China A-shares look set to eat into India's FPI flows this year

Shares listed in mainland China look set to eat into India’s share of global foreign portfolio investor (FPI) flows this year.  

While the inclusion of the so-called China-A shares in the global indices designed by MSCI and FTSE Russell has been talked about for many years, it will finally play out in a meaningful way in 2019.

Indices such as MSCI Emerging Market (EM), FTSE EM and FTSE Global All Cap are tracked by both passive and active funds, totaling trillions of dollars.

By August, the weightage of China-A shares is set to quadruple to 2.9 per cent from the current level of 0.7 per cent in the MSCI EM index. The adjustment will lead to trimming of weightage of other countries, including India. An analysis by Morgan Stanley indicates India’s weightage in the index could drop by 70 basis points (bps) to 8.7 per cent by August 2019.

Experts say this decline could cost India close to $5 billion in global exchange traded fund (ETF) flows. In addition, actively-manage funds could also see higher flows to China at the cost of markets like India.

“We expect 2019 to be a record year for foreign inflows into the Chinese A-share market. We forecast $70-125 billion of aggregate inflows for passive and active shares combined,” said Morgan Stanley in a note on Wednesday. 

China is the world’s second-largest market, after the US, in terms of market capitalisation. Chinese companies in Hong Kong have adequate weight in global indices such as MSCI EM.

However, those listed exclusively in the mainland have little representation. This is because China imposes several restrictions on FPIs in trading and owning A-shares.

Following global pressure, the Chinese administration has been relaxing some of the restrictions. To begin with, the MSCI EM Index has assigned an inclusion factor of 5 per cent. This means that if China-A shares worth $100 qualify to be part of the index, only $5 will be allowed to enter. However, over a period of time, the inclusion factor will be raised.

According to Morgan Stanley, the first such rebalancing will take place on May 31, when the inclusion factor will be increased to 12.5 per cent from the current 5 per cent. The second rebalancing will take place in August 31, when the inclusion factor is increased to 20 per cent, from 12.5 per cent.

Similarly, the FTSE Russell, too, will rebalance its China weightage in three trances from June 2019 through March 2020.

Experts say such rebalancing could trigger FPI outflows from India as funds realign their portfolios. According to one estimate, a 100 bps cut in the MSCI EM weightage triggers outflows to the tune of $7 billion from passive funds.

Morgan Stanley is bullish on FPI inflows into Chinese markets. This is on account of: “The Chinese government’s determination to further open up the A-share market; global investors' long-term commitment to A-share allocation; and A-shares' better positioning — on account of multiple market-impacting factors turning positive, including more attractive valuations, better visibility into the government's easing policy, and more realistic consensus earnings forecasts.” The dent in overseas flows into India comes at a time when the sentiment is already weak. The consensus FPI overweight stance on India is already at a multi-year low.

On an absolute basis, FPI flows into India have been drying over the last few years. Since 2015, average FPI flows on an annual basis have been just $2 billion, down from an average $20 billion for the three-year period ending 2014. Last year, FPIs pulled out $4.5 billion from the domestic equity market.