SHANGHAI, June 20 (Reuters) - Foreign investors are betting U.S. index publisher MSCI will finally agree to include China-listed shares in its emerging markets benchmark this week, stepping up their buying of Chinese blue-chips that could gain from inclusion in the index.
In May, overseas investors bought a net 19.8 billion yuan ($2.90 billion) of mainland shares via the "Connect" schemes that link the Hong Kong and China markets, pushing up volumes by 56 percent from the previous month.
"We believe this was due to foreign investors' expectation that MSCI will announce the inclusion of A-shares this week," said UBS strategist Gao Ting, noting that northbound investors have mostly chosen shares in the consumer and pharmaceutical sectors over the past month. Net inflows so far this month have reached nearly 15 billion yuan.
The flows into Chinese firms such as Midea Group and Gree Electric Appliances came ahead of MSCI's decision on whether to open up its Emerging Markets Index (EMI) to mainland-listed China shares. The announcement is due shortly after 4.30 pm New York time on Tuesday, June 20 (4.30am Wednesday in Hong Kong).
If China A shares were to be included, consumer and real estate stocks in particular would see their weighting increase - at the expense of financials - under MSCI's new methodology unveiled in March, which will cut the number of constituents to 169 from 448.
MSCI has previously declined to include China in the EMI three times amid investor complaints about curbs on repatriating capital from China and concerns over the country's large number of suspended stocks. The newly adopted methodology is designed to address these issues and make inclusion more likely, analysts said.
China's securities regulator said on Friday that it hopes MSCI can open its index to China shares, but if not, Chinese capital market reform will not be derailed.
All the Chinese stocks set to be included are big-caps and can be easily accessed by foreigners through the "Connect" trading link between mainland and Hong Kong markets.
Morgan Stanley sees a more than 50 percent chance of a "Yes" decision, expecting a 0.5-1 percent rise in the Shanghai Composite Index on a positive result, although it noted that actual implementation would not take place until June, 2018.
Eligible Chinese stocks would represent a weighting of only 0.5 percent in the MSCI EM index. "In the case of a 'No' decision: The A-share market might first react with a minor decline of 1.0 percent," Morgan Stanley said in a recent report.
Asset managers have noted that inclusion in the index after the three previous rejections is likely this time, with the weight of money flowing into Chinese A shares evidence of that conviction.
Over the past two weeks, an average of 1.2 billion yuan has flowed into Chinese shares via the Connect each day, nearly 30 percent more than the average during the Jan-May period.
Shenzhen-listed Chinese home appliance maker Midea Group Co - potentially a heavyweight in the EMI - has witnessed a surge in foreign interest since MSCI in March unveiled its new methodology for China inclusion.
Overseas holdings in Midea via the Shenzhen-Hong Kong Stock Connect doubled to 4.16 percent, from 1.94 percent three months ago, with about 230 million shares acquired by foreign investors during the period.
Founder Securities, another potential EMI constituent, has seen foreign holdings in the brokerage under the Shanghai-Hong Kong Stock Connect surge to 17.2 percent, from just 10 percent three months ago.
In another sign of rising foreign interest in Chinese big-caps ahead of the MSCI decision, qualified foreign institutional investors have visited a total of 29 Chinese listed companies so far this month, 23 of which have stocks in the Connect schemes, the Shanghai Securities News reported on Tuesday.
However, some investors appear retreating just ahead of the MSCI announcement, exchange-traded fund (ETF) data suggests.
ETFs tracking China stock indices saw 14.5 million yuan of outflows on Friday, reversing a trend of steady inflows seen since the beginning of this month, according to independent ETF selection platform TrackInsight.
That suggests some investors are thinking again about the likelihood of inclusion in the index, TrackInsight said. ($1 = 6.8338 Chinese yuan renminbi) (Reporting by Samuel Shen and John Ruwitch; Additional reporting by Michelle Price and Liu Luoyan; Editing by Eric Meijer)