Too big to ignore but too opaque to entirely trust.
China is engaged in a charm offensive to lure foreign money into its bond market, which has grown in a short period of time from a minnow to the third largest in the world, after the US and Japan.
The opening of the bond market to foreigners is part of a transformation in the international financial system, which is slowly linking up with a Chinese economy that was once walled off behind tight capital controls. It is a crucial step in Beijing’s plan to turn the renminbi into one of the anchor currencies of the global economy.
But the risk for China’s economic planners is that no one shows up to their bond market party, amid fears over capital controls and default risk. International fund managers acknowledge that Chinese onshore debt is bound to become a big part of global fixed-income portfolios, but add qualifiers such as “eventually” and “medium- to long-term”. Few, it seems, want to go in first.
“For an economy that is a tenth of the global economy with a similar share in global exports and investment, the singular lack of financial integration is striking and cannot last,” says Qu Hongbin, chief Greater China economist at HSBC in Hong Kong.
Until recently, foreign participation in the Chinese market was tightly controlled by quotas and licensing requirements. That changed in February 2016, when the People’s Bank of China threw wide open the doors to the interbank bond market, where most Chinese debentures trade. With one stroke, the central bank cleared the way for banks, insurers, securities firms, asset management companies, pension funds and non-profit endowments to enter the market without prior approval.
Last month the government widened access further, announcing a programme to let investors in Hong Kong buy Chinese onshore bonds through their own brokerages. Modelled on the Stock Connect programmes linking Hong Kong’s exchange with those in Shanghai and Shenzhen, the Shanghai Bond Connect will allow foreigners to buy onshore Chinese bonds without the need for an onshore account.
Despite expanded access, however, interest from foreign investors has so far been tepid. Foreign holdings of Chinese domestic bonds rose a modest 13 per cent last year, according to central bank figures. At Rmb853bn ($124bn) by the end of 2016, foreign holdings equal only 1.3 per cent of total market value.
“China’s interest rates are modestly higher than in the west, and the long-term prospects for the economy and the currency are still good,” says David Dollar, former US Treasury economic and financial emissary to China and now a senior fellow at the Brookings Institution in Washington. “However, there are all kinds of risks, and interest rates strike me as low relative to the risks.”
Among the types of foreign investors, central banks and sovereign wealth funds have responded most positively. After the International Monetary Fund’s decision in late 2015 to add the…