In the first 1.5 months of 2021, the Hong Kong market was flooded with massive Southbound liquidity, and investors have begun to ask: will the momentum continue? It may look like a simple yes-no question at first glance, but the answer to it is far more complicated than one would imagine.
We must first understand China’s ability to generate foreign exchange reserves in the past year, because the Chinese government will only allow further outflows of foreign exchange if it has a reasonably sufficient amount of it. Secondly, understanding China’s monetary policy is key as an accommodative stance will likely spur southbound inflows. But even if both conditions are fulfilled, it boils down to the appeal of Hong Kong-listed stocks. In other words, mainland investors will not necessarily see Hong Kong as a good enough investment destination if the companies listed in the city are not attractive to begin with.
China’s robust forex reserves growth in 2020
Over the past year or so, China posted strong foreign exchange earnings with Covid-19 having minimal impact on the country’s exports. The Chinese government’s swift move to impose lockdown measures had effectively reined in the outbreak, allowing productions to recover sooner than other countries, which led to a strong export growth. Given the decline in international travel spending among Chinese tourists due to the pandemic, China’s services trade deficit retreated substantially by 42% year-on-year in the first three quarters of 2020.
In addition to its record trade surplus, foreign direct investments in China soared last year. This is primarily down to the widening interest rate differentials between China and Western countries, and with the country being one of the handful whose government bonds offer positive real returns, meaning that their bond yields stand above inflation rates, China has been sought after by many bond investors globally. In the first three quarters of 2020, net foreign investment inflows into onshore bond market reached $86.8 billion, a 130% increase compared with the same period last year1.
Overall, given China’s ability to generate forex reserves last year, a substantial inflow of mainland capital into Hong Kong will likely have minimal impact on the size of its foreign exchange reserves.
Are China’s loose monetary policies coming to an end?
Given China’s ample forex reserves, the level of capital flows is to a larger extent a question around the government’s monetary policy.
With China’s financial market lagging that of the US and UK, its monetary policies are implemented using various tools. While interest rate is an important indicator of a country’s monetary policy stance, it is by no means the only factor one should look at when assessing where the Chinese government stands, unlike the US Federal Funds Rate. Fortunately, the People’s Bank of China maintains and updates monthly the total social financing (TSF) data, providing investors insights on capital flows into the economy through bank loans, trust loans, and entrusted loans.
However, the scale of TSF is meaningful only when compared with the size of the real economy. Simply put, a higher growth rate of social financing loans versus that of GDP reflects an increase in hot money circulating in the economy, which will likely drive asset prices to rise.
Over the past year, central banks globally including China adopted loose monetary policies to cushion their economies from the impact of Covid-19. Meanwhile, the growth rate of China’s social financing was almost 10% higher than GDP growth, so the excess capital found its way into the stock markets and were reflected in the performance of onshore equities and the level of southbound trading activities.
Looking ahead, we believe China’s monetary policy will remain accommodative over the short term, but money growth relative to GDP growth is expected to moderate this year due to the high base factor, which may interrupt the pace of fund flows into Hong Kong.
The appeal of Hong Kong-listed stocks
Finally, we have to consider the appeal of Hong Kong-listed stocks. While the city’s stock exchange, which in the past was heavily weighted towards traditional industries such as financial services and real estate, was hardly the most vibrant bourse for investors. The Hong Kong stock exchange’s move to relax listings rules has attracted multiple US-listed Chinese tech companies to seek a secondary listing in the city, with many Chinese tech firms continuing to fill the IPO pipeline. Hong Kong-listed stocks, in our view, will be increasingly attractive to both domestic and foreign investors.
This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.
Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.
There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.
 Source: State Administration of Foreign Exchange, as of March 2021
 Source: Statistics and Analysis Department of The People’s Bank of China, as of March 2021