Since the QDII (qualified domestic institutional investor) plan launching last July, it has not been very popular in its test market, Hong Kong.
The QDII plan will allow Chinese citizens to invest in overseas equities markets with designated foreign currencies. QDII works through qualified institutional investors such as fund management companies.
A quota of US$12.6 billion has been allotted for the operation, but only US$300 million, or 2.4 percent, has been utilized. Obviously, when the domestic stock market is like a crazy bull and nobody cares about risks, who will bother with the seemingly low yielding overseas market.
But things may be about to change. The number of players in China's stock market is now rapidly approaching 100 million, and the banks are still flooded with liquidity. The bubble is about to burst, and decision-makers have to do something fast.
QDII is an obvious candidate on the short list of possible measures. If successful, it has the advantage of killing three birds at the same time: curbing the surplus of savings and foreign exchange and cooling the yuan-denominated A-share stock market.
Another advantage, the plan is already in place. The machinery is now moving smoothly along after a year's experience in establishing, operating and refining the system.
This will be the fastest measure to be implemented since all it takes is some relaxation fine tuning. It is also safer because it is highly regulated and orderly. Any possible troubles will take place in Hong Kong, where there is a firewall separating the mainland.
In a nutshell, this is the background of the new development in QDII in mid-May, when the China Banking Regulatory Commission (CBRC) announced its decision to widen the scope of investment under the QDII scheme. Mainland commercial banks offering overseas wealth-management business are allowed to invest in a wider range of asset classes, including equities and equity funds authorized by a supervisory authority with whom the CBRC has a memorandum of understanding (MOU).
Where an overseas intermediary is appointed as investment manager, it must also be regulated by a supervisory authority which has an MOU with the CBRC. As the first and the only authority to sign a MOU with the CBRC, the Hong Kong market and Hong Kong-authorized and regulated financial products and intermediaries are now given a head start to implement it.
Now that the funds can invest in the stock market and equity funds, Hong Kong, the fourth biggest stock market in the world with the highest concentration of mainland listed companies, clearly stands to gain in the revised scheme. Needless to say, with this psychological boost, the Heng Sang Index has been heading northward ever since.
China's foreign exchange surplus is already high and its growth remains unabated. There is increasing current-account surplus, continued strong capital inflow, rapid accumulation of foreign reserves and increasing difficulty in monetary management. This all leads to inflationary pressure and financial instability. This has also put the country in a very awkward position, with constant international pressure for RMB revaluation.
China cannot always use administrative measures to bar the flow of capital as the nation tries to integrate itself into the global economy. And it has no intention of artificially slowing its exports. China must come up with ways and means to spend these accumulating foreign currencies in the market fast.
QDII can help China quickly link its financial market to the world, especially as China still imposes foreign exchange controls. These new measures will facilitate the orderly outflow of funds from the mainland and fully utilize Hong Kong's position as an international financial center.
The implementation of QDII in Hong Kong can be seen as one of the classic examples of how best to utilize Hong Kong's advantages for the mutual benefit of both the mainland and Hong Kong.
However, if we put too much hope in the revised QDII plan, we might be in for another disappointment. It now looks as if we will call ourselves lucky to quickly consume the existing US$12.6 billion quota. But this solves only a small portion of the problem.
After all, how long will it take for the QDII system to digest this sizable amount is still a question. One thing is certain, QDII alone cannot save the day for the country's foreign exchange predicament.
On the other side of the coin, QDII will be a possible source, a very big one for that matter, of investment funds for Hong Kong. But whether the money will actually be invested in the Hong Kong equities market will depend on many factors.
Currently numerous commentators put a lot of emphasis on the price differential between mainland A-shares and Hong Kong H-shares. But that margin will seem small compared with the possibly huge short-term windfall that could be made in the mainland market.
On top of that, there is currency exchange risk investing outside the mainland when all eyes are still on China to appreciate the RMB. On the whole, the Hong Kong equities market is very narrow, concentrating only on stocks and warrants.
Should the US$12.6 billion be thrown into the Hong Kong stock market within a short period, it will certainly create a bubble there. And when the bubble bursts, a lot of investors, including many mainlanders channeled through QDII, will get hurt.
On the whole, the revised scheme poses great challenges to the skill and professionalism of the fund managers and the supervisory capability of the Hong Kong financial sector, which is now being put under great strain.
The author, from Hong Kong, is a member of the National Committee of the Chinese People's Political Consultative Conference
(China Daily May 21, 2007)