By Mei Xinyu (China Daily)
Updated: 2007-08-28 07:14

The State Administration of Foreign Exchange (SAFE) inspired a bout of fresh dynamism among domestic investors last Monday when it issued a regulation allowing mainland individuals to invest in securities traded in the Hong Kong Special Administrative Region as well as in other countries.

According to the SAFE statement, a pilot program is to be launched in Tianjin, a port city close to Beijing, under which mainland residents can use foreign currencies or purchase foreign currencies to open an account with either the Bank of China's Tianjin branch or the Bank of China International Securities in Hong Kong.

Before this change, individuals could only invest overseas indirectly, via banks, brokerages, insurers and fund managers, through the qualified domestic institutional investors (QDII) scheme.

Buoyed by the release of the statement and a strong rebound in neighboring markets, Hong Kong stocks surged more than 1,200 points, or 5.93 percent, last Monday, representing the biggest single-day rise since October 1998.

Against the backdrop of the ever increasing amount of liquidity in the domestic financial market, the decision to allow individuals to invest their money directly will definitely upgrade the structure of the country's foreign assets, offer opportunities to mainland residents for investment and satisfy their demand for overseas equities.

However, the volume of investment will probably be limited in the short and medium terms, so it will not significantly influence China's international balance.

Even with State approval, not all investors would prefer to put their money in overseas securities rather than in domestic ones. And only those investors who prefer more returns for higher risks are likely to invest on their own rather than entrusting their money to the QDIIs.

In other words, the number of individual investors in this pilot program will be limited.

Another factor making overseas securities less attractive to individual investors is the fact that the A-share market on the Chinese mainland is much more rewarding than markets in other regions and countries at the moment.

The location of the pilot program also limits the size of the investor group. Beijing, Shanghai and South China's Guangdong Province are home to the most active individual investors. The SAFE statement asks investors to open an account in Tianjin, and many may feel troubled by traveling there.

Also, under the current circumstances, allowing residents to directly invest overseas may open new channels for money laundering. So the authorities should be very prudent, keep an eye on the pilot program and put the necessary precautionary measures in place before the rules are loosened further.

As mentioned above, it is unlikely that we will see an immediate boom in direct individual investment.

The SAFE statement stipulated that the individual investment amount overseas is not subject to the existing annual limit of $50,000 on individual purchases of foreign currencies. Some have taken the news as an indication that the country would further open its capital account.

Actually, businesses have been allowed to purchase foreign exchange to invest overseas since 2006, and SAFE scrapped the caps on businesses purchasing foreign exchange for overseas investment on July 1, 2006.

So SAFE has really just extended these rights to individuals. Since the volume of business investment is usually much bigger than that of individual investment, the new stipulation governing individual investments is not quite the breakthrough many have assumed.

Boiled down, the real significance of the SAFE pilot program is that it will increase the transparency of capital flows across the Chinese border.

China has for a long time maintained strict capital account controls, and the authorities are cautious about capital account liberalization. However, considerable amounts of cross-border capital flows have eluded State monitors since the 1980s.

The actual amount of overseas investment by businesses and individuals, both in the form of direct investment and in equities, far exceeds what is recorded in the official statistics, especially since the mid 1990s.

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