Foreign investors’ purchases of Chinese bonds will probably surge more than fourfold in the coming two years as global central banks diversify their reserves.
Monetary authorities and supranational organisations will lead buying of about $48bn each in 2017 and 2018, according to a Bloomberg News survey of 11 analysts. That’s more than four times the $12bn of the whole of last year. Inflows have slowed to $8bn so far in 2016 as the yuan’s 4.2% decline sapped investor confidence.
“There’s still huge potential for reserve managers to slowly diversify their reserves into the yuan,” said Paul Mackel, head of emerging-markets currency research at HSBC Holdings. “The appetite from real money managers, such as pension funds and mutual funds, is again very, very high. If China is eventually included in major bond indexes, it could bring an average $80bn-$100bn annually over the coming years.”
While China opened up its bond markets in preparation for the yuan’s entry into the International Monetary Fund’s Special Drawing Rights on October 1, capital inflows have seen a limited impact. The scenario will change over time, with the Chinese currency accounting for as much as 10% of the world’s $11tn of foreign-exchange reserves in a decade’s time, according to Eswar Prasad, a Cornell University professor and former head of the IMF’s China division.
Nine of the Bloomberg News survey’s 11 respondents put more than even odds of Chinese government debt being added to major bond indexes by the end of 2018. Inclusion would help bring $750bn of inflows in the next 10 years, according to the median estimate in the poll.
PBoC Deputy Governor Pan Gongsheng said earlier this year that China will push for the inclusion of domestic notes in global measures such as those compiled by Citigroup and JPMorgan Chase & Co. Citigroup said that it is seeking client feedback that can be used in any potential review, while JPMorgan said it has placed Chinese onshore government bonds on review to be included in its emerging-market indexes.
Chinese sovereign bonds have handed investors a profit in all but one of the past 11 quarters amid an asset famine, with a total return of 25% in the period. The mainland’s benchmark Shanghai Composite Index of stocks is down 12% for the year, the government is moving to curb rising property prices, while channels for moving money abroad have been choked as policy makers look to discourage the flight of capital.
SDR-driven inflows are already showing signs of picking up, with foreign investors’ holdings of Chinese onshore sovereign debt rising a record $6bn in September, according to data from China Central Depository & Clearing Co Many have been drawn by the nation’s higher yields: China’s benchmark 10-year sovereign debt yields 2.70%, compared with 1.72% in South Korea, 1.85% in the US and close to zero in Germany.
“The IMF’s acknowledgement of the yuan as a freely usable currency enables central banks to count yuan assets as part of their official reserves, rather than just foreign-currency assets,” said Becky Liu, senior greater China rates strategist at Standard Chartered. “The nature of reserves investment is to get exposure to reserve currencies, instead of hedging everything back to the dollar.”
Private players are on the way too. Pacific Investment Management Co will probably be onshore in China in a year or two, Asia Pacific head Eric Mogelof said at the Bloomberg Markets Most Influential Summit in Hong Kong on September. 28. Earlier this year, Bridgewater Associates became the first foreign hedge fund manager to win approval to set up a wholly owned investment-management business in China, according to Shanghai-based consulting firm Z-Ben Advisors.
A Deutsche Bank survey indicated that the aggregate share of Asian local currency bond portfolios allocated to onshore yuan bonds will rise from roughly 5% now to almost 13% a year later, and over 26% in five years’ time. Still, a lack of liquid hedging instruments is most frequently cited as a factor limiting investments, according to the poll.
China’s efforts to open its $8tn onshore bond market have been hampered by secondary trading that’s far less than levels seen in the US While the market is the world’s third- largest, annual trading as a ratio of total outstanding debt is 1.9, compared with 4.7 in the US, Bloomberg calculations based on official data show.
“There is certainly a lot of work to do, including improving market infrastructure, liquidity and ratings, but the obstacles should be able to be removed soon,” said Wu Qiong, a Hong Kong-based analyst at BOC International Holdings. “Once China is included in global indexes, it’s likely to see very impressive growth of holdings by foreign fund managers.”