China has opened up its onshore bond market to foreign investors with the launch of the bond connect scheme today.
The scheme allows investors to buy domestic bonds via Hong Kong, whereas previously investment was restricted to foreigners with onshore trading accounts.
Although trading volumes surpassed RMB7bn today, Julian Evans-Pritchard, China economist at Capital Economics, warns the high level of interest may not continue.
“If previous steps to expand market access are any guide, however, the move will do little to boost inflows. These are being held back by more intractable concerns over exchange rate risk, credit risk and capital controls,” Evans-Pritchard says.
“The HK-Shanghai stock connect also had a strong first day, only for trading activity to subsequently fizzle out.
“There are good reasons to think that foreign demand for Chinese bonds will remain tepid for the foreseeable future. For a start, there is little evidence that market access has been a binding constraint on foreign investment. Most large institutional investors have long had access to the interbank bond market via the QFII scheme. And since that access was expanded to a wider pool of foreign investors early last year, foreign ownership of onshore bonds has only edged up marginally.”
Mo Ji, chief economist Asia ex Japan at Amundi, says “no-one should underestimate” the normalisation of Chinese capital markets, with Chinese stock markets accounting for 10 per cent of global market capitalisation and Chinese bond markets the third largest globally.
“We will see their integration into global markets go progressively deeper,” Ji says. “Governance and transparency will continue to improve in the process. Investors who ignore this strategic development will be at a significant disadvantage. We will increasingly see central banks buying Chinese government bonds. Likewise Amundi expects to fully participate in bond connect, especially in relation to government bonds, and in the recent inclusion of Chinese A-shares in MSCI indices in late June.”
Claudia Calich, emerging market debt manager at M&G Investments, says there are “operational advantages” for investors using the bond connect scheme with government bonds likely to see the bulk of flows initially.
“The China – Hong Kong bond connect is another gradual step that China is taking in opening up its domestic bond market for foreign investors,” Calich says. “Bond connect will have some operational advantages versus investing directly onshore in the sense that it will not require the investor to have a local custodian or accounts and it will not require the investor to be subject to quotas or reveal how much it intends to invest beforehand.
“I would expect that foreign investors would initially venture into government bonds as opposed to state-owned companies or corporate bonds given valuations, liquidity and the fact that this is still an incipient market. As such, the ratings will not be as key a driver for investment, but rather one’s views on the renminbi, capital flows into and out of China, monetary policy and potential for inclusion of renminbi-denominated government bonds in major global bond indices.”