SHANGHAI: China’s recovery from the COVID-19 pandemic and a flurry of market reforms are creating an ideal backdrop for the possible inclusion of its government bonds in a major global index this week.
Index provider FTSE Russell is widely expected to add Chinese government bonds (CGBs) to its flagship World Government Bond Index (WGBI) after an annual review on Thursday, a potentially major step for Chinese bonds as investors seek safe-haven assets in a zero-interest-rate world.
“If China is included into WGBI, it indicates that it has passed FTSE Russell’s rigorous index inclusion criteria, particularly around market access and tradability,” said Danny Suwanapruti, rates strategist at Goldman Sachs.
“This opens the doors for several global fixed income investors beyond index trackers, such as total return funds, multi-asset funds, DM bond funds and central banks.”
China fumbled inclusion in last year’s WGBI review over long-standing investor concerns, in particular the poor liquidity, limited flexibility in foreign exchange settlement and tight bond settlement cycles.
Since then, regulators have addressed many sticking points, simplifying regulations, scrapping quotas, extending trading hours and bringing market structures more in line with global norms, including a raft of measures in the past few weeks.
“A couple of weeks ago, people would have thought inclusion is going to be a close call because there were still some outstanding issues,” said Suwanapruti. The recent changes have improved the chances of being included in the index, he said.
Chinese government bonds are already becoming a part of the J.P Morgan and Bloomberg Barclays index suites. But the FTSE WGBI has a far larger passive band of investors following it.
Goldman Sachs estimates there is $2.5 trillion of global cash following the WGBI, and China’s inclusion could drive $140 billion into mainland bonds.
PANDEMIC PREMIUM
A WGBI inclusion would help to legitimise Chinese bonds for more investors, particularly as the People’s Bank of China keeps policy steady while the rest of the world is cutting rates.
Hiroshi Yokotani, managing director of State Street Global Advisors, said Japanese investors seeking to diversify away from U.S. assets have begun to look at China as a possible destination, noting that “of course, investors are desperate for yields.”
Ten-year CGBs yield 240 basis points more than their U.S. equivalents, and expectations of a strong yuan mean hedging costs are low.
Foreign interest is rising. On Monday, the largest exchange-traded fund to invest purely in CGBs listed in Singapore..
It took foreigners 22 months to go from 1 trillion to 2 trillion, official data shows. Just fourteen months later, at the end of August, foreigners held Chinese bonds worth 2.8 trillion yuan ($412.61 billion), nearly 3% of all outstanding bonds, and 9.2% of CGBs.
The structure of inflows has also shifted. In 2017, short-term debt instruments, such as certificates of deposit, made up a large proportion of inflows as “less sticky” investors bet on the yuan appreciating, said Min Dai, Morgan Stanley’s head of Asia ex-Japan macro strategy.
There are now more mutual funds and pension funds investing primarily in bonds, Dai said. He expects foreigners to own around 20% of CGBs by the end of 2030.
($1 = 6.7861 Chinese yuan)
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