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China opens its financial markets

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The connection between the stock exchanges of Shanghai and Hong Kong has been operational since November 17th.

Chinese Prime Minister, Li Keqiang, had evoked the idea of this measure in April as an example of the will of the government to open up the financial system. The program should then be introduced within six months. But, having failed to obtain approval from the executive in Beijing, the Hong Kong Stock Exchange had to announce a delay, on October 26th, while saying being ready technically. The whole decision suggested that Beijing was punishing the former British colony for the recent sit-in of students asking more democracy.

The Shanghai Stock Exchange finished Monday, November 17th up by 2.30% and by 0.83% in Shenzhen, driven by the announcement of this common exchange platform that will provide unprecedented access for foreign investors to the Chinese financial market.

China’s trade with the rest of the world are still tightly controlled by Beijing. Trade flows are indeed opened, which allowed China to become the world’s largest exporter and the first to raise foreign exchange reserves in the world. However, capital flows, including foreign access to China’s stock market, remain very limited.

Opening guarantees

But Chinese Chairman Xi Jinping, is willing to provide opening guarantees. Especially because on Monday 10th and Tuesday 11th, the APEC summitmeeting was held inBeijing with all the Asia-Pacific Heads of State.

Only a limited number of foreign banks and funds can, to this day, invest in yuan to the Shanghai Stock Exchange. They must be screened by the Chinese regulator and their investment are limited by an individual quota set by Beijing, called the “qualified foreign institutional investors” program” (QFII).

In this context, Chinese companies wishing to receive foreign funding, blocked at borders, prefer to be listed on the Hong Kong Island. This financial sector is consistently recognized as the most opened in the world over the last twenty years by the American conservative Heritage Foundation.

The new program, whose approval was announced Monday by Beijing, is sometimes called “direct train”: banks and funds located in Shanghai will be allowed to invest in yuan in Hong Kong-listed shares, and vice versa.
It allows the Chinese government to progressively open the lock between the stock market of mainland China and the one of Hong Kong, so to say the rest of the world.

This is part of the commitment of the authorities to promote the use of the Chinese currency abroad. “This facilitates the orderly flow of renminbi (RMB) between the two places, supports the development of the offshore yuan market and thus accelerate the internationalization of the RMB, decisive movement in the opening of the capital account in China,” says the Research Director of the Bank of China in Hong Kong.

Such a program was mentioned as early as 2007, but it remained in the drawers as the global financial crisis has prompted China to the utmost caution. However, this new opening phase will also be controlled by quotas, according to the strategy, now classic, consisting of “crossing the river by feeling the stones”, as the late father of reforms, Deng Xiaoping said.

Investors based in Hong Kong will be allowed to place up to 300 billion yuan (39 billion euros) in total, to the Shanghai Stock Exchange, with a limit of 13 billion yuan for daily movement. Financial from mainland China, meanwhile, can only get 250 billion yuan out to the Hong Kong Stock Exchange. “Even with these quotas, it is still considerable, it is a significant step in the trend of controlled liberalization” judge John Zhu, an economist at HSBC in Hong Kong.
Monday in Beijing, at the opening of the APEC summit, US President Barack Obama, however, called on China to accelerate the liberalization of markets and the conversion of its currency.


In fact, the recent value of quantity of shares already reflected as well the hope generated by the influx of new investors. “The anticipation was already fully in prices in recent weeks on the market,” said Xu Gao, chief economist at Everbright Securities.
According to Xu, the long-term effect is significant however. China has promised to make Shanghai an unavoidable financial center by 2020, a project that was lying because of the closure of capital flows on the borders of mainland China.

The stock market of mainland China attracts strong interest. As a consequence, on Monday Nov. 17th, the first day of connection between the financial centers of Hong Kong and Shanghai, investors based on the island quickly exhausted the quota of daily cash flow available and authorized to the continent.

On the first session, the opening of this valve has essentially generated flows to Shanghai, reflecting the attractiveness of the outside world to the Chinese stock market, which was still closed until now.

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