Strong year to spark more foreign interest

Undoubtedly one of the catch-phrases that Chinese stock investors like to hear most is "opening up".

The government has already taken numerous steps to ease restrictions on foreign capital in the domestic stock market. You must have heard about QFII, or, more recently, the Shanghai-Hong Kong Stock Connect.

So far, these conduits of foreign capital have produced results that have failed to meet the expectations of stock brokers and investors. Foreign capital accounts for less than 2 percent of market liquidity. It is too small a proportion to make a difference. But things are expected to change in 2015.

Analysts say international investors will have a bigger involvement in China's A-share market as the authority is expected to broaden the investment channels and speed up the internationalization of the Chinese currency.

Although the Shanghai-Hong Kong Stock Connect program, initiated in mid-November, has been a big letdown with the daily trade quota remaining largely unused, stock analysts suggest that given more time the market will warm up, with more long-term investors like pension funds joining in after they have sorted out the compliance issues and technical obstacles.

Hong Kong Stock Exchange data showed that less than 5 percent of the 250 billion yuan ($40.3 billion) worth of southbound aggregate quota had been used before the Christmas break, in comparison to one-quarter of the 300 billion yuan northbound aggregate quota being used.

Average utilization of the daily quota has been lingering under 10 percent in both ways since the start.

"Overseas hedge funds are dominating current trade volumes, while many large-scale mutual funds are still observing the program and making evaluations. But one thing is for sure－they are very interested," said Zhu Haibin, chief China economist at JPMorgan & Co.

UBS chief China strategist Chen Li said in a recent report: "We estimate that in the coming year, new overseas funds flowing into the A-share market will exceed 550 billion yuan, and the market value of shares held by international investors will increase from the current 350 billion yuan to 900 billion yuan, equivalent to 8-9 percent of the total A-share free float market cap".

Chen cited the internationalization of the renminbi as the biggest catalyst that will lure foreign capital in. The government has set the goal of making the currency fully convertible by 2020, the subject of numerous seminars held by the People's Bank of China, the central bank.

This means that in six to eight years' time, A shares will likely be included in international indexes in accordance with internationally accepted rules and will not be given significant discounts.

It also means that in that time, A shares will also have considerable weightings in international indexes such as MSCI Emerging Market, Chen said.

In fact, the changes may come faster. Several stock analysts and fund managers have told China Daily that they believe MSCI, the world's most influential index provider, may include A shares into its Emerging Markets Index as early as 2016, and that would directly cause a catch-up in A-share allocation by global investors.

Around $1.4 trillion are benchmarked against MSCI's Emerging Markets Index, according to Reuters data.

China's A-share market, suffering from depressed valuations for years, showed very definite signs of a rebound in 2014. The benchmark Shanghai Composite Index had rallied more than 50 percent so far since last year, a lure surely for international investors.

"The rally we're seeing right now is unprecedented, even including 2007's bull run. Even though the rebound has been very sharp, if you look at the overall market valuation, it's still about 14 times, compared to 2007 when it was 60-70 times. When people say we're taking on excessive risk, it isn't true because the market is still cheap in China," said Hong Hao, managing director of research at BOCOM International.

Some investors are simply using Qualified Foreign Institutional Investor and Renminbi Qualified Foreign Institutional Investor schemes to tap the lucrative mainland market.

During January-November 2014, a 140 billion yuan RQFII quota and $16 billion QFII quota were granted, plus a 150 billion yuan quota under the interbank bond market direct access program.

Linan Liu, greater China rates strategist at Deutsche Bank, said in a recent research note that the bank believes another stock connect scheme between the Shenzhen and Hong Kong bourses will be launched in the second half of 2015, with roughly half of the quota of the Shanghai-Hong Kong Stock Connect program.

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