China bonds in key index herald more capital flows

With the long-awaited inclusion of China government bonds, or CGBs, in the World Government Bond Index, the flagship of London-headquartered index provider FTSE Russell, on Friday, the Chinese bond market will be further internationalized amid more foreign capital inflows, experts said.

Up to $130 billion of indexation-related foreign capital will flow into the CGB market over the 36-month inclusion period, as per an estimate by Andre de Silva, head of global emerging markets rates research at HSBC.

The People's Bank of China said on its official website on Friday that the inclusion shows international investors' confidence in the healthy development of China's economy in the long run and the country's further financial opening-up.

The latest inclusion for the index's November 2021 profile will take 36 months to complete and conclude at the October 2024 index profile.

CGBs issued after Jan 1, 2020 will be included if they reach the required minimum size of 35 billion yuan ($5.5 billion), while CGBs issued before Jan 1, 2020 are eligible for inclusion only if the outstanding stock meets the threshold of 100 billion yuan, FTSE Russell said.

Given such criteria, there will be 50 CGBs eligible for inclusion, according to de Silva. After assessing the market capitalization of outstanding CGBs as of Oct 29, China's weighting in the WGBI comes at about 5.9 percent, implying a monthly weight increment of 0.16 percent, he said.

More foreign capital inflow can be foreseen after the inclusion, thanks to the Chinese onshore bond market's higher yields on average and its lower correlation with other markets, said Zhong Haidan, senior investment manager at investment company Invesco.

A favorable policy has been introduced on time. Overseas institutional investors will be exempted from income tax and value-added tax for their bond interest income derived from China's onshore bond investments, the State Council, China's Cabinet, announced on Wednesday. Such policy will be effective till Dec 31, 2025.

Wang Dan, chief economist at Hang Seng Bank China, said the favorable tax policy will help stabilize foreign investors' expectations and enhance the appeal of the Chinese bond market. More foreign capital will be thus attracted to the Chinese financial market, which should facilitate the internationalization of the renminbi in the long run, she said.

The latest addition to the flagship FTSE Russell index is another major step forward in terms of the internationalization of the Chinese bond market. China bonds were included in the Bloomberg Barclays Global Aggregate Index in April 2019 and the JPMorgan's GBI-EM index in February 2020. The bond connect program linking the Chinese mainland and Hong Kong bond markets was launched in July 2017.

Foreign investors will continue to allocate more yuan-denominated bonds in the mid- to long-term, said Wang Chunying, deputy director and spokesperson of the State Administration of Foreign Exchange at a news conference on Oct 22. The higher yields and the stable renminbi foreign exchange rate indicate the higher investment value of the Chinese bond market, she said.

By the end of September, the country's CGBs held by foreign investors were worth nearly 2.28 trillion yuan, up by 77.12 billion yuan from the previous month, according to China Central Depository& Clearing Co Ltd.