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2017-06-20 23:41:02
China Will Be Part of a Popular Stock Index, Opening the Door to Foreign Money

HONG KONG — China’s effort to open its door to foreign investors has received a big push, as its stocks were accepted into a closely followed global index.

The index provider MSCI announced in New York on Tuesday that it would add domestic Chinese stocks to its influential emerging markets benchmark. As a result, investment funds representing $1.6 trillion will be under heavy but informal pressure to start buying Chinese domestic stocks next year, leading to $17 billion in fresh money being pumped into the stock markets, according to MSCI.

Currently, foreign investors own just under 1.5 percent of Chinese stocks.

The decision is a symbolic victory for China. The Chinese government had lobbied MSCI for years to include in its indexes the so-called A shares traded on the Shanghai and Shenzhen stock markets.

MSCI said it would add 222 domestic stocks from both the Shanghai and Shenzhen exchanges. Most of these stocks are already trading on the Stock Connect, a closed system that allows international investors to buy Chinese domestic stocks in Hong Kong, a semiautonomous Chinese city that, unlike mainland China, has a freely traded currency, the Hong Kong dollar.

Those stocks would account for just 0.73 percent of the overall MSCI emerging market index at first. But that share could grow if China continues to reform its financial markets.

“MSCI is very hopeful that the momentum of positive change witnessed in China over the past years will continue to accelerate,” the index company said.

Many investors measure the performance of money managers, like mutual fund and hedge fund managers, against MSCI indexes. That puts pressure on active managers to buy the shares in the index, and then add or subtract a few stocks in an effort to beat the index.

China’s inclusion, even on a limited scale, means that money managers will find the indexes more attractive. Many investors have also gravitated toward index funds that try to match the indexes directly, by buying all or nearly all of the stocks in them.

The Chinese government had long sought MSCI inclusion because it could help establish Shanghai and Shenzhen as global financial centers.

It could also push international money managers to pay more attention to corporate governance in China and demand that Chinese executives improve business practices, such as providing greater financial disclosure and limiting insider transactions.

“MSCI inclusion not only mandated global investors to allocate more funding into the Chinese A share market, but also provided a much-needed impetus to move Chinese stock markets closer to global standards,” said Shen Jianguang, a China economist at Mizhuho Securities.

A more recent goal, stemming from a stock market crash two years ago and a subsequent flight of money outside the country, has been to lure in more foreign investment to offset those outflows. Though China has since stemmed the outflows in part through tighter capital controls, the potential departure of money remains a problem as the Chinese economy cools and as a wide-ranging anti-corruption campaign has persuaded many wealthy families that their savings might not be safe inside China.

But money managers have been leery of pushing large sums of money into Chinese financial markets, and many have been unenthusiastic about China’s inclusion. International investment into China’s financial markets has been tiny in recent years in part because of growing worries that state-run banks were making huge and wasteful loans to state-owned Chinese companies to spur economic growth, adding to China’s debt load. That burden prompted Moody’s to downgrade China’s sovereign debt rating last month.

“Having exhausted the ability to use state-owned banks as A.T.M.s, Beijing would love to entice foreign money into China’s stock and bond markets,” said Diana Choyleva, a China specialist at Enodo Economics, a financial advisory firm. “But the MSCI symbolic move falls well short of diverting global passive money into China’s equity markets.”

At the Lujiazui Forum, an annual gathering of top Chinese economic and financial policy makers in Shanghai, Chinese officials underlined on Tuesday their desire for foreign participation in the country’s financial markets.

“The financial service industry is a competitive service industry which benefits from opening up, and will continue to expand its opening up,” said Zhou Xiaochuan, the governor of the country’s central bank, the People’s Bank of China.

Yet a variety of restrictive measures that China has taken in the past had prompted MSCI to decide on three previous occasions not to include China in its global indexes. These restrictions have included weekslong suspensions in the trading of shares in companies that encounter financial difficulties, and the increased limits on moving money out of the country.

But international companies have to some extent been exempted from those restrictions, particularly since the start of this year, in an effort to convince them that if they put more money into China, they will be able to take it out someday. Limits on the repatriation of dividends have been removed, and limits on foreign trading of Chinese bonds have been lightened.

On the previous occasions that MSCI chose not to include Chinese shares, it was also considering whether to include them as a sizable percentage of its emerging markets index. The index company disclosed in a draft paper this year that it was considering a much smaller percentage role for Chinese shares in its emerging market index than in previous years, notably by reducing by two-thirds the number of Chinese stocks that would be tracked in the index.

Chinese shares traded on markets outside mainland China, such as in Hong Kong, already represent the largest concentration of companies from a single country in the MSCI emerging markets index, fluctuating at about a quarter of the entire index.

While China received a greenlight from MSCI, another emerging market hopeful, Argentina, was not so lucky.

Despite Argentina’s successful sale of a 100-year government bond on Monday, the index company said it was not ready to upgrade the country to its emerging markets index because recent market reforms “needed to remain in place for a longer time period to be deemed irreversible.”