The size of China’s bond market
China’s onshore bond market has doubled in the past five years. The fixed income market expanded by 18% to RMB114tn (USD17tn) in 2020; local governments (which issued 22% of total outstanding bonds), the central government (18%), and policy banks (16%) were the largest issuers.
Flows to China’s bond market
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China’s bonds have recorded average net monthly inflow of a little over USD9bn over the past two years. FTSE Russell announced that it would include China government bonds in the World Government Bond Index over a period of three years. Their weightage would be 5.25%, translating into inflow of USD150-180bn.
Accessibility reforms, index inclusion and onshore opportunities attract global capital; however, foreign investors own only 2.5% of the market. Commercial banks are the main investors in local-government bonds, holding c.85% of total local-government bonds outstanding as of March 2021.
The case for investing in China government bonds
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For global asset managers, China bonds are an attractive option, as they enhance returns (spread of ~300bps over aggregate G3 yields) while de-risking a portfolio (correlation of >0.2% with major developed-market global bonds).
Investor concerns on China’s onshore bonds
Given the value added to global portfolios, asset managers are likely to want a share of China’s bond market (the world’s second largest). However, there are risks:
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Recent defaults by state-backed issuers (which account for c.60% of the outstanding bonds) have caught investors off guard
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The low credibility of domestic rating agencies (<90% of the bonds are rated AA and above), as the recent defaults were by issuers rated AA and above
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Lower transparency, weak governance standards and international investors’ lack of expertise in the local language