In this article, we provide an introduction and quick overview of China's fixed income markets. Whilst many foreign investors have been captivated by Chinese equities, including stocks of Chinese companies listed in China or Hong Kong as well as in the US, fewer investors have turned their attention to China's debt markets. A reason for this is that it was relatively difficult to invest in Chinese fixed income until the expansion of CIBM Direct in 2016 and the launch of Bond Connect in 2017, although the Chinese government and regulators have increasingly opened up foreign access to the country's bond markets in the past few years. Moreover, the establishment of these schemes has contributed to the inclusion of Chinese government bonds in major global indices starting in 2019, whilst the relatively high yields of Chinese sovereign bonds are continuing to attract more and more investors from across the globe as large degrees of monetary easing and low to negative interest rates are becoming the norm in major economies.
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An Overview of Global Bond Markets
As of the end of 2019, the US is still leading the global bond market, with a market size of US$41.2 trillion. The EU27 countries follow with a combined bond market size of US$21.8 trillion, although taken at the individual country level, the Chinese bond market is the second largest in the world at US$14.7 trillion (approximately RMB99 trillion). The Chinese bond market has overtaken Japan's bond market in size since 2019.
China's Onshore Bond Market
China's onshore bond market refers to debt issued in mainland China and denominated in RMB.
China's Onshore Bond Market is Dominated by Government Bonds
As of the end of 2019, over half of China's onshore bond market constitutes of government bonds, including bonds issued by the central government, local governments, the central bank, and policy banks. Non-financial corporate and financial corporate bonds make up a third of the bond market, interbank negotiable certificates of deposit (CDs) constitute 10% of the market, whereas other bonds, such as asset-backed securities and bonds issued by government-supported institutions, make up 2% of the onshore bond market.
***In China, interbank CDs are included as part of the overall bond market. Only interbank CDs are counted whereas CDs sold to individual investors are not.
***Government-supported institutions include institutions that used to be part of the government but are no longer a government entity, even if they get financial support from the government (similar in some sense to government-sponsored entities in the US).
China's Government Bond Market Is Evenly Divided Among Three Types of Issuers
The graph below breaks down the total notional value of all bonds outstanding in China's government bond market by issuer type. The market is roughly evenly divided into regional government debt (40%), Treasury bonds (31%) and policy bank debt (29%). Central bank bills also form part of the government bond market, but only constituted RMB0.02 trillion of the overall bond market in 2019.
China's Corporate Bond Market is Dominated By Financial Institution Bonds
A breakdown of total notional volume outstanding by issuer sector is provided below. Financial institutions are the biggest issuers of corporate bonds, accounting for 39% of the total notional volume of outstanding bonds. Industrial companies are the second largest issuers, accounting for almost 13% of all outstanding corporate bonds. Unfortunately, WIND does not provide a further breakdown for the "Others" category.
Growth of China's Bond Market
China's bond market is growing in terms of both the total outstanding notional volume and in terms of the total notional volume of new issuances each year.
China's Onshore Bond Market Has Doubled in Size Over the Past Five Years
China's onshore bond market has doubled in size over the past five years, from RMB47.9 trillion in 2015 to RMB99.1 trillion in 2019. This growth is expected to persist as the Chinese government continues to maintain a focus on developing the country's capital markets (read more about the future of China's capital markets here).
The Total Notional Volume of New Bonds Issued Has Also Doubled During the Same Period
The total notional volume of new bonds issued in China's onshore bond market has more than doubled over the past five years, from RMB22.3 trillion of new issues in 2015 to RMB45.3 trillion in 2019.
The following graph provides a breakdown of the types of new issues from 2017 to 2019. The share of Treasury and municipal bonds as a percentage of the total notional volume of new bonds issued has remained relatively constant across the three years, with Treasuries and municipal bonds each accounting for approximately 10% of each year's new issues. There is a general decreasing trend in the proportion of new interbank certificates of deposit issued, where interbank CDs represented 49.5% of all bonds issued in 2017, 48% of all bonds issued in 2018, and 39.7% of all bonds issued in 2019. In contrast, the share of non-financial corporate (labelled as "Corporate" below) and financial corporate (labelled as "Financial Institution" below) bonds have increased during the three years. Non-financial corporate bonds accounted for only 13.5% of all new issuances in 2017, but increased to 21.4% in 2019. Similarly, financial corporate bonds constituted 11% of new issuances in 2017, but grew to 15% in 2019.
The "Others" category includes bonds issued by government sponsored agencies as well as asset-backed securities.
Although government bonds constitute half of China's fixed income markets, the majority of new issuances are interbank CDs and financial and non-financial corporate bonds. This is because interbank CDs only have a maturity of one year at most, so they are consequently issued more frequently. Corporate bonds in China also tend to have relatively short maturities compared with government bonds.
Higher Yields Than Developed Markets
A key characteristic of China's government bond yields is that they are substantially higher than those of developed economies, backed by a track record of solid economic performance, good growth prospects, a relatively healthy balance of payments position, and political stability. This has drawn many foreign investors to invest in Chinese government bonds.
The table and graph below compares the yields for government bonds of different tenors in China, Japan, the US, the UK and Germany. Short- and medium-term Japanese and UK government bonds have negative interest rates, while German government bonds have negative rates across the entire range of the tenor spectrum. The highest interest rate available for US Treasury bonds is 1.60% with a 30-year tenor. In contrast, Chinese government bond yields average around 3% for all maturities.
Inclusion of Chinese Government Bonds in Global Indices
Although China's government bond market has been too large to ignore for many years, Chinese government bonds have only been included in major global government bond indices in recent years. This is likely due to the more recent opening up of the country's fixed income markets to foreign institutional investors, through the expansion of CIBM Direct Program in 2015-2016 as well as the establishment of the Bond Connect Program in 2017.
Chinese SSA bonds were/will be added to...
Bloomberg Barclays Global Aggregate Index (Agg) in April 2019
JP Morgan Government Bond Index - Emerging Markets (GBI-EM) in February 2020
FTSE Russell World Government Bond Index (WGBI) in October 2021
As of August 2020, Chinese bonds now represent 5.3% of the Agg and 9.4% of GBI-EM. Inclusion in these major indices is beneficial in boosting inflows to the Chinese bond markets due to the large number of tracking funds. WGBI has over USD2.5 trillion worth of tracking funds and CNBC predicts that the inclusion of Chinese government bonds will draw inflows worth at least $100 billion into the country's bond markets.
Increasing Foreign Inflows into China's Bond Market
The attractiveness and growing importance of Chinese bonds, combined with the country's significant opening up of its fixed income markets through the particularly notable launch of the Bond Connect scheme in July 2017 (see here), have resulted in a significant rise in foreign investment. The graph below shows the monthly volume of onshore Chinese bonds held by foreign investors since June 2017, one month before Bond Connect was launched. The orange part of the bars represent the notional volume of bonds owned by foreigners through the Central Clearing House, while the blue portion of the bars represent the notional volume of bonds owned by foreigners through the Shanghai Clearing House. The unit of measurement on the left hand side is RMB hundred million. The green line shows the corresponding monthly change, with percentages as the unit of measurement indicated on the right hand side.
As of the end of December 2019, over RMB2 trillion (approximately US$0.30 trillion) of onshore Chinese bonds were held by foreign investors
Conclusion
Most investors have primarily focused their attention on high profile Chinese equities, whether they be listed in China and Hong Kong or in the US. However, the Chinese fixed income markets are definitely not to be ignored, and is expected to continue to grow in significance in coming years. Onshore Chinese government bonds are particularly attractive due to their relatively high yields, the relative stability of the yuan, and the overall resiliency of the Chinese economy. In contrast, Chinese corporate bonds still present some issues in terms of transparency and the credibility of accounting standards. Investors interested in Chinese companies are rather encouraged to turn to publicly listed Chinese equities.
How to Invest in Chinese Fixed Income
Currently, only institutional investors can invest directly in Chinese fixed income, through the following programs: (1) CIBM Direct, (2) Bond Connect, (3) QFII, and (4) RQFII. Further information is provided in this article.
However, individual investors can consider ETF alternatives, such as:
How to Invest in Chinese Equities
Both institutional and individual investors can invest in Chinese equities, as explained here. We also provide a summary of the differences between various Chinese share classes here.
The Future of China's Capital Markets
The newest publication by China's central bank governor suggests that China will continue to pursue "normal" monetary policy without significantly lowering interest rates, as well as continuing to maintain a stable value for the yuan. These policies are expected to boost the attractiveness of yuan-denominated assets, which to some extent has already been proven by the influx of foreign investors to the Chinese sovereign bond market particularly during the COVID era as developed markets continue to expand quantitative easing programs whilst China remains the only major economy to grow with traditional economic policies.
The Governor of the People's Bank of China has also voiced his support for the central government's decision to further open up the Chinese capital markets to foreign investors, alongside other policies to further reform and expand China's equity market by attracting more high quality Chinese companies to be listed domestically. These developments are good news to foreign investors looking for quality returns in a world where growth is stagnant.
Detailed information is provided in the article China's Monetary Policy and the Future of Foreign Investment in China.
Glossary of All China-Related Terminology:
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