The forthcoming inclusion of Chinese local currency bonds in the Bloomberg Barclays Global Aggregate Bond Index will significantly open up China's bond market, bringing greater diversity and representation to the global fixed income universe.
It will also mark an important stage in China's progress toward more open and transparent capital markets. For investors, this will provide an opportunity to invest in a vast and important bond market that has until now been very difficult to access.
Chinese RMB‑denominated government and policy bank bonds will be phased into the Global Aggregate Index over a 20‑month period beginning in April, and the weight will ultimately increase gradually to around 6% of the index. In total, more than 300 issues denominated in Chinese renminbi will enter the index universe.
Low foreign ownership levels in China
In the past, China's determination to remain in control of its currency and to supervise the flow of capital into the country has meant its bond market has not operated as efficiently and transparently as those of most developed market countries. As such, foreign ownership of China's onshore market has been very low - 3% versus an average of more than 25% across developed country markets.
The inclusion of Chinese bonds in the Global Aggregate Index will significantly increase foreign ownership of those bonds, which means the authorities will be forced to hand over a certain amount of control of its capital markets to overseas investors. Active bond investors will be able to sell Chinese bonds if they have a negative view on China, and even short them if there is a functioning futures market.
As such, the inclusion of Chinese bonds in the Global Aggregate Index functions as both a carrot and a stick for the Chinese government. The carrot is that China will be able to attract capital, which will underpin the currency and diversify against the risk of domestic outflows. The stick is that if the foreign investors disagree with the path of monetary policy followed by the People's Bank of China (PBoC), they will be able to quickly disengage from the Chinese bond market.
Chinese bonds offer a strong diversifier
From a cyclical perspective, we expect Chinese onshore rates to perform given that the PBoC is currently embarking on an easing cycle. Ultimately, renminbi‑denominated Chinese bonds are likely to act as a strong diversifier in global portfolios if China's policy cycle diverges from the U.S. and EU.
T. Rowe Price is already invested in local Chinese government bonds, ahead of their inclusion in the index. We have the capability to invest in onshore (CNY) as well as offshore (CNH) currency markets, in addition to markets in Hong Kong. Our office in Hong Kong gives us a local presence, enabling our team of research analysts and traders to gain on‑the‑ground insights into this evolving and increasingly prominent market.
As things stand, our inclination is to adopt a longer position than the opening weight of Chinese bonds in the index as we believe that there will be significant demand for the bonds from investors looking for diversification. At present, the 10‑year yield is 3.1% and inflation is under control, so Chinese bonds look reasonably attractive.
Quentin Fitzsimmons, portfolio manager of the T. Rowe Price Dynamic Global Bond Fund