The Chinese government has received a lot of attention for starting to liberalise capital outflows from the country part of its plan to help local companies by promoting the use of the renminbi offshore but it still has a lot of work to do on inflows.
There are some signs the government is moving in the right direction. Regulators lifted the quota for qualified foreign institutional investors from $30bn to $80bn last month although less than $25bn had been allocated at this point as well as increasing the amount of offshore renminbi that the Hong Kong subsidiaries of Chinese companies could remit to the mainland to invest in the local market.
But the full liberalisation of the capital market is still some time away. Most analysts do not expect the currency to be liberalised until 2015, and foreign investors are unlikely to be allowed into China en masse before that point. Even the World Bank only got permission to invest in the onshore renminbi market last month, despite its strong ties with the government. (International Finance Corp, an arm of the World Bank, was allowed to become the first foreign issuer of renminbi bonds in October 2005.)
The government is slowly moving in the direction investors want, and foreign investors are understandably anxious to get access to the country. But they should walk into the countrys capital markets with their eyes wide open. China may be an exciting growth economy and it may give impressive returns (especially for those who already invest in the comparatively tight dim sum bond market), but investor protections in the country are another story altogether.
China gets a mark of five out of 10 on the World Banks investor protection scale, which specifically refers to protections for shareholders, rather than bond investors.
Chinas score is, unsurprisingly, nowhere near the scores posted by Hong Kong and Singapore, which each get more than nine out of 10. But that is an unfair comparison: after all, the two Asian financial hubs are more investor friendly than both the UK and the US, which have scores of 8.0 and 8.3, respectively. It is when you compare China to other emerging market nations that it really looks poor.
The country, in fact, more closely mirrors France than it does other emerging market countries. Brazil, India, Russia and South Africa the other members of the BRICS grouping of rising economies all have a degree of balance when it comes to protecting investors, although Russias protections still leave a lot to be desired.
France, on the other hand, is on a similar plane to China when it comes to investor protection: extreme disclosure rules, backed by almost no liability at the director level and a difficult environment for shareholders to sue companies for misconduct. In other words, we have to tell you what were doing, but if you dont like it, theres not much you can do about it.
But while France may have shoddy investor protection, it does not have China's closed-shop political system where ministers are said to appoint many of the chief executives of the biggest state-owned companies. The combination of the two is a recipe for disaster.
In average terms, China does not look bad compared to East Asia and the Pacific Islands (see table). But its average is driven up by disclosure rules, not by any attempt to protect investors in a real recovery situation.
Foreign investors have already got used to taking a certain amount of recovery risk with Chinese credits. The deals they buy in the international bond market are usually sold by offshore subsidiaries which have little or no control over the onshore assets, effectively subordinating offshore creditors to onshore ones.
But they need to realise another truth: just because they are now getting direct access to companies, that doesnt mean they are safe.