(ATF) Chinese government bonds (CGBs) have a strong likelihood of being included in the widely tracked World Government Bond Index when index provider FTSE Russell conducts its annual review later this month, Standard Chartered Bank said in a note.
This would pave the way for China to comprise 5.7% of the WGBI upon full inclusion, leading to passive inflows of US$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.
The bank 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”
It said the recent integration of the interbank and exchange bond markets, as well as wider participation in the treasury bond futures market, suggest that more progress is likely to be made in the coming quarters.
Jump in foreign ownership tipped
This would pave the way for its inclusion and that would trigger passive inflows of $150-$180 billion, boosting foreign ownership of CGBs by 6-7% and foreign ownership of the overall China bond market by 1%. It expects 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.