The inclusion of Chinese bonds in international indices like the Bloomberg Barclays Global Aggregate Index will advance the renminbi’s globalisation.
“As China seeks to improve the relevance of its currency to the world economy, it will need to increasingly open its doors to capital flows. Including Chinese bonds in the Bloomberg Barclays index is another step in the right direction,” said Peter Sengelmann, chief investment officer of US investment management and financial planning firm Thun Financial.
On April 1, China's renminbi-denominated government and policy bank securities were included in the Bloomberg Barclays Global Aggregate Index, a global fixed-income investment benchmark.
China's markets reacted with excitement on the first day of this bond inclusion, with Rmb1 trillion ($150 billion) of bonds traded on the Shanghai Stock Exchange on April 1, above the exchange's daily turnover for 2018 which was Rmb874 billion. To be sure, turnover dropped back to Rmb878 billion on April 2 and Rmb874 billion on April 3 indicating that the euphoria was short-lived.
“In creating supply and demand for the renminbi in the international arena, this is a major step in the internationalisation of the Chinese currency,” said Jack Siu, Asia Pacific senior investment strategist at Credit Suisse.
As more foreign investors trade Chinese bonds, there will be more free-floating demand and supply for the renminbi, as well as more hedging of the renminbi. “This expands an ecosystem of international renminbi trading,” Siu explained
In the longer term, index inclusion will increase the role of market forces in stabilising and setting the foreign exchange rate of the renminbi. Foreign funds will play a bigger part in keeping the Chinese currency stable, instead of the People’s Bank of China alone.
COUNTER TO THE GREENBACK
Though the US dollar is the world’s dominant reserve currency, several trends will boost the renminbi as an alternative. This includes index inclusion and the closer integration of Chinese onshore markets with the global financial system spurred by this index inclusion.
“China's equity and debt markets are going to be so large, and Asia Pacific trade so interlinked and dependent on the Chinese economy, that we'll have a renminbi-denominated currency bloc,” said Hayden Briscoe, head of Asia Pacific fixed income at UBS Asset Management.
China’s $8.6 trillion stock market and $13 trillion bond market are the world’s third largest behind Japan and the US. Currently, foreign holdings account for only roughly 2% of China’s bond market and stock market. The Bloomberg Barclays index will increase its weighting of Chinese bonds in stages to 6% over the next 20 months.
Bloomberg’s inclusion of Chinese onshore debt will propel China’s bond market to overtake Japan to second place.
The internationalisation of the renminbi “is hugely positive for the world because the US Federal Reserve’s policy is driving global macro-volatility,” explained Hayden. “We need someone to counter them.”
The Chinese government’s efforts to promote portfolio inflows through various measures, like further opening the capital markets to foreign investment, is helping to fulfil its long-term objective of renminbi internationalisation.
“Gradual but sustained foreign portfolio inflows into the largely under-owned Chinese equity and bond markets would be a medium-term driver for renminbi outperformance,” said a Nomura report at the end of March.
Foreign fund inflows into China’s bond market will be a significant source of demand for the renminbi.
Over the long term, some reckon that full inclusion of Chinese domestic debt into the Bloomberg Barclays index could lead to a total of $2 trillion of fund inflows into China’s onshore bond market.
The huge fund flow into China sparked by index inclusion potentially turns China into a competitor for capital inflows with other major economies, Wilfred Wee, portfolio manager of the Investec All China Bond Fund at Investec Asset Management, told FinanceAsia. "Today, Chinese renminbi-denominated bonds barely feature in global fixed income allocations; but in two years' time, China's weight will eclipse that of sterling, Canadian dollar and Australian dollar bonds."
SHORT-TERM EFFECT
But in the short term, the impact of the inclusion of Chinese bonds in the Bloomberg Barclays index will be limited.
A Barclays report at the start of February forecast that it will result in foreign fund inflows into China’s bond market at an average of $5.5 billion per month for a 20-month period starting in April. Credit Suisse's Siu is more optimistic. He estimates the index inclusion will create foreign fund inflows of $8 billion per month this year.
The impact of a few billion dollars of foreign fund inflow per month is limited in the near term. The financial account inflow will be offset by the erosion of China’s trade surplus with the US, assuming the US and China agree on a deal soon.
In the ongoing trade talks between the US and China, US President Donald Trump has been trying to get China to reduce its trade surplus with the US. A trade deal between the world’s two biggest economies is expected to be sealed in a few months.
Chinese securities are set to increase their presence in international indices. Chinese bonds may be included in the FTSE World Government Bond Index as early as September. And MSCI has said that it intends to quadruple the weighting of Chinese A-shares in its indices to 20% by November.
This story has been corrected to show accurate average trading data on the Shanghai stock exchange
