Reform, opening-up measures to attract more attention to Chinese bonds

Chinese government bonds were officially included in the FTSE World Government Bond Index on Oct 29. Prior to that, they were included in Bloomberg Barclays Aggregate Bond Index in April 2019, and in JPMorgan's Government Bond Index-Emerging Markets Series in February 2020. The bonds are now fully included in the three major international bond indexes.

According to China Central Depository and Clearing Co Ltd, offshore holdings of Chinese government bonds totaled 3.5 trillion yuan ($550.7 billion) by the end of October, a record, and reporting an increase for the 35th consecutive month. Among these holdings, nearly 2.6 trillion yuan was under depository via the Global Connect program and 920 billion yuan via the Bond Connect program.

These data fully reflect international investor acknowledgment of the reform and opening-up measures in the Chinese bond market. They also show that the infrastructure construction of Chinese bond market has reached international market standards, and triggered interest among international investors to further tap into the market.

In fact, the Chinese bond market is already the second-largest in the world, and Chinese bonds have gradually become important options for international investors to allocate assets globally.

International investors' increasing attraction to Chinese bonds is the result of the country's higher level of economic opening-up and stable economic growth. It reflects that the country's economic growth has entered a new phase featuring higher quality.

High-quality economic development not only supports the development of China's bond market but also boosts economic growth driven by innovation.

China's economic growth mode has undergone significant changes over the past few years, with innovation becoming an important driver propelling China's economic growth.

According to the National Bureau of Statistics, new industries, new business types and new business models have accounted for an increasing part of China's economy, taking up 17.08 percent of China's GDP in 2020－up 0.7 percentage point from a year earlier. The NBS also pointed out that China's innovation scale was up 6.4 percent year-on-year in 2020.

Driven by innovation, China's economic growth rate has remained at a relatively higher level, which means better returns on investment. This is one major reason that international investors have been attracted to the Chinese bond market.

China's 10-year treasury bond yield has remained at around 3 percent as of late November, fluctuating between 2.8 percent and 3.3 percent. This is a higher investment value if compared with the low and even negative treasury bond yields seen in developed economies. Yields on 10-year US treasury bonds, for example, have remained at around 1.4 percent this year. The yield gap for 10-year treasury bonds between China and the United States has been around 150 basis points this year, while that for one-year treasury bills remains at around 200 bps.

Chinese government bonds have also shown better stability in terms of yields, showing lower volatility than US government bonds. The 10-year US government bond yield has swung between 0.8 percent and 1.9 percent this year, fluctuating more significantly than that of the corresponding Chinese government bonds whose yield is between 2.8 percent and 3.3 percent.

Chinese government bonds and policy banks' financial bonds have taken up the majority－87 percent of bonds held by overseas institutions under depository－which shows their recognition of Chinese government credit.

Typically, government bonds are the underlying assets of the entire bond market, upon which risk premium is built. The Ministry of Finance issued US dollar-denominated bonds and euro-denominated bonds in October and November, with a combined value of nearly $9 billion. The issuance is key to boosting the confidence of global capital markets and strengthening ties between Chinese and international financial markets. Chinese government bonds are thus facilitated to participate in pricing activities in the global financial market.

The Chinese government's goal of building a new economic paradigm under which the country's economy will be opened up at a higher level has largely promoted opening-up in the country's financial sector. Two-way opening-up has been advanced in the Chinese bond market.

Ever since Sept 24, eligible Chinese mainland institutional investors have been able to plow their money into Hong Kong's bond market via the Southbound Bond Connect with a daily quota of 20 billion yuan. Therefore, the Chinese mainland and Hong Kong bond markets are fully connected with the Northbound Bond Connect launched in 2017.

While the global economy has been stricken by the COVID-19 pandemic ever since early 2020, China managed to report GDP growth of 2.3 percent last year and its GDP growth in the January-September period this year was 9.8 percent.

Stable economic growth and favorable monetary policy have helped renminbi assets to demonstrate independent performance. RMB-denominated bonds have helped international investors to lower their portfolio volatility amid international market complexity. Chinese bonds have helped to diversify risk in this sense.

As the Chinese bond market carries on its internationalization, overseas institutions will certainly increase their holding of Chinese bonds. In this sense, Chinese government bonds should further improve their liquidity and maintain their yields on a stable level so that international investors can be better attracted.

While the Chinese financial market proceeds with its two-way opening-up, more attention should be paid to manage risks in cross-border capital flows. There should be close-ended capital management in bond trading, depositories, settlements and remittances. Supervision over capital flow should be more active and comprehensive to avoid major risks.

Meanwhile, high-quality corporate bonds should seek substantial development in China. The yield of corporate bonds is crucial to the formation of risk premium, credit differences and risk identification of the entire market. They can largely meet the insufficiency of a market where government bonds make up the majority of the market share. The development of a multilevel bond market can change the indirect financing system in China which is dominated by banks. A modern financial system in which banks compete with the rest of the market and resources more efficiently can thus be built.

The writer is a research fellow of the National Academy of Development and Strategy at Renmin University of China, and the vice-president of the School of Economics at Renmin University of China. The author contributed this article to the think tank China Macroeconomy Forum.

The views don't necessarily reflect those of China Daily.