Beijing is selling its relaxation of inward foreign investment limits as a natural opening of financial markets. The reality is that China needs the capital to keep the economy going, and the question is whether investors will buy the hype.
Authorities doubled to $300 billion the quota for stocks, bonds and other financial products under the Qualified Foreign Institutional Investor (QFII),
program, the State Administration of Foreign Exchange announced last month. China has resisted for years opening its financial markets, so the changes – combined with a broadening of the scope of the QFII program unveiled at the end of January – represent a significant step. The trouble is that China is no longer an attractive investment story.
Only about $101 billion of the previous $150 billion quota, or about two-thirds, is in use by overseas institutions, according to data compiled by Bloomberg. The fundamental problem is that China no longer has large surplus inflows. The current account was officially in a small deficit of $5 billion through September 2018 and banking data indicate net current account outflows of $32 billion. The country is starved for capital.
The government has been pushing to get into passive investment indexes such as those compiled by MSCI Inc., which could result in hundreds of billions of dollars in inflows. Beijing has said it will open the banking and securities markets, hoping to entice foreign investors. It also needs to attract foreign capital to buy bond issues that domestic investors and banks are struggling to absorb.
When an entire economic model depends on capital accumulation, a flattening of net inflows crimps growth prospects. This opening has less to do with some new-found belief in the orthodox benefits of foreign investment and knowledge spillover effects, and is more to do with their ability to keep capital flowing.
It might seem counterintuitive for an economy that was growing strongly until recently, but China is increasingly capital-constrained because of poor returns on historical investments. Beijing has been lowering reserve ratios to keep banks’ lending and then having the People’s Bank of China buy their fundraising offerings when they run short of capital. In contrast to its reputation as a high-savings, capital-abundant economy, China increasingly faces real constraints.
The passive mandate money that will flow in as foreign fund managers match index weightings will do little to boost Chinese finances. The country has hit the law of large numbers hard. In 2007, the current account surplus peaked at 10 percent of GDP, or $353 billion, In 2017, the surplus declined to $165 billion – but that represented a mere 1.35 percent of GDP. Even if net inflows resume in significant amounts, they will represent an ever smaller share of the economy.
To make matters worse, savings rates are falling as an aging population pays for its retirement, while foreign investors are becoming less willing to dive into a slowing, over-leveraged and state-controlled economy that’s in the middle of a trade war.
If China wants to reinvigorate its capital and financial markets, it needs more substantial reforms. Bigger quotas make for nice headlines but if confidence is lacking in the accuracy of financial statements and the strength of legal protections, overseas asset managers will remain hesitant. Foreign direct investment, a good long-term indicator of confidence, is up only 3.5 percent since 2017.
Christopher Balding is a former associate professor of business and economics at the HSBC Business School in Shenzhen and author of “Sovereign Wealth Funds: The New Intersection of Money and Power”