China pushes for bonds to be included in global indices even as some foreign investors seek delay

Beijing is pushing hard for the inclusion of yuan-denominated bonds that are traded in onshore markets in major global bond indices, in an effort to encourage needed capital inflows.

But some foreign investors are pushing back on an early inclusion, claiming they have not yet created the necessary infrastructure to handle the investments that would result.

The Chinese government is urging bond indices to move forward anyway, arguing that lack of preparations by a few investors should not deny other investors the opportunity to own Chinese bonds.

Clearly, China needs capital inflows to fund its industrial restructuring and support for the economy, which has slowed dramatically because of the trade war with the United States, and because its once-massive current account surplus is shrinking rapidly.

The inclusion of Chinese bonds into global indices would automatically channel funds into China as many funds allocate money by passively tracking these indices.

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To support the inclusion of Chinese bonds in these indices, Pan Gongsheng, deputy governor of the People’s Bank of China, told hundreds of delegates at the China Bond Market International Forum in Beijing on Thursday that China would create “a more friendly and accessible investment environment” for investors.

In addition, China would create exchange traded funds and foreign exchange hedging services for investors, he added.

The speech by Pan – who also the heads the State Administration of Foreign Exchange (SAFE), China’s foreign exchange regulator – highlighted Beijing’s effort to team up with the Hong Kong stock exchange, Bloomberg, FTSE and JP Morgan to channel money into China. In particular, China is keen to get China bonds included in the Bloomberg-Barclays Global Aggregate Indices, with a decision expected in April.

Pan said that Bloomberg chairman Peter Grauer told him last year that there were three key preconditions – clear income and value-added tax rates, deployment of a delivery-versus-payment service on trading platforms and a trading allocation mechanism – that had to be met before Chinese bonds could be included in the indices.

“I solved all three issues by September and I gladly wrote to Mr. Grauer,” Pan recalled in his speech.

Nevertheless, some investors continue to call for a delay in the inclusion of Chinese bonds in the Bloomberg-Barclays indices. This has aroused great concern at the central bank.

“We publicised the plan last year. Why cannot you prepare the investment process and technical preparations early?” Pan asked.

“Of course, the decision is up to Bloomberg and I have no right to interfere with it. But if it is delayed just because a few investors are not well prepared, it’s unfair to other investors,” Pan said in a raised tone.

Beijing is now well positioned to lure international bond investors, given their under-allocation of long-term, high yield Chinese bonds. The yield on 10-year Chinese Treasury bond is about 3.3 per cent, higher than 2.8 per cent earning on US Treasury 10-year notes.

The enthusiasm is also borne out in the statistics. Overseas investors hold 2.3 per cent of issues in the world’s third largest bond market at the end of 2018, up from 1.9 per cent a year earlier, but still well behind the rates of 35 per cent in Indonesia and 25 per cent in Malaysia.

“Despite yuan depreciation expectations in the latter half of last year and China-US trade frictions, overseas investors remained enthusiastic, as 80 per cent of their funds allocated to emerging markets went to China, ” Pan noted.

Earlier this week, the SAFE announced that it would double to US$300 billion the investment quotas in the Qualified Foreign Institutional Investors programme, a channel through which institutional investors can buy Chinese stocks and bond.

Although the growth pace of the world’s second largest economy is set to slow this year, Pan said investors should focus on China’s medium- and long-term potential.

“A slowing economy isn’t a bad thing since the government has already shifted to prioritising the quality and sustainability [of growth],” he said.

Instead, he reminded investors of China’s complete industrial chains and rapidly increasing middle class, which should underpin the success of the country’s economic transformation.

Still, Beijing remains cautious about capital outflows, which could exert pressure on yuan exchange rate and threaten financial stability. It continues to impose strict capital controls on outbound investment and has, so far, refused to open the “southbound” channel of the Bond Connect that would allow Chinese domestic investors to buy foreign securities through Hong Kong.

The one-way bond market flows also indicated an uneven progress int the opening of the country’s financial market.

Foreign access to the financial industry remains limited except for a few cases, most notably the controlling stake that Swiss bank UBS Group recently was allowed to buy in its China joint venture.

A majority of foreign financial firms who have applied to expand their businesses in China – including bank card payment firms Visa and Mastercard as well as rating agencies S&P and Fitch – are still anxiously waiting for license approval.