China on-site: renminbi worries and the rise of A-shares

Although currently concerns have abated, every now and then investor worries crop up about the renminbi. We have confidence, however, that China has its currency under control.

Over the last few years, the Chinese government has undertaken an extensive process to liberalize and internationalize the renminbi, which is now the sixth most used currency in world trade.

The main reason for investors to get nervous, is the prospect of a weakening renminbi, causing Chinese investors to lose confidence in the national currency and looking for ways to invest their money outside of China, triggering a downward spiral.

However, we see the People’s Bank of China (PBOC) managing this risk carefully. Since late 2015, it manages the currency against a basket of currencies (China Foreign Exchange Trade System or CFETS), and no longer versus the USD alone. Capital controls mean that only limited amounts of money can leave the country. Stepped up measures worked well in early 2017, for example, when investors were nervous because of shrinking Chinese reserves. The PBOC intervened by strengthening its capital controls, causing the renminbi to stabilize and markets to relax. Figure 1 shows that the renminbi has been quite stable of late.

Of course, renminbi worries may re-appear, which can have a short-term impact on market sentiment and is an important issue to watch. Longer term, however, we have confidence in the PBOC’s ability to safeguard the currency’s stability.

Chinese A-shares, trading on two exchanges in Shanghai and Shenzhen, are becoming increasingly important. As the A-share market is opening up to investors and MSCI plans to include A-shares this year, a lot of capital is expected to flow into the onshore Chinese market.

A-shares offer investors access to themes that are less well represented in the offshore universe. Some sectors that make up the ‘new economy’, like healthcare, mass market consumer products, services and technology, are showing better growth than the market as a whole. They account for about 40% of total A-share market capitalization. The market also offers exposure to state-owned enterprises, which we expect to make significant progress in terms of mixed ownership and corporate governance.

The A-share market offers broad exposure to China, and is currently still lowly correlated with the offshore Chinese market, and other global equity markets.

The vast A-share market, which makes up over 70% of the Chinese market, is increasingly opening up to foreign investors. At the start in 1990, only domestic investors could purchase A-shares. From 2002, foreign institutional investors that met strict conditions were granted access in the shape of quotas. In 2014, the Shanghai-Hong Kong and in 2016, the Shenzhen-Hong Kong Stock Connect schemes were launched, providing further access. They allowed investors to easily trade shares on the other markets using their local brokers and clearing houses.

In June, MSCI is to include Chinese A-shares in the MSCI Emerging Markets Index, starting with a 5% inclusion factor. This is an important step, as we expect it to support the renminbi and improve the A-share market’s investor structure from retail-dominated to a more balanced mix of institutional and retail investors. Furthermore, we expect the inclusion to improve China’s capital market liberalization and regulation. Full inclusion will take five to ten years, depending on progress in market accessibility.

Major new themes, such as the consumption upgrade due to China’s growing middle class, the Made in China 2025 initiative to become a quality producer, and China’s leadership in technology and innovation, are creating many investment opportunities. The Chinese A-share market is a good place to gain access to them.

In the next edition: trade wars and opportunities in the healthcare sector.