Chinese government bonds officially "entered" the FTSE Russell market impact interpretation

Starting from 29 October 2021, Chinese government bonds will be included in the FTSE Russell World Treasury Bond Index (WGBI) in batches over the next 36 months, and their weights are expected to reach around 5.25% after full inclusion in September 2024. So far, China's government bonds have joined the world's three major bond indices.

Liu Linan, Head of Macro Strategy for Greater China at Deutsche Bank Group ("Deutsche Bank"), recently released a series of updates to explore the impact of the inclusion of Treasury bonds into FTSE Russell. She said that foreign investors are accelerating the allocation of RMB bond assets, and the "index" will further attract the continuous inflow of overseas funds, which is expected to bring a total of about 105 billion US dollars to the treasury bond market by the end of the third quarter of 2024, and the monthly inflow is expected to reach 2.9 billion US dollars.

The effect of "entering the index" has emerged, and overseas investment has continued to increase

Liu Linan pointed out that the "entry" is a recognition of the continuous opening up of China's capital market to the outside world, and the connection between the RMB domestic market and the international financial market will be closer in the future.

In addition, on October 27, the State Council announced that it will extend the implementation period of the policy of exempting foreign institutional investors from corporate income tax and value-added tax on bond interest income obtained by investing in the domestic bond market until the end of 2025.

In this context, Liu Isan is optimistic about the continued attractiveness of China's bond market to foreign investors. She said that since the end of 2015, foreign investors have continuously increased their RMB bond assets, and the annual bond inflow has risen from 47 billion yuan in 2015 to 1.073 trillion yuan in 2020, and 604 billion yuan has flowed into the bond market since the beginning of 2021. As of the end of September 2021, foreign investors held about RMB3.94 trillion in bonds, accounting for 3.15% of the total domestic fixed income market (Figure 1).

At present, attracted by liquidity, regular tenders, a good yield curve and a diversified maturity structure, offshore funds are concentrated in the flow of government bonds, policy bank bonds and interbank certificates of deposit. Since the beginning of 2021, foreign investors have purchased treasury bonds and policy bank bonds accounted for 30% and 12% of the net supply, respectively, and their treasury bonds and policy bank bonds accounted for 10.4% and 5.4% of the market, respectively.

Structural asset allocation demand is strong, and the trend of capital inflows will continue

Liu Linan believes that the demand for structural allocation from active asset management funds and global reserve funds has accelerated the inflow of offshore funds into China's bond market, and the structural inflow trend will continue for the following five reasons:

1. Relative valuation: The U.S.-China 10-year Treasury spread has fluctuated between 0 and 250 basis points over the past decade and is currently at 140 basis points, in the middle. Spreads are expected to narrow further to 100 basis points in the future, but still effectively mitigate the risk of yield volatility.

2. Low volatility: Rmb bonds are recognized as relatively "safe" assets among emerging market assets, measured by RMB currency and yield fluctuations. With the exception of linked currencies such as the Hong Kong dollar and the Singapore dollar, the renminbi is the least volatile currency in Asia, with a much lower volatility than the G10 currency.

3. Risk diversification: Since the correlation between RMB bond yields and the yields of major global bonds is much lower than that of other emerging market bonds, RMB bonds have obvious advantages as an asset allocation for risk diversification. This is due to the high level of localization of China's bond market, with domestic investors accounting for 89% and 94% of the market of government bonds and policy bank bonds, respectively. In addition, given China's relatively controllable monetary and fiscal policies during the COVID-19 pandemic, a healthy balance of payments situation, and effective control of domestic risks, the correlation between China's monetary policy and global monetary policy is expected to further narrow.

4. Low market share of RMB assets held abroad: At present, the share of RMB bonds held by foreign investors accounts for 3.15% of China's domestic fixed income market, which is much lower than the 10 to 30% offshore holding rate of other emerging market bonds. As of June 2021, the total size of RMB bonds was US$311.9 billion, accounting for 2.6% of global reserves (Figure 2), which is much lower than the 10.92% weight of the RMB in special drawing rights (SDRs).

5. Rmb capital market will be further opened: Liu Linan believes that China will further expand the opening up of its capital market and continuously strengthen its connection with the global market. She expects China to gradually ease market access for interest rate derivatives, foreign exchange derivatives and credit derivatives, providing foreign bond investors with richer risk management tools.

Combining the above factors, Liu Linan maintains the same forecast, expecting 800 billion yuan of overseas funds to flow into the RMB bond market in 2021, and the total amount of overseas funds flowing into the RMB bond market from 2021 to 2025 will reach 4 trillion yuan (US$590 billion).

This article originated from the Financial Circle Network