One of the most encouraging news items for the Hong Kong financial market in recent months must have been the expanded scope of investment by mainland banks for their clients under the QDII (qualified domestic institutional investors) scheme.

The benefits that this new decree by China Banking Regulatory Commission (CBRC) can bring to Hong Kong are seen by policymakers and economists to extend far beyond the various investment markets.

Helping to reaffirm Hong Kong's importance as a financial center to the mainland, the CBRC's decision has greatly bolstered Hong Kong people's confidence at a time of growing doubt about the city's relevance to China's economic development.

In a column published on the website of Hong Kong Monetary Authority (HKMA), the de facto central bank, Joseph Yam, HKMA's chief executive, eloquently declared that the CBRC's "decision has longer-term, strategic significance" to the mainland in monetary management and to Hong Kong in financial market development.

Yam and other economists in Hong Kong believe that the decision was an integral part of the capital account liberalization process which encourages the outflow of funds under a framework of effective regulation and control. Such an outflow can help relieve some of the pressures on the exchange rate of the renminbi and on monetary management brought about by the rising current account surplus, strong capital inflow and the rapid accumulation of foreign reserves.

The latest expansion of the QDII scheme also offers mainland investors a welcome alternative to diversify their enormous savings from low-yielding bank deposits. The strong desire by mainland investors for other investment channels has been forcefully demonstrated by the flood of cash into the stock market from bank deposits in the past 18 months of so.

At current price levels, the risk-return profile of the Chinese equity market may have become increasingly unpalatable to a growing number of mainland investors. The newly created opportunity to invest in the Hong Kong equity market under the QDII scheme would seem most welcome despite the inherent foreign exchange risks, which should remain small.

Further expansion of investment flow from the mainland to Hong Kong under the QDII scheme and from Hong Kong to the mainland under the QFII (qualified foreign institutional investment) scheme could go a long way in addressing the nagging anomaly arising from the persistent price difference between the Hong Kong-listed H shares and mainland-listed A shares of the mainland enterprises.

The price differential between these two classes of shares, which are entitled to the same rights, is a symptom of market segregation which is understandable but unhealthy, and, as Yam noted, "should be addressed in an orderly way before the market springs a surprise on everyone".

The CBRC's decision must be seen as a move in achieving the objective to allow domestic supply and demand on the mainland to interact with the internationalized market forces in Hong Kong. Such interaction is seen as essential for making the market more structurally stable and price discovery more efficient.

Some market participants may feel disappointed by the limitations of the QDII quota, which restricts the equity component to 50 percent and the investment in any one individual share to 5 percent. But as Yam said: "It is more important for us to appreciate what the mainland authorities are trying to achieve and the role the financial system of Hong Kong can play in helping to bring it about."

E-mail: jamesleung@chinadaily.com.cn

(China Daily 06/12/2007 page10)