Crying Game

No more squirreling US dollars out of the country in suitcases, people thought. Here was just the vehicle to help make the process of inflow and outflow orderly and legal, all in aid of a smooth march to currency convertibility.

Month after month, year after year even, policymakers have been blowing hot and cold on China's long-debated qualified domestic institutional investor (QDII) scheme that would allow institutions to go offshore and invest in stocks and bonds, make some money and spread their risk around. But it does seem to be getting closer.

Nowhere was this better illustrated than in the pages of Shanghai Securities Journal, which in an early June commentary said, "China needs to adopt QDII as a prelude to convertibility in the capital accounts". The QDII plan had stalled back in March 2003 on fears it would drain China of an estimated US$150 billion in foreign-currency bank deposits.

With the yuan still under some revaluation pressure, an outflow of dollars wouldn't seem such a bad thing. But with China's A-share market continuing to slide, a chorus of Cassandras have predicted that the country's struggling equities market will be stunted if investors are given more compelling outside investment options via QDII.

By July, the same newspaper was singing a gloomier QDII tune. Fang Xinghai, a deputy general manager of the Shanghai Stock Exchange, warned in a commentary that if authorities did not take a go-slow approach on QDII, China's equities markets would indeed face irreparable harm.

While the pressure mounts daily, and Beijing struggles to find some workable middle ground, fund managers wait in the wings, confident the QDII machinery is ready to fire up. "It's only [a question] of finding the right time," one Shanghai fund manager said in June, "and the coming weeks may be it."

With mid-August approaching, Jeff Tang, deputy general manager of China Securities' information division, wasn't about to go out on a limb. Asked if the QDII scheme might launch as early as September, he simply laughed. But he did say he had noticed something interesting: "I have seen some domestic insurance companies running recruitment ads looking for guys familiar with the Hong Kong foreign exchange and debt markets," he said. "That means we're getting close."

But it may be significant that the advertisers, all insurers in this case, were not casting around for people with offshore equities experience.

Tang said he believes the government will choose to launch QDII by one of two routes – either 1) let all institutions, including banks and fund managers raise money and invest it through Hong Kong brokers, or 2) restrict activity to non-bank institutions, and allow insurers and social security funds to invest directly. The second seems more likely, he said. Which means there would be next to no QDII impact on Hong Kong's equity markets initially because the mainland's first contingent of overseas institutional investors in all probability would make a beeline for fixed income products where returns are better than bank interest and safer than equities.

As with most central government macro policy, there is always a political subtext to take into account, and no less in QDII policy. Tang said Beijing is determined to support Hong Kong as an international financial center and any IFC worth its name needs a decent debt market to call its own – something that Hong Kong, like other Asian centers, has been struggling to build for years. "So I think the first step will be for the authorities to focus on the Hong Kong market which, because of the Hong Kong-US dollar link, gives investors diversified products between [the two currencies]."

Something has to give eventually. Like others, Tang said the government needs to shrink the amount of US dollars piling up in the country – and set up a balancing mechanism such as QDII to offset inflows from QFIIs – and insurers particularly need options for investing their foreign exchange insurance income.

Hong Kong has been buzzing with QDII rumors for two years now, but what's to ensure money stays there? "Good question," Tang said. First, he said, investors will head for bonds, not the equities markets, where institutions will be easier to track. "So far, domestic equities have been closed to insurance companies and the authorities could control them even more overseas, limiting them to investing 5-7% of their funds and requiring them [to file] monthly or even biweekly reports."