Asia > Eastern Asia > China > The launch of Bond Connect is the latest in a series of steps that open up China’s markets to overseas investors

China: The launch of Bond Connect is the latest in a series of steps that open up China’s markets to overseas investors

2017/08/11

In October the International Monetary Fund included the yuan as a fifth world reserve investment ; last month Morgan Stanley Capital International (MSCI) added Chinese stocks to its benchmark index following the Stock Connect schemes between Hong Kong’s stock market and bourses in Shanghai and Shenzhen; and on Monday, the launch of Bond Connect will allow overseas investors to invest in the China interbank bond market.

Presently, all of China’s major financial commodities – currency, stocks and bonds – can be included in an international investor’s portfolio as Beijing further opens up its financial markets.

The Chinese economy will benefit from allowing international investors to access its domestic deficit market, which will help finance the sustainable increase of the world’s second-major economy. The increased trading volumes will tend to lower the cost of capital.

The opening up of the Chinese onshore bond market to foreign investors will help equip it for inclusion in major world bond indices. The majority optimistic calculations suggest the world’s third-major bond market, next the US and Japan, could from presently on represent 18 % of the major world bond indices. Goldman Sachs Group estimated that if Chinese bonds were included in three key benchmarks, it would translate into inflows equalling about US$250 billion.

MSCI inclusion points China’s stock market in right direction

The foreign fund will not only boost China’s corporate financing, but as well help offset its foreign-exchange outflows, which in 2016 saw a monthly drop of US$10 billion to US$20 billion.

It will signify an extra large step towards the yuan’s internationalisation as a result of the opening up of a large pool of investable and yuan-denominated assets to world investors. The inclusion of the Chinese currency in the IMF’s Appropriate Drawing Rights and the intake of A-shares into the MSCI Emerging Markets index have created huge request for yuan-denominated assets and the Bond Connect will create a supply of such assets.

Given China’s increasing significance in the world economy, most investors have apparently severely underweighted yuan-denominated assets, causing a supply-request imbalance. Currently, overseas investors hold only 1.25 % of the shares, much lower than the average 20 % to 30 % that they generally hold in other key emerging markets.

Chinese products are comparatively lucrative. For instance, the yield of China’s one-year government note has risen to 3.46 %, while the US note is up only 1.24 %.

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The programme will as well help Hong Kong cement its status as a prime financial centre in the Asia-Pacific region, since its bond market capitalisation and bond investor people are comparatively smaller than their major rivals. The city’s status as the sole platform to access Chinese markets will boost its position in the world bond market.

The Stock Connect schemes, introduced in 2014, have increased inflows of Chinese funds into Hong Kong. If such enthusiasm is replicated under Bond Connect, the city’s fixed-gain market – which had a modest HK$1.5 trillion (US$193 billion) outstanding for 2015 – will receive a decent boost.

The Chinese economy and world financial markets will as well receive a large boost from the opening of a 64 trillion yuan (US$9.3 trillion) bond market.

Most importantly, all the new developments mark significant milestones for the communist-ruled country, as it follows a path towards further integration into the world economy and as well world capitalism.

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