China’s quest for financial respectability has hit a road bump. After a two-month review, MSCI has decided against including mainland-listed shares in its widely-followed emerging market index. Recent stock market reforms may help China fare better next time. Yet for all its growth, the country’s restricted capital flows are an obstacle to joining the global financial community.
Getting the thumbs-up from MSCI can have big long-term consequences. The organisation estimates that funds worth about $8 trillion admit to using its indices as a benchmark; a significant chunk of that tracks its emerging markets index. Including mainland Chinese “A” shares in the basket of stocks would have boosted demand from international fund managers, at a time when China’s stock markets look limp.
The short-term impact of exclusion, though, is small. Chinese stocks listed on offshore exchanges like Hong Kong already account for almost 19 percent of the emerging markets index. MSCI’s plan was to include just 5 percent of the freely-traded market value of mainland shares. The initial boost to China’s overall weighting would have been just 0.6 percent.
Fund managers objected to even this limited shift. Though foreign investors can buy mainland-listed stocks, they can only do so with a quota awarded by the Chinese authorities. And they can only move money in and out of the country once a week.
The conclusion that China’s markets aren’t open enough may resonate elsewhere. The International Monetary Fund will decide by next January whether to broaden the basket of currencies used to value its reserves. Including the yuan alongside its big global peers would represent a big vote of approval for the Chinese currency. Yet the fund’s criteria for inclusion are that the currency should be “freely usable”.
Both the yuan and mainland stocks are bound to contribute to their respective benchmarks one day. China may do better when MSCI next reviews its indices in 2015, especially if a new scheme that allows Hong Kong investors to buy Shanghai-listed shares takes off. But MSCI’s decision shows that while China’s barriers remain in place, international financial acceptance will not come easily.