China’s Power on Capital Flows

China’s A-shares have been finally approved to be included in MSCI global indices on Wednesday, after three rejections in 2014 to 2016. Beginning in June 2018, Yuan-denominated shares will be included in the MSCI Emerging Markets Index and the MSCI ACWI Index. 222 Chinese shares will be included in the MSCI Emerging Markets Index with a weighing of 0.73%. This may seem to be only a small step for Chinese equities to attract new investors, but it is one giant leap for China’s financial markets to be recognized globally. Also, MSCI’s approval could largely impact capital flows between major Asian countries and economies in the coming periods.

On Wednesday, following the MSCI’s decision, Chinese stocks gained: Shanghai Composite Index rose +0.52% and SZSE Composite increased +0.76%. In specific, CSI300, an index including top 300 stocks on both Shanghai and Shenzhen exchanges, soared +1.17% and closed at a one-and-half-year high.

On the contrary, indices in other major Asian economies all dropped. Japan’s Nikkei 225 lost -0.45%, Korea’s KOSPI fell -0.49% and Hong Kong’s Hang Seng Index dropped -0.57%. The Vice Chairman of Korean Financial Services Commission, Jeong Eun-bo, said on Wednesday that investors may pull out up to 4.3 trillion won ($3.76 billion) funds from Korean stock market after MSCI’s approval on China’s A-shares.

MSCI’s recognition is expected to increase the demand in Yuan-denominated shares. Yet, remember China currently maintains capital controls on financial markets; thus, the supply of Chinese stocks available for overseas investors is determined by the pace of China further opening up its markets. The channels for foreign investors to directly purchase Chinese equities are limited right now, such as Shenzhen/Shanghai - Hong Kong Stock Connect, but when China increases those channels, moves similar as what were seen on Wednesday could happen again: investors relocate their funds from other Asian countries to China. This means that with a global recognition, China’s opening up in its financial markets will not only impact itself, but could largely affect its neighbor countries.

The next major channel that is in the preparation phase is a trading link between London and Shanghai, so called Shanghai-London Stock Connect. UK’s divorce with the EU has escalated the process of such an introduction. On Wednesday, the Vice Chairman of China’s Securities Regulatory Commission Jiang Yang told that the regulator has been making steady progress in preparing the link. MSCI’s inclusion set the global stage for China; what “shows” will be performed on the stage and when they will start are determined by China. Thus, investors will want to keep a close eye on the development of Chinese financial markets.

The Yuan Rate

The MSCI approval led to a pullback in the USD/CNH, falling below the top line of a parallel. Currently, the offshore Yuan pair is still testing the upper bound of this channel. The next level to watch is 6.8436, 100% extension of the March range and 100-day moving average.

USD/CNH 1-day

Prepared by Renee Mu.