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[LONDON] Chinese government bonds could receive at least US$155 billion of investment flows should the relaxation of rules around foreign participation lead to their inclusion in various global indexes, JPMorgan said on Monday.
China has been gradually easing foreigners' access to onshore debt markets and on Friday the state foreign exchange regulator said foreign institutions would be allowed to remit funds freely.
The latest developments suggest China is "serious about attracting foreign capital" and there is now a greater probability of its government bonds (CGBs) entering global benchmark indexes, according to JPMorgan, which runs the most widely used emerging bond indexes.
"The potential inflow impact for China is significant if CGBs are to be included in GBI-EM (emerging index) and other frequently used cross-over investment grade indices. In our estimate, China could see potential (passive) inflows of US$155 billion as a result of inclusion by three major index providers," JPM told clients in a note.
When a country joins an index, so-called passive funds that track the benchmark, must invest in it. "Active" funds can decide if they wish to allocate but may find it difficult to bypass a credit with a big index weight.
A key development for China, rated AA-/Aa3/A+ by three big ratings agencies, would be inclusion in Citi's World Government Bond index. Used as a benchmark for over US$2 trillion of assets it has stringent criteria as to size, credit quality and open access.
JPM calculated that a 5 per cent weight in a "frequently used" global investment grade government bond index and a 2 per cent share in a key crossover investment grade benchmark would bring in US$100 billion and US$35 billion respectively.
Its own GBI-EM index of emerging currency debt would assign a 10 per cent weight to CGBs, resulting in inflows of US$20 billion.
Index inclusion decision can take 3-6 months, followed by a lead time of at least six months during which weights are staggered to allow investors to enter, the bank said.
"As a result, we estimate that if CGBs are included in indices in the next half year then the bulk of any passive index inflows would take place in 2017 or even 2018, with perhaps some 'early' inflows in the later part of 2016," JPM said.
Among emerging markets, China currently ranks third after Brazil and Mexico in terms of foreign ownership but inclusion in key indexes would catapult it to first place, the bank added.