‘Financial patriotism’ is not working too well for the China markets. The slow pace of reforms, arbitrary controls and lethargic pace on global bourses continue to cast their shadow in Shanghai. The markets opened after the long national holidays with a reversal of fortunes as nearly 20 billion yuan worth of non-tradable shares were unlocked over a 15-day period in Shanghai and Shenzhen.

The release of massive volume of shares and the restarting of IPO applications process after a suspension of nearly two months has triggered fears of oversupply of stocks among cold investors. The only way out of this negativity is the entry of more foreign investors.

The China Securities Regulatory Commission (CSRC) which wants a buoyant stock market by the end of this year, has promised to speed up approvals for qualified foreign institutional investors, or QFIIs, and ease entry criteria. Foreign investors can operate in China’s markets only through the QFII quota. Although this scheme has been around since 2003, market observers this time detect a more determined effort by the regulators to encourage more long-term investment funds from overseas, which would help lift the domestic stock market in the short run.

To encourage the reform of the capital market, authorities have accelerated processing of QFII applications. The State Council increased total QFII quotas in April to $80 billion from the previous $30 billion. Overseas-fund providers can hold 30 percent of the stocks of one company, compared with 20 percent before, which is a signal of an advanced opening-up reform to hold up the domestic capital market.

Global road-shows

Interestingly, Chinese financial institutions, including representatives from Shanghai and Shenzhen stock exchanges as well as the China Financial Futures Exchange, launched aggressive investment road-shows in Canada, Europe and some Asian countries last month, to woo foreign pension funds and other investors to the Chinese financial market.

The organizers, who also included representatives from banks, fund companies and securities firms, tried to woo institutional investors in North America with the volume and potential of the Chinese capital market, going all out to target sovereign wealth funds and pension funds. CSRC regulators also pitched in with an assurance that institutions with QFII quotas can invest in the interbank bond market and in privately raised corporate bonds for small and medium-sized enterprises, to diversify their investment portfolios.

Foreign investors however remain concerned over the transparency of Chinese market and regulations, which authorities insist will see drastic improvements, a crack down on insider trading and more legal protection to foreign fund companies.

The CSRC policy easing thus can help increase domestic stock market liquidity by absorbing more foreign long-term funds. This has now become more than urgent because in the past few months, China has posted monthly capital outflows due to lowered growth.

For a long time, Chinese banks’ yuan holdings for purchasing foreign exchange was the main channel for them to create money. Foreign exchange had become a main source of the country’s liquidity over the past two decades as the central bank sterilized its fluctuation to stabilise the yuan exchange rate.

Now the old pattern is changing, which means the banks need to find new ways to issue currency if it wants to maintain stable money supply growth. Yuan holdings of foreign exchange purchases started to increase at the beginning of the year, but the hikes ended in April, when a 60.6 billion yuan monthly fall was reported.

This came as a shock and in the following months, yuan holdings among banks for purchasing foreign exchange, an important measure of capital flows, kept declining. In August it fell by a whopping 17.4 billion in yuan August to 25.64 trillion yuan due to slow economic growth.

China therefore needs new sources of liquidity and the easiest option now is increasing QFII quotas. Experts say buying treasury bonds in the secondary market could become a major channel for the central bank to create money in the future. But controlling liquidity through purchases and sales of treasury bonds requires a bigger and more mature secondary market, which China does not have.

The writer is a freelance journalist based in China.