We think that the inclusion of Chinese bonds into global benchmarks is a watershed moment in the opening up of China’s bond market to foreign investors. Starting today, with the inclusion of Chinese government and policy-bank bonds into the Bloomberg Barclays Global Aggregate (BBGA) Bond index, we expect about US$1.2 trillion worth of inflows over the next five years.
Presently, around 3% of the onshore RMB bond market is owned by foreign investors. We think that over the next five years, foreign ownership will increase by at least 10 percentage points to reach about 13%. If this materializes, there would be at least US$1.2 trillion in inflows.
There are many reasons why international investors find Chinese onshore bonds attractive. The most important reason is diversification. China runs on a very different economic cycle than other major economies, and as such Chinese bonds have low correlation with other assets. Secondly, they offer attractive yields. Thirdly, the renminbi has been strengthening against most other currencies, making it very appealing to hold RMB-denominated bonds.
We expect that as foreign appetite for China’s government and policy-bank bonds intensify, interest in Chinese local corporate bonds will also increase. This is aided by the fact that S&P Global recently won the approval from Beijing to start rating domestic bonds. Domestic bonds will now be rated according to international standards, and this will help foreign investors familiarize themselves with the Chinese corporate bond market. Some investors may wonder about the attractiveness of Chinese bonds amid rising default rates, but we see that this is still at low levels and they remain at an appropriate range. China’s easing of monetary policy and financial markets will be supportive of private-sector financing and keep default rates low.
With the inclusion of China into the BBGA index, we expect allocations to other bond markets, especially those in emerging markets, to be affected. Even though there will be an ex-China version of the Global Aggregate index, we think its effect will be minimal. China remains an attractive investment destination with its robust economic growth with monetary policy providing continued support in terms of liquidity.