May 16, 2007 / 11:43 AM / in 10 years

China gives investors foretaste of liquidity wave

<p>A man closes his umbrella in front of an electronic board at a stock exchange in Wuhan, the capital of central China's Hubei province, May 15, 2007.Stringer</p>

LONDON (Reuters) - China's recent loosening of rules to allow more investment abroad is a reminder to investors and central bankers around the world that a new wave of global liquidity may well buoy future asset prices.

In what Morgan Stanley dubbed a "baby step", China last week announced moves to allow Chinese investors to invest indirectly in foreign equities and derivative products.

The scope, however, was narrow. It applies to investment through qualified Chinese commercial banks and the quota at issue is currently only about $14 billion with just half of what is raised allowed to go to equities instead of fixed income.

Then there is the issue of why a Chinese investor would want to buy overseas equities at the moment.

Domestic class-A shares .SSEA are up around 48 percent year-to-date despite a couple of hefty falls. Compare that with single digits on Wall Street and in Europe.

"Chinese investors are mostly return-driven," Hsien Chiang, chief executive officer of GTJA-Allianz Fund Management, told Reuters. "We are foreseeing a continued enthusiasm towards the A-share market."

In a similar vein, things move slowly in China and there is little expectation either that domestic investors will suddenly embrace foreign shares or that China will lift its quota significantly in the short term.

Stewart Edgar, managing director for Asia of Fortis Investments, one of the first foreign firms to get joint asset management ventures in China, reckons the amount flowing out to overseas equities will be relatively thin.

He estimates it will take three years or more before it reaches the $10 billion that is allowed in from abroad to buy stocks.

"It is not (a) wave of money that is coming in the next few years," he said.

New Wave

That said, the mere idea of Chinese money coming to overseas stock markets has been enough to stir investor juices. Hong Kong-listed stocks in mainland companies, or H shares, surged more than 5 percent to an all-time high on Monday after the Chinese announcement.

The excitement, of course, is primarily based on potential, the belief that a wall of money will eventually come to world markets from Chinese investors.

To get some idea of the potential, consider that total yuan deposits in China were worth around $4.8 trillion at the end of April, with slightly less than $2 trillion of it in household deposits.

Fitch Ratings estimates China held nearly $500 billion in external assets last year excluding foreign exchange reserves while, in another baby step, China is setting up an agency to invest part of its $1.2 trillion reserves in world markets.

State media suggests it will initially manage some $200 billion.

Great oaks from such little acorns grow.

And if this is not enough, China's latest move simply adds to an existing trend for global markets to be funded by new players.

South Korea's $200 billion state-run pension fund, for example, is being allowed to increase investment abroad aggressively in non-debt assets.

At the same time, new wealth from mainly Arab countries is already making an impact and set to grow.

Youssef Affany, head of investments, Middle East, for Citi Private Bank, says there were 300,000 dollar millionaires in the region at the beginning of 2005 and there are likely to be 500,000 by the end of the decade.

The bulk of the investment is being recycled locally, but much of it also is bound to flow into global, probably emerging, markets. "Where the new money is being built is in the Middle East, Africa and Asia," Affany said.

While investors will doubtlessly welcome the additional new liquidity, central bankers might not be so bullish about it.

Many major central banks have been trying to rein in liquidity by raising interest rates to cut supply. But any wall of new money could undermine their ability to do so.

"It doesn't help. It makes it more complicated because it is related to global imbalances," said Lex Hoogduin, chief economist at Robeco Group and a former European Central Bank adviser.

"The only thing that (a) central bank can do is raise interest rates," he said.

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