I Dream of China

Today, Chinese officials announced Chinese commercial banks will be allowed to make foreign stock investments. These banks can put as much as 50% of funds in what is called the qualified domestic institutional investors (QDII) program in overseas stock markets. This is being lauded by some as big news and further evidence China is going gangbusters capitalist. Not so fast.

This may seem like a dramatic shift in China's capital controls, but the announcement is really no big deal. The QDII program isn't new. China launched its QDII program in July 2006, allowing approved banks, insurance companies and fund management companies to invest overseas. Initially, banks and insurance companies were limited to investing in foreign bonds, money-market products and fixed-income derivatives, whereas fund management companies were able to invest in overseas equities.

Today's announcement increases the scope of the program to allow banks to invest half of their existing quotas in overseas equities. But the total QDII quota for all banks is a mere $13.4 billion, and today's announcement only impacts about $7 billion of potential investment. Compare that to a global stock market of many trillions, and it's obvious this announcement is chopped liver.

And anyway, the current QDII program has been largely unsuccessful in attracting investor interest. Chinese investors right now favor mainland equities because Chinese equity prices are surging and expectations the yuan will appreciate versus other currencies in the future. As of the end of 2006, Chinese banks had only sold about half their quotas.

All of this pretty well sums up our view on China: yes, it is getting more capitalistic relative to what it used to be, but it's still very much a communist government. Just about everyone is an employee of the state. Virtually all land and property is still government owned, and the vast majority of citizens live in rural villages in poverty.

The idea that China is the new bastion of capitalism today is probably more an illusion than reality. That makes it much more risky and unstable than most folks appreciate. But we recognize even small improvements are welcome, and are certainly pleased the bias is toward more capitalism rather than less. But today, folks dreaming of a robust, capitalist China probably need another forty winks of sleep.