(ATF) The opening up of China’s domestic bond market has gathered pace in the past year and revealed surprising resilience despite the recent build-up of debt and growth in defaults.
Foreign participation has risen on the back of its inclusion in global bond indexes and the strength of the yuan currency has also played a part.
“We've seen certain seismic shifts from pure bonds, investment into what is called medium-term notes, and a different format, shorter-term bonds. So we've seen a structural change in the market,” said Christian Kronseder, CEO of ALLINDEX speaking to Asia Times Financial Television.
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The interview was to mark the first anniversary of the launch of the Asia Times Financial China Bond 50 Index.
“What we found is that it's a very deep and very active market and not so well invested from outside investors, and I think this is an interesting opportunity here,” Kronseder added.
Foreign investors have bought a net $41.5 billion of Chinese bonds since the start of the year, already about a third of what they did in all of 2020. Inflows into other emerging Asia bond markets this year are $2.8 billion, or 61% of last year's total.
Chinese 10-year government bonds offer a healthy 160 basis point pick-up over comparable US Treasuries, even after the recent sell-off in the latter. The differential between Chinese and US high-yield bonds is even more and at 250 basis points provides a healthy cushion for currency fluctuations.
“Beijing has sent out a clear message we are open for business and foreigners have grabbed this opportunity with both hands, given the external environment of negative yielding bonds. Inflows have also accelerated after three major global benchmarks included Chinese bonds, into their indexes,” said Umesh Desai, Executive Editor at Asia Times Financial.
Last year, FTSE Russell became the third major index provider to add Chinese bonds to its benchmark. The inclusion in its flagship World Government Bond Index (WGBI), followed similar moves by JPMorgan and Bloomberg Barclays indexes.
In April 2019, they were included in the Bloomberg Barclays Global Aggregate Index for the first time, of which China is projected to comprise around 6% upon full inclusion.
JP Morgan added Chinese government bonds into its Global Bond Emerging Market Index in February 2020. FTSE Russell said it will include CGBs into its World Government Bond Index, starting from October 2021.
Inclusion of Chinese bonds in all the three major indices is estimated to bring a total of USD300 billion inflows, according to a DBS projection.
This has vindicated experts who have been touting the diversification benefits because Chinese domestic monetary policy is not that closely linked with global monetary policy.
“We could clearly see that while the US was very effective there was a lockdown, China at the same time didn't show any correlation to what was happening in the US. So the market continued to work as expected, which was a big surprise to us because we had assumed there's a much bigger correlation between the Chinese bond market and the rest of the world which didn't happen,” said Kronseder.
This view holds, notwithstanding the pick-up in leverage and amid the growing number of defaults among Chinese corporations.
But rising defaults are seen as a sign of maturity and proof of the government’s deleveraging efforts to contain systemic risk and local governments’ greater tolerance toward defaults. Still at 1.3%, it is still low relative to global peers.
“We can only expect defaults to go up. Of course, that doesn't mean that there is going to be rampant episodes of defaults,” said Desai. “If that happens the authorities will, in a very limited way, intervene and prevent a systemic crisis from developing.”
In any nascent market, trading liquidity would be a priority for investors and this has also been taken care of by ATF’s China bond index.
“We look every three months, we check whether the constituents of the index are still fulfilling the criteria which are laid down in the rulebook, what we have observed is that since we are tracking the most liquid, most tradable issues of an issuer of a company, is that these bonds are trading relatively often compared to a regular bond index,” said Kronseder.