Bonds Sep 23

China a 90% chance for WGBI index, Morgan Stanley says

Investment bank says chances lifted by Beijing allowing flexible settlements and dropping the need for Japanese investors to make paper submissions in the Bond Connect system; FTSE Russell decision due Thursday

by Umesh Desai and Jim Pollard
China a 90% chance for WGBI index, Morgan Stanley says
People take photos by the Morgan Stanley building in Times Square in New York City in this file photo from February 2020 by Brendan McDermid / Reuters. 

Morgan Stanley says the chance of China being added to one of the world's top government bond indexes tomorrow has risen substantially after the country made improvements to ease access to its market.

FTSE Russell, which runs the World Government Bond Index (WGBI), a benchmark for an estimated $2 trillion in cash, is due to announce a decision on Thursday September 24 during its annual review of the index.

Last week Morgan Stanley put the chance of China's inclusion at 60%-70% but raised it to 90% on Tuesday after Beijing allowed more flexible settlement of trades.

Regulators also scrapped the need for Japanese investors to make paper submissions in the widely-used Bond Connect system.

"This is a material improvement to bond access, in our view, and increases the chances of WGBI inclusion on September 24 significantly," the bank's strategist Min Dai told Reuters.

Inclusion would give China a 5.7% weight in the high-profile WGBI based on current estimates, just behind Germany at 6% and compared to 33.8% for the United States and 16.7%, 8.2% and 7.3% for Japan, France and Italy respectively.

The actual inclusion will happen in September 2021 with a 20-month phase-in.

Morgan Stanley estimates it could help funnel $60-$90 billion of investment money into the country in the next few years and $3 trillion over the next decade.

Standard Chartered: Strong likelihood

This news echoes an assessment by Standard Chartered Bank, which said last week that Chinese government bonds (CGBs) have a strong likelihood of being included in the widely tracked WGBI when index provider FTSE Russell conducts its annual review on Thursday.

But the UK bank thought China would gain even greater benefits, Asia Times Financial reported last week.

Full inclusion on the WGBI would lead to passive inflows of $140 to $170 billion, Becky Liu and Terry Chan said in a strategy note. (Passive flows are investments by funds that buy specific bonds in order to replicate the index).

“We expect foreign inflows to accelerate further in the coming quarters on a stronger CNY outlook, high interest rate premium, ongoing global reserve diversification, and global bond index inclusion,” they said.

China is currently on the WGBI’s watch list for potential index inclusion, according to FTSE Russell’s March 2020 interim review.

At the time of the 2019 final review, the index provider had made the assessment based on user feedback that further improvements to secondary-market liquidity, increased flexibility in FX execution and the settlement of transactions was required prior to the inclusion.

Standard Chartered said China had made good progress on several fronts.

“Under the China interbank bond market (CIBM) access scheme, foreign investors can currently have up to three counter-parties for their bond investment-related FX hedging and transactions. We expect similar arrangements to be implemented soon for investors under the Bond Connect programme,” it said.

“CGBs’ secondary-market liquidity conditions have improved markedly in recent years following an enhanced primary auction format. In recent years, the Ministry of Finance (MoF) has reduced the number of new issues, instead issuing more bonds by reopening existing issues. This practice has reduced the number of bonds in the market while enlarging their individual sizes, materially enhancing secondary liquidity”

Plus, it said recent integration of the interbank and exchange bond markets, as well as wider participation in the treasury bond futures market, suggested that more progress is likely to be made in the coming quarters.

This would boosting foreign ownership of CGBs by 6-7% and foreign ownership of the overall China bond market by 1%. Standard Chartered expected foreign ownership of CGBs to rise to 20% by end-2022 from 8.5% currently.

The bank retained its forecast for 2020 foreign inflows to China’s bond market to range from 800 billion to 1 trillion yuan, and rising further to 1 trillion to 1.2 trillion yuan in 2021.

China’s bond market, already the world’s second biggest, has been expanding at a breath-taking pace over the past two decades.

JP Morgan estimates it will grow to around $16.5 trillion this year or 112% of nominal GDP from just $200 billion or 18% of GDP at the turn of the century.

The expected inclusion in the WGBI follows China's inclusion in the Bloomberg Barclays Global Aggregate Bond Index and the JP Morgan Government Bond Index.

“These three benchmarks, even at their planned low inclusion weights, could draw potential additional inflows of between US$250 billion and $300 billion into China’s onshore bond market,” JP Morgan’s Ian Hui and Chaoping Zhu said.

With reporting by Marc Jones of Reuters