Source: China State Council Information Office
China’s Ministry of Finance (MOF) issued $6 billion worth of sovereign bonds into Hong Kong Special Administrative Region on October 14, with subscriptions by international investors reaching 4.7 times the volume issued by the time the dollar-denominated bonds were released at a premium. According to data from China Central Depository & Clearing Co., Ltd. (CCDC), holdings of Chinese sovereign bonds by overseas institutions have grown continuously for the last 23 months, now totaling $370 billion. This figure is up by 38.5 percent compared with the end of 2019.
FTSE Russell, the world’s second largest index service provider, has revealed that China’s sovereign bonds will be included in FTSE GBWI from October 2021. In February and April 2020, China’s treasury bonds were included by J.P. Morgan Government Bond Index-Emerging Markets (GBI-EM) and Bloomberg Barclays Global Aggregate Index.
Amid escalating China-U.S. trade frictions as well as Western politicians’ bombardments of the Chinese economy, why are international investors still so interested in China’s sovereign bonds?
The major reason for the enthusiasm is the high yield of China’s sovereign debts, as capital is always chasing profit. A deeper analysis, however, reveals that high yields do not offer a full explanation for foreign investors’ enthusiasm. As far as institutional investors are concerned, security of their capital comes ahead of yields and no matter how high a potential yield is, a lack of security is a strong disincentive for investors.
Overseas investors’ rush to China’s sovereign bonds is fueled not only by a relatively high bond yield, but also China’s robust economic rebound. This is a decision based on investors’ careful comparison of different bonds and an analysis of investment information from various channels.
China’s bond yields are not only rising faster than any others’, in the first half of 2020 they also stood out as premium assets on the global market. While other major economies are trying to spur their economic recovery by cutting interest rates to cushion the impact of the novel coronavirus disease (COVID-19) pandemic on their economy, China chooses to maintain a relatively high interest rate, with the addition of various fiscal supports. China is expected to be the only major economy to register positive growth on a year-on-year basis in 2020, and this is one of the key factors attracting overseas institutional investors. The inflows of international capital to the Chinese bond markets strike a sharp contrast to the outflows of capital from the majority of emerging markets that are being battered by COVID-19.
At the same time, China can also boast of stable investment credit ratings. Take the $6 billion worth of sovereign bonds for example, Moody’s has assigned an A rating to the bonds, Standard & Poor’s (S&P) and Fitch have issued an A+ rating, while Pengyuan International has assigned an AA rating.
These endorsements suggest that China’s government bonds are premium assets that are almost risk-free at the current stage.
That overseas investors continue to pile into China’s bond markets, and that major international index service providers include Chinese treasury bonds in their major indexes reveals international investors’ confidence in China’s sustained and healthy economic growth, and also their recognition of the openness of China’s financial market. The subscriptions for Chinese sovereign bonds exceeding the issue by 4.7 times in Hong Kong last month is a prime example of international capital’s demands for China’s treasury bonds now outstripping supply.
Statistics from CCDC also reveal that foreign capital makes up only a small fraction of China’s bond portfolio, although China is now the world’s second largest bond market. Currently, overseas investors hold only 8.7 percent of China’s inter-bank treasury bonds. For the sake of financial security, the Chinese Government has been relatively conservative in overseas debt issuance. At the present stage, overseas institutions are allowed to conduct only derivatives trading such as bond forward and interest rate swaps on China’s inter-bank bond markets for the purpose of hedging. Limited tools to control interest rate risks have restrained overseas institutions’ investment in the Chinese bond markets.
Currently, a new development pattern is taking shape that centers on internal circulation and features a dual- circulation growth model in which internal circulation and international circulation promote each other. Through this new pattern, China will open its financial market wider to the outside world. The openness of China’s financial market makes up an important part of China’s overall opening up to the rest of the world, while the bond market plays a dominant role in the opening up of the financial market.
Encouraged by China’s stable economic growth, the charisma of renminbi-denominated assets, and the inclusion of China’s treasury bonds into global indexes, overseas institutions are expected to double down on China’s treasury bonds, which will in turn speed up the internationalization of China’s bond markets.
It’s time for MOF and other relevant authorities to improve risk control measures so as to accelerate the opening up of China’s financial market and facilitate trading. More foreign institutions should be allowed into China’s bond markets and their involvement in China’s treasury bonds futures market should also be permitted when the time is right.