The Effect of the China Connect

Abstract

We study the effect on Chinese firms of the Shanghai (Shenzhen)-Hong Kong Stock Connect. The Connect was an important capital account liberalization introduced in the mid-2010s. It created a channel for cross-border equity investments into a selected set of Chinese stocks while the overall capital controls policy remained in place. Using a difference-in-difference approach, we find that mainland Chinese firm-level investment is negatively affected by contractionary U.S. monetary policy shocks and that firms in the Connect are more adversely affected than those outside of it. These effects are economically large, robust, and stronger for firms with higher leverage, a higher share of foreign sales, and operating in the non-tradable sector. Because firms would try to stay out of the Connect if increased sensitivity to external shocks were the only effect, we broaden our analysis. We find that firms in the Connect hold more cash, enjoy lower financing costs, and have higher profitability than unconnected firms. We discuss the implications of our results for the de- bate on capital controls.

Keywords: Capital Controls; Global Financial Cycle; Foreign Spillovers; FOMC Shocks; China Connect; Corporate Investment

JEL Classification: F38; E40; E52; G15