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 While both MSCI and Chinese state media spun the decision as a speed
bump on the way to inevitable inclusion, which will allow and in
some cases require foreign funds to buy into Chinese stocks, the
agendas of Chinese bureaucrats and foreign institutional investors
are much further apart than they seem.
"With this announcement (MSCI has) further hemmed themselves in, as
they've outlined exactly what China needs to do. And if China
satisfies them, they'll be within their rights to ask why MSCI
hasn't lived up to its side of the bargain," said one source
familiar with MSCI's strategy.
MSCI's says the process requires time.
"It wouldn't be a negative, it would simply be the recognition that
this process needs to take its own pace," said Remy Briand, MSCI
managing director and global head of research, when asked whether
there could be fallout for the company if it finds itself delaying
inclusion again next year.
The changes foreign fund managers want are not minor tweaks.
MSCI's clients want Beijing to open its capital accounts so they can
reliably move their money in and out of China's markets, but the
economy is facing its slowest growth in decades, which has led to
capital flowing out of the country.
For China, inclusion in the index could over time bring an estimated
$400 billion into its stock markets and would help in its drive to
internationalize the yuan currency.
That might encourage Beijing to try to do the bare minimum to check
MSCI's boxes without facilitating further outflows during its
current economic slowdown, and therefore without addressing the real
source of offshore fund managers' anxiety.
Some of China's market-oriented government economists have publicly
lobbied against more opening, warning it could destabilize a
financial system still struggling to rationalize itself.
"China's financial sector is one of its Achilles' heels," said Xiao
Lian, senior economist at the government-run Chinese Academy of
Social Sciences (CASS).
"Banks cannot cope with a sudden market opening, and it will be even
more difficult to control if they (further) open up the financial
markets."
WIGGLE ROOM
But controlling these flows means keeping in place the very quotas
and restrictions that the foreign fund managers told MSCI are
unacceptable.
"Many investors have stayed away from China because of the quota
system, and the fear that they won't easily be able to adjust their
portfolio or exit their investments," said Wayne Bowers, chief
investment officer EMEA and APAC, Northern Trust.
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Given the current mainland stock rally, which has pushed Shanghai
stocks up nearly 150 percent in 12 months, foreign investors are
nervous about getting left in the market during a selloff.
"Foreigners are not that stupid to come into the stock market now,"
joked one retail investor in a social media post in reaction to the
MSCI decision on Wednesday.
"But we've been mistreated by foreigners for 200 years; why can't we
mistreat them just once this time around?"
The source familiar with MSCI's strategy said major U.S. funds were
so resistant to inclusion they threatened to abandon its emerging
market benchmark.
There's also a legacy of distrust of Beijing's intentions;
pessimists argue that a series of pilot programs to open up parts of
the capital account offer the appearance of reform without the
substance of fair treatment of foreign investors and a stable legal
regime that regulators abide by.
That distrust is amplified by Beijing's historical preference for
giving itself the maximum amount of room to adjust policy on the
fly, especially when it comes to capital being allowed out of the
country, leading to a record of delay, revision and retreat.
Vijay Sumon, an analyst at HSBC in London, cited the example of the
Shanghai-Hong Kong Stock Connect scheme, which was launched in
November last year, later than expected, and before some of the
wrinkles - such as the tax treatment of gains - had been ironed out.
"You saw what happened with Stock Connect; it was delayed," he said.
"MSCI doesn't want to be put in a position where they may have to
delay."
(Additional reporting by Lisa Jucca and by Kevin Yao in BEIJING;
Editing by Will Waterman)
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