Index-linked $100b inflows may spur onshore yuan bonds

Foreign investors deepened their participation in China's onshore bond market in the first quarter of this year, in anticipation of the market's inclusion in a key global index from April 1.

Market mavens expect foreign capital inflows to remain steady this year. Impact of this on the market performance may be limited in the short term but could help improve efficiency in the long term.

In the first quarter, turnover of overseas institutional investors in China's onshore bond market reached 919.1 billion yuan ($137 billion), up by more than one-third year-on-year, according to the China Foreign Exchange Trade System.

During the same period, overseas institutional investors opened nearly 300 new online accounts in the domestic market, equivalent to 70 percent of the whole-year total of 2018, the CFETS said.

"Such increments are not a surprise. Foreign investors have been rapidly increasing their holdings in onshore bonds as the market's opening-up gathered speed since 2016," said Meng Xiangjuan, chief fixed-income analyst with mainland-listed SWS Securities.

According to the State Administration of Foreign Exchange, the foreign exchange regulator, the total net inflows of foreign capital into the onshore bond market hit $63.7 billion last year, or 2.4 times that in 2017.

Li Bing, head of Bloomberg China, said the inclusion of the Chinese bond market in the Bloomberg Barclays Global Aggregate Index will further stoke foreign participation.

On April 1, the global fixed-income investment benchmark started to include yuan-denominated government and policy bank bonds. It would increase their weight evenly each month over the next 19 months.

Upon completion of their inclusion, yuan-denominated bonds will represent 6.03 percent of the index's market value, attracting a potential $100 billion or more in fresh capital to Chinese securities, analysts said.

"With more foreign investors, especially experienced market players who trade to seize local opportunities, entering China, the market will become more liquid," Li said.

"Higher foreign participation will also require the onshore players to increase their market-making capability and thus further advance the development of China's bond market."

Agreed Zhang Yu, chief macroeconomic analyst with Hua Chuang Securities, based in Guiyang, Guizhou province. "However, despite the long-term benefits, the inclusion should have limited impact on market performance in the short term," Zhang said, adding additional capital inflows are equivalent to about only 3 percent of the total value of outstanding onshore government and policy bank bonds.

Zhang further said the market has not yet received a big boost in real terms as the inclusion took effect on April 1. It's still early days to measure any significant impact, she said.

Since April 1, the 10-year treasury yields went up by 24.5 basis points to 3.325 percent as of Friday. When bond yields go up, prices go down.

Based on the inclusion schedules, Zhang estimates each month to November 2020 may see a steady capital inflow of about $7.5 billion.

Li from Bloomberg said that in the first few months after the inclusion, expected foreign capital inflows may experience some delays as "some foreign investors still have to solve certain operational issues".

Besides the index inclusion, the probable decline in interest rates in overseas markets amid dovish changes by major central banks, may also accelerate foreign capital inflows into the Chinese market, analysts from Nanjing, Jiangsu province-based Huatai Securities wrote in a note.