China’s Great Wall of Worry

What You Need to Know

China’s rise as a preeminent economic power makes it impossible for globally minded investors to ignore. With the integration of China’s domestic-listed equities and bonds into major global indices, the potential of investing in the broad economy is increasingly opening to the world. It’s time, then, for investors to familiarize themselves with misconceptions that can distort the view of China’s economy and corporate landscape. We survey several myths about the Chinese market—from a looming debt bubble to export dependence to an inability to innovate—and explain what investors need to pay attention to in order to make informed decisions as they tap China’s opportunities.

Despite projections that this giant will eventually surpass the US and claim the mantle of the world’s largest economy, China remains a developing country with its own unique brand of economic peculiarities.

While China’s central government has ably shepherded the country to unprecedented expansion, it still exerts a dominant and sometimes heavy-handed influence on the economy and markets. Many investors are understandably unnerved by China’s perceived mountain of debt, its giant shadow-banking sector, and a potential real estate bubble. Still others worry that the country is overly dependent on low-cost exports and infrastructure projects, rather than domestic consumption and innovation. And environmentally responsible investors are uncertain about the steps China is taking on its environmental front.

Such an investment climate may appear overly exotic and too risky. However, before deciding to pass over China, investors need to familiarize themselves with several misconceptions that can distort perspectives about China’s economy and corporate landscape.

Capital Markets

Myth: China’s capital markets are liberalizing.

Reality: Lingering restrictions and government intervention mean markets won’t resemble those of the US or Europe anytime soon.

It was another sign of the wave of foreign investment destined for China’s capital markets. In February, MSCI announced plans to quadruple the weighting of Chinese equities in its benchmark indices this year.

But days later, MSCI decided to drop Han’s Laser from its indices because of regulatory intervention: ownership of the stock was about to touch a long-standing government-imposed ceiling on foreign investment. Buy orders halted. The turn of events illustrates both the opportunity and the complications from the opening of China’s equity and bond markets to foreign investors.

Adding Onshore Securities

Seeking a more accurate reflection in trading indices of China’s giant but underrepresented capital market, prominent global bond and equity benchmarks are increasingly adding China’s onshore securities. As a result, foreign inflows into its stock market are projected to double in 2019 to US$89 billion, according to Citigroup. Cumulative net flows have already reached US$114 billion through April 30, 2019 (Display).

Today, China’s A-shares market, which is composed of stocks that trade on the mainland exchanges, looks a lot like the US stock market circa 1965. It’s still unevenly regulated, marked by patchy governance of its listed companies, and dominated by retail investors, whose tendency to buy high and sell low can exacerbate volatility.

But thanks in large part to the inclusion of Chinese stocks in the MSCI Emerging Markets Index in 2018, the liberalization of access to China’s A-shares market and its regulatory framework—such as the strengthening of trading-suspension rules—has progressed much more rapidly than expected.