China has been continually denied admission into the MSCI Emerging Markets (EM) Index. Last week that changed. Will this spell doom and gloom or prosperity to the China stock market?

The MSCI index has denied access over the last three years out of concerns that many of China’s market policies were not ‘free market’ friendly. Continued attempts by China to gain access to the index listing indicates its intent to become a meaningful measure of economic standards. The admission indicates MSCI’s belief that their structure and actions (or lack of action) have become more free market friendly.

There are over 450 large cap companies in the China index, with 222 of them gaining exposure to the MSCI EM index over the next year. The overall weighting however is fairly nominal, as it will only represent 0.73% of the index.

The bigger story is the admission to the index as it indicates China’s willingness to allow their stock market to be run as a free market. This will encourage investment from foreign investors and allow the market cap (which is already sizable) to expand.

Conclusion

As a member of the MSCI EM Index, what has been a predominantly domestically owned stock index will gain additional interest and potential growth. EM Index funds around the world will have to add exposure to stay in tune with the MSCI index. In addition, active managers will be more inclined to add exposure as that market becomes more diverse in its ownership and less restrictive from a state standpoint. In all, the additional demand should spell higher prices for equities out China over the long haul.

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