China is by far the world’s biggest emerging market
(EM), yet the nation’s locally listed shares—referred to as China A-shares— are not part of the major global indices such as MSCI EM.
The reason being the country has several restrictions on participation by overseas investors and its trading rules are seen as opaque.
Since 2014, MSCI, biggest global index provider, has been considering adding the A-shares to its indices. However, the index compiler had laid down several pre-conditions, such as making the market more accessible to foreign investors and linking its stocks with Hong Kong.
Although China has only partially fulfilled the conditions, MSCI on June 22 took a landmark decision of including China A-shares in the MSCI EM
index, which is tracked by an estimated $1.6 trillion of assets.
However, analysts see this as more of a token addition and a full-fledged addition, which could be many years away.
Given its giant size, complete addition (inclusion factor of 100 per cent) of China domestic shares, could see the world’s second-biggest economy have a weightage of 40 per cent in the MSCI EM
Index. This could potentially squeeze other markets
like India and South Korea, which are part of the EM index, resulting into massive outflows.
For now, at least, these markets
will not have to break any sweat. This is because MSCI has set the inclusion factor at just five per cent and its weightage in the MSCI EM
index is likely to be less than 0.8 per cent. Also, the inclusion is happening in two phases in May 2018 and August 2018.
Although the move will see India’s weight shrink in the MSCI EM
index, this will be very modest to make a dent into passive investment flows.
Brokerage firm CLSA says India’s weight in MSCI EM
index will reduce by only seven basis points (bps) to 8.85 per cent from current 8.92 per cent, resulting in potential outflow of only $214 million.
Similarly, other markets
like South Korea and South Africa will see their weight drop by 12 bps and 4 bps, respectively. South Korea could potentially see outflows of $373 million, while South Africa could see modest outflow of $160 million.
Goldman Sachs says while South Korea, Taiwan, and India will see the largest dilution in index weights in the MSCI EM
and MSCI Asia ex-Japan indices, the “selling pressure could be modest”.
“Overall, we view this announcement as an important milestone in the integration of China’s equity markets
with the rest of the world, but that there is unlikely to be a significantly positive impact on A-share index performance near term due to the low inclusion factor and implementation period,” says Jonathan Garner, Chief Asia and EM Equity Strategist at Morgan Stanley.