Don't Let Recent China Data Obscure Larger Story

There is much discussion over the slew of macro economic data China reported yesterday. The high frequency data, which is often looked upon with a jaundiced eye, is not the key story for investors, though much ink has been spilt on it. It has well been appreciated that the world's second largest economy is slowing and that the new government is willing to sacrifice near-term growth prospects for structural reforms.

There is more important news from China. Over the weekend, China's Securities Regulatory Commission made two announcements. First, it nearly doubled the quota for qualified foreign investment (QFII). Second, it expanded the remnimbi qualified foreign investment (RQFII) program to include yuan London and Singapore.

China boosted QFII from $30 bln to $80 bln in April 2012. It now has boosted it to $150 bln. The previous limits were not a constraint on activity so the larger limit may have little immediate impact, but does suggest officials are more eager for capital inflows and/or are taking advantage of what appears to be a lull to further liberalize capital flows.

Reports suggest that Chinese officials have granted $6 bln of QFII this year, compared with almost $16 bln for all of 2012. Of the $80 bln quota, foreign investors have also used $43 bln.

Following the expansion of QFII in April 2012, the Shanghai Composite rallied 1.7% the next day. Yesterday the Shanghai Composite gained 1%.

Until now the RQFII program was essentially designed for the yuan accumulating in Hong Kong to be invested in the mainland. It was launched in 2011. At the end of last year, Chinese officials had increased the RQFII quota to CNY270 bln from CNY70 bln. The regulatory authorities announced that yuan in London and Singapore (and unspecified other cities) could fall under RQFII program, but did not indicate whether the quota would be increased. Regulators report that only CNY150 bln of the RQFII have been drawn on.

Foreign investment in Chinese shares remains marginal. Between the QFII and RQFII, investors hold about 1.5% of the mainland's market capitalization (Shanghai Composite market capitalization is about $2.35 trillion). Its 9.25% loss this year makes it among the worst performing equity markets this year.

Expanding QFII and RQFII appears to be part of the financial reforms that the new government is pushing. From last week's US-Chinese talks emerged a new commitment to negotiate a bilateral investment treaty. Last week, the PBOC also published new rules making it easier for companies to lend yuan to their overseas affiliates. It also liberalized the rules allowing companies that raised yuan offshore to bring the funds onshore through yuan accounts with local lenders.