Observers say Beijing’s decision to gradually open its bond market to foreign investment will have profound ramifications for international capital flows.
Despite the long-standing dominance of banks within its domestic finance sector China is already host to the world’s third largest bond market, while foreign holdings of Chinese bonds continue to rise as the central government pushes forward with measures to expand overseas access.
Foreign central banks and overseas financial institutions first garnered access to Chinese onshore bonds in July 2015, as Beijing sought to obtain reserve currency status for the renminbi from the International Monetary Fund.
In February 2016 China granted foreign institutional investors qualified access to its interbank market, while in July of this year the market was opened further with the launch of the Hong Kong-Shenzhen bond connect scheme.
Data from the People’s Bank of China indicates that foreign investors increased their holdings of onshore Chinese bonds by 62 billion yuan ($9.5 billion) in the second quarter, while some analysts expect total holdings to rise to over 1 trillion yuan in the current quarter.
According to data from Bloomberg Intelligence the number of overseas participants in the Chinese bond market has doubled in the space of two years to 400.
Beijing’s decision to broaden access to China’s bond market for foreign investors is being hailed by some as a potential paradigm-changer for the international finance system.
“The biggest story of the last 15 years has been China’s integration into the global trading system,” said David Loevginer, a former China expert with the US Department of the Treasury, to Bloomberg. “The big story for the next 10 years will be its integration into the global financial market.”
In response to the opening of the bond market key overseas financial institutions are beginning to add Chinese bonds to some of their key indices, with Citigroup announcing in March that it would include mainland sovereign bonds in three indexes starting next year.
Opening up the market to foreign investment will give domestic enterprises a major alternative channel of funds, which Citigroup estimates could push capital inflows to USD$3 trillion by 2025, given the strong enthusiasm shown by foreign institutional investors for China’s interbank bond market.
There nonetheless remain a number of major hurdles to Beijing’s ambitions to open up China’s bond market.
Chief amongst them are capital controls and currency convertibility, with Beijing still tightly controlling the renminbi’s movements and the ability of investors to move funds across borders.
Analysts have also raised concerns about the lack of transparency within China’s corporate sector and the validity of the assessments provided by domestic ratings agencies, which China’s biggest bond clearing house recently declared have overrated the quality of some corporate debt.
While China’s bond market has posted rapid growth in recent years, it remains heavily dominated by policy bank notes, with Bloomberg data indicating that the interbank market comprises 90% of all Chinese notes, or around $8.3 trillion in outstanding securities.