New China heft on MSCI list could squeeze India, others

Morgan Stanley may include China mainland shares to its widely tracked emerging markets index

Global index provider MSCI is expected to add mainland China-traded shares (called China A-shares) to its emerging market (EM) index, at its annual review on June 15.

MSCI is Morgan Stanley Capital International.

The move to include the world’s second biggest region in terms of market capitalisation is likely to squeeze others, including India, in the 21-nation index.

Full inclusion of China A-shares (the likelihood is slim) could spark an outflow of up to $1.5 billion from the Indian markets. For, the MSCI EM is often used by global investors seeking exposure to developing nations like India. An estimated $75-80 bn worth of passive funds are channeled through this index. Additionally, a lot of active funds are also benchmarked to it.

The mainland China shares have already rallied this week, in anticipation that they could soon be added to the global benchmark. Brokerages estimate the inclusion could lead to a flow of at least $16 bn into the Chinese markets. Currently, only Chinese shares traded in Hong Kong are part of the index, with a weightage of nearly 24 per cent. India’s weight is around 8.1 per cent.

Morgan Stanley, the multinational financial services entity, says full inclusion of mainland China shares could reduce India’s weight by 170 basis points (bps) to 6.4 per cent, potentially triggering billions of dollars worth of sell-off. China A-shares could command a weightage of 18.2 per cent if included fully. Experts, however, see little chance of that happening and, therefore, don’t see a huge impact on the Indian market in at least the near term.

“It is a 50-50 probability. Even if they do come in, it will be a relatively small initial inclusion factor. The announcement might be made in June but the inclusion will happen the following year— middle of next year. It won’t be negative for a market like India in terms of reshaping the EM indices,” said Jonathan Garner, chief Asia & EM equity strategist, Morgan Stanley.

Roughly, a 100 bps change in the index leads to passive flows of $0.8-1 bn.

Experts feel the inclusion of China A-shares in the MSCI indices will happened in a phased manner. To begin with, mainland shares might have one to five per cent inclusion, as China is yet to address certain issues raised by MSCI.

Saifullah Rais, quantitative analyst at Kotak Institutional Equities, who closely tracks flows into the Indian market, says full inclusion of China A-shares will take place in a phased manner.

In a report earlier this week, Goldman Sachs increased the probability of inclusion of China A-shares in the MSCI indices from 50 per cent to 70 per cent. It said China had addressed two out of five concerns raised by MSCI in April. It added China would have to address the remaining issues like “20 per cent monthly fund repatriation limit for QFIIs (qualified foreign institutional investors), the anti-competitive clauses on index products and the daily quota limits on Stock Connect”.

The global brokerage said the road map by MSCI on how their global indices would change would be critical. A year before, MSCI had taken up the issue of including China A-shares in its global indices but had decided against it, due to issues such as limitations on foreign investors and ease of access.

Why China mainland shares are not part of MSCI emerging markets index?
Because Chinese mainland markets aren’t as open to foreign investors as India and others are. Thus, non-mainland shares, such as those traded in the markets of Hong Kong and Macau, with easy access to foreign money, are listed on the index.

On March 31, global index provider MSCI, or Morgan Stanley Capital International, laid out key problems for China to solve. These included relaxing rules for foreign investment in mainland shares. Brokerages say China has resolved some issues. Mainland shares’ inclusion may depend on resolution of the rest.

What is China mainland?
It is the area under the direct jurisdiction of China. It excludes special administrative regions of Hong Kong and Macau.