China, well known for its capital controls, made some steps towards loosening those controls for individual investors last month with the announcement that individual mainland Chinese investors would be able to invest in the HK stock market although now it appears the implementation will be delayed slightly according to an announcement by the Bank of China (BOC).

To understand the impact of these changes, for a moment, imagine yourself a wealthy mainland Chinese entrepreneur. You've been incredibly successful in the manufacturing business (hopefully not in toys) and now you're wondering where to put all your new found wealth as your mattress is stuffed. Well, China isn't the easiest place to invest. The government doesn't allow you to invest (legally) abroad, so you have to invest domestically in either the frothy real estate market or the even frothier stock market. With valuations on both of those choices getting into the irrational end of the spectrum, you're a bit stuck. 

Now of course, you could just assume that economic cycles don't matter and China's real estate and stock markets are immune from historical boom-bust cycles that all the other markets are subject to, which some people are thinking. A smart investor though would be looking for diversification, which these changes will give you...at least a little bit.

Once BOC starts the program, you’ll be able to open an account with a BOC branch in Tianjin (NE of China) and an account with BOCI Securities Ltd. in HK, which is BOC’s HK brokerage arm. Once both accounts are opened, you can take some of your manufacturing profits and invest them in the HK market. The program is being trialled in Tianjin though agreements with other branches of BOC, will allow investors from all over China to invest.

It will be interesting to see how this plays out.  A-shares* in Shanghai are nearly 4 times overvalued as compared to their HK H-share counterparts, so there’s a lot of speculation that there will be a big adjustment as capital flows from the Shanghai market to HK as people may rebalance their portfolio and move from A-Shares to the more sensibly valued H-shares.

Whatever the outcome, it’s a step in the right direction for the economy and will hopefully ease a little bit of the pressure on the excess domestic liquidity and yuan appreciation (even though most of this comes from China’s tremendous trade surplus made up of things like...er, well, toys).

 

* In case you’re unfamiliar, the shares traded on the mainland Shanghai exchange are called A-shares and are typically not open to non-Chinese individual investors. Shares on the HK exchange are called H-shares and are more open to foreign investment. A Chinese company will often have listings on both the HK and Shanghai markets and hence have both A and H-shares.