China's move this month to relax restrictions on its foreign equity investment initiative reflects growing awareness of the challenges facing the country to attract overseas capital following the global financial crisis.

New draft regulations announced on Sept 4, including a provision to raise the upward limit for individual Qualified Foreign Institutional Investors (QFII) to $1 billion from $800 million, are likely to be followed by more changes to encourage buy-side investors and expand institutional activity.

China's stock market plunged 22 percent in August, its second-worst monthly performance in 15 years. But the market has since shown more signs of stability, helped by recent policy initiatives.

With the combined quotas for all QFIIs remaining unchanged at $30 billion, the broad market impact of the new rules is expected to be limited. The draft rules have been sent to investors for feedback and likely will be implemented shortly.

But with individual QFIIs being given more investment quotas, shares in sectors they favor have opportunities to out-perform. QFII picks appear to focus on consumption, construction, utilities and financials.

"The QFII relaxation comes after the performance of China's stock market lagged its US counterpart since late July amid signs that capital is flowing into mature economies due to their stronger-than-expected recovery," said Chen Lu, chief economist at Haitong Securities in Shanghai.

Market watchers said that foreign funds have fled China's market since it tumbled in August.

The quick exit means foreigners no longer believe, as they did during China's market peaks in 2006 and 2007, that a bull run in Chinese stocks can last for years - a shift in attitude after China's economy proved vulnerable to the global crisis, as well.

The new rules will also lower the minimum required quota to $20 million from $50 million and cut the lock-up period for insurance funds, pension funds and open-ended funds to three months from one year, among other reforms.

Several QFII managers said that such relaxations reflect, in part, regulators' efforts to introduce more buy-side investors to help stabilize China's ever-volatile stock market.

"Most QFIIs are now brokers using funds they have raised to invest in China," said Wu Haijun, Shanghai principal at Power Pacific Corp of Canada, a QFII investor in Chinese stocks.

"Funding channels for those brokers are not always stable. Some might not be able to assume the role of stabilizer in case of market volatility. By lowering the minimum quota requirements and other steps, China apparently hopes to diversify QFII investors," Wu said.

Long-term QFII-friendly steps might include quotas and other preferences for those who invest in Chinese stocks with their own funds, and an eventual expansion of total quotas for QFIIs.

Fan Jianjun, head of the securities research unit at the Development Research Center of the State Council, said QFII reforms were part of official measures to bolster the stock market.

"But it will have a more symbolic than real impact on the market because QFIIs' capital base is really too small," Fan said.

China has so far granted only about $15 billion of the total $30 billion investment quotas for QFIIs.

These figures are less than 1 percent of China's combined stock market capitalization of $3.1 trillion for the mainland's Shanghai and Shenzhen stock exchanges, where QFIIs are investing.

But traders said investors could still add positions in sectors likely to be favored by QFIIs, because their buying with additional quotas might help these sectors outpace the market. QFIIs typically decline to discuss stock picks.

Reuters

(China Daily 09/28/2009 page8)