nationals will no longer be limited to the former ceiling of $50,000 in forex acquisitions per year. They will be able to use their existing forex, or buy the foreign exchange with renminbi, apparently with no ceiling on the amount they can send abroad.

ôThe new rules come at a good time. Many people in China believe the A-share market is overvalued, as is domestic real estate. People are also worried about inflation and low interest rates. So there will be appetite for investing overseas,ö says one Chinese banker in Beijing.

However, the same source estimates that there will not be a huge outflow of funds in the near term. ôBasically, this is legalising what has been going on for years. Chinese companies with branches in Hong Kong have long funnelled money out of China into Hong Kong. Individuals have also frequently brought suitcases full of cash across the border.ö

The scheme, announced by ChinaÆs State Administration for Foreign Exchange on Monday, is experimental. No start date was provided in the press release.

Initially, investment will only be permitted into Hong Kong. And only nationals with a bank account at the Binhai New Zone in Tianjin will be able to participate. Binhai New Zone is part of TianjinÆs efforts to accelerate its growth rate after several years of underperforming other first-tier Chinese cities.

ôThis is part of a raft of reform measures in Binhai,ö notes Zuo Xiaolei, head of research at Galaxy Securities in Beijing, adding that geographical restrictions in the early stage of a reform measure are common in China.

Macquarie BankÆs Paul Cavey, head of China research in Hong Kong, says the big draw will be Hong KongÆs H-shares. ôH-shares will look cheap to domestic investors. Equalization of prices between Hong Kong and Shanghai is bound to happen, and thatÆs behind the huge spike in Hong Kong today.ö

Citi confirmed in a research note that H-shares were, on average, 47% cheaper than A-shares on August 17.

While the move is great news for punters in Hong Kong, itÆs less clear what the impact will be on ChinaÆs swollen foreign exchange reserves û a clear symptom, according to critics, of an undervalued currency. ôChinaÆs current account surplus is running at $20-$30 billion per month. ItÆs unlikely, at least in the near term, that the outflows from the scheme will match that figure, and bring the currency into equilibrium,ö says Cavey.

On the contrary, further hot money flows into China might be the issue over the coming months, given the US Federal ReserveÆs indication over the weekend that it might lower interest rates.

ôLooser monetary policy (in the US) will do nothing to end the undervaluation of the renminbi, and by cutting the return on US dollar assets, could even make China's liquidity problems worse," says Cavey.

Ironically, there is a dearth of foreign currency in China, as forex accounts have been wound down to profit from renminbi appreciation and booming asset markets. According to Macquarie, forex funds account for just 3.6% of the total bank deposits. That is far less than the ratio five years ago, says Cavey.

Foreign currency outflows under the scheme will not directly affect the value of the renminbi, whose value against the US dollar is set by central bank fiat. ôBut any outflow of money has the potential to slow the build-up of foreign exchange reserves, removing one of the clearest signs of the undervaluation of the currency,ö points out Cavey.

That might appease US critics of ChinaÆs bulging trade deficit with the country.

For Galaxy SecuritiesÆ Lei, the news was hardly surprising. ôWe recently had the æQualified Domestic Institutional InvestorÆ scheme, permitting certain insurance companies and banks to invest abroad. Now, we have the same being applied to individuals. ItÆs just one more step towards the liberalisation of the capital account.ö

Others are not quite so sure.

ôChinaÆs historical memory is that capital accounts saved China during the Asian financial crisis. ItÆs very difficult for China to get out of that mindset,ö estimates Cavey. ôThey donÆt want to make channels for money draining out of China too easy. Were sentiment on China ever to change, the consequences could be capital flight.ö

A bonus of the measure is that any outflows would help deflate asset bubbles which have been building up in the real estate and stock market bubbles. Other measures introduced by the government have so failed to have much effect.

ChinaÆs second quarter growth this year was almost 12%, leading to overheating concerns.

The Hang Seng Index closed the day up 6% to 21,595.63 points on Monday, a gain of 6% and its best single-day percentage gain since 1998. But the discount window rate cut in the US also contributed to the euphoria.
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