Global investors venture into China bonds after IMF boost

[HONG KONG] Confirmation that the International Monetary Fund will include the renminbi in its basket of reserve currencies has added to hopes for further internationalisation of China's bond market, but investors say they are not going to jump in headfirst while regulation remains heavy and the currency's direction remains unclear.

Global central banks are expected to add more renminbi assets to their reserves after the IMF announced last week that it will include the renminbi as the fifth world reserve currency in its Special Drawing Rights (SDR). The so-called redback will have a 10.9 per cent weighting in the basket, the third highest after the US dollar and euro.

The move had little immediate impact on the currency or on markets, but is set to drive more global investors to renminbi bonds in the long run. "Once the Chinese fixed income market opens up, it will be very difficult for global investors to ignore the market. It will change the market structure for the Asian and global fixed income market," said Neeraj Seth, head of Asian credit at BlackRock.

The first movers are likely to be central banks that have yet to join 70 of their peers already deploying their foreign reserves into renminbi-denominated debt, raising the proportion of global reserves held in RMB from around 1.4 per cent, as estimated by the People's Bank of China.

Days before the IMF's announcement, a G10 central bank began investing in Chinese bonds for the first time, according to sources familiar with the matter. Philippine central bank governor Amando Tetangco told reporters last week it may increase renminbi assets to diversify its foreign exchange reserves. "We're going into the next phase where a vast majority, if not all the central banks around the world with investable reserve assets are going to be looking to take exposure to the RMB," said Karby Leggett, Asia head of public sector and development organisations at Standard Chartered. "It's really just a question of pace and speed and timing." In the short-term, the impact is expected to be limited because net inflows will be too small to move the 40 trillion yuan (S$8.8 trillion) Chinese onshore bond market, the world's second-largest after the US.

Even if the proportion of global reserves held in RMB reaches 4 per cent, similar to those currently held in yen, potential inflows would amount to US$210 billion, which is still not significant enough to have a material impact on Chinese Government Bond (CGB) yields or drive the trend of the remminbi, according to Frances Cheung, a rates strategist at Societe Generale.

But the IMF's inclusion marks a symbolic shift for central banks, who will be making long-term adjustments to raise their holdings of renminbi-denominated bonds despite concerns about Chinese growth and tight onshore yields, as well as the weak outlook for the renminbi against the dollar.

"We don't expect that the changed views on RMB appreciation will fundamentally influence the decision-making process for central banks regarding their interest in deploying reserve assets into China," said Leggett. "That decision is not driven by the return they get on the assets they hold, but rather by a far more fundamental and strategic consideration around how they best protect the nation's currency reserves. This will lead to an enormous shift in the global currency landscape as central banks recalibrate their balance sheets."

Fund managers cautious Fund managers appear less likely to mark the renminbi's updated status by increasing their bond holdings through qualified foreign institutional investor and renminbi qualified foreign institutional investor quotas. Unlike central banks, who have a fundamental reason to shift assets in renminbi, they are concerned that the currency could depreciate further.

"For us, China has been a great allocation and it performed well, but as valuations in other markets now sort of have improved because of the weakness we have seen in both the currency space and bond space, to some degree, we are likely to rotate a little bit of our positions to these markets and, to some degree, some of that may come out of China," said Kenneth Akintewe, senior investment manager in Asian fixed income with Aberdeen Asset Management. "We will be maintaining exposure to the onshore market, and we might see some reduction in exposure in the offshore CNH market," Akintewe said. Aberdeen has a QFII quota of US$255 million and a RQFII quota of 600 million renminbi.

Concerns over credit fundamentals have also deterred foreign fund managers from getting involved in renminbi corporate debt. "Sometimes, trading desks of (foreign institutional investors) wanted to buy Chinese corporate credits, but their risk control departments did not allow it," said a Chinese trader who deals with overseas clients.

According to data provider Chinabond, by the end of October, the position of overseas investors (both central bank and fund managers) in corporate bonds stood at only 58.4 billion renminbi, compared to 487 billion renminbi in treasuries and policy bank bonds.

Despite reservations among foreign asset managers, they will inevitably have to increase exposure to China's bond market. "In the longer term, in addition to sovereign bonds and policy banks bonds, two other areas will be very important to focus on: first, a proper corporate credit market, and second, a municipal equivalent market," said Seth at BlackRock, which has a QFII quota of $1.25 billion and a RQFII quota of 640 million renminbi.

Diversification In the near term, central banks who have been investing in China and who are new to the market are largely expected to focus on buying CGBs and policy-bank bonds both onshore and offshore.

The Chinese government is greeting this heightened interest by facilitating the investment process. The People's Bank of China last month registered seven public institutions, including the central banks from Hong Kong, Australia and Hungary, to enter China's interbank foreign exchange market, removing limits on the size of investments.

But as China continues to relax restrictions, and foreign investors become more comfortable, offshore interest is expected to shift away from the traditional CGB and policy-bank bonds to other types of debt, such as Dim Sum and Panda bonds.

A day after the IMF announcement, a Hong Kong-based banker said he received queries from European and African central banks on Dim Sum bonds, which are still easier to invest in than the nascent Panda bond market.

In the coming years, bankers and investors even predict central bank appetite could even trickle into local government debt.


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