China’s domestic bond market is the third largest in the world. The JP Morgan GBI-EM indices are among the most widely referenced indices of their kind. In February 2020, these heavyweights will unite as JP Morgan begins to ease China into its emerging market (EM) Government Bond Index suite. The inclusion, announced in early September, is expected to infuse a monthly sum of USD 3 billion into China’s bond market.
It is not a particularly surprising decision, given China had been on JP Morgan’s watchlist since 2016, pending market development and investor feedback. This past April, China was included in a similar Bloomberg Barclays index, however FTSE Russell has decided not to include China in its flagship World Government Bond Index. This was despite saying measures taken by Beijing to improve foreign investor access to its government bonds “mark significant progress”.
Our view is that while China is facing both internal and external challenges it appears to be determined to carry out structural reform, deregulate domestic markets and internationalise the yuan (CNY).
In a major step to open the domestic debt market, the government launched its Bond Connect initiative in 2017. The cross-border platform links China and Hong Kong’s bond markets, and it has massively improved the ease with which foreign investors can access the Chinese market. In September 2019, the State Administration of Foreign Exchange (SAFE) took the additional step of eliminating the strict quota restrictions placed on its qualified foreign institutional investor schemes.
Overall foreign direct investment into China has risen by 7.3% in the first seven months of 2019, and it is likely to continue to accelerate. We believe that for China, the inclusion in global indices will be an important source of capital inflows.
As the changes begin to take hold, the only uncertainties lie in their long-term effects. My colleague Markus Heider, Investment Manager on the EM fixed income team, believes the inclusion of China in the JPM GBI-EM GD index will lead to a change in index fundamentals: the importance of relatively low yielding manufacturing markets will increase, while that of commodity producers will decline. The index will give China its maximum allowance of 10%, causing predicted cuts of one percentage point in the weightings of several EMs – Thailand, Columbia and Malaysia, to name a few.
This index inclusion is a major milestone, for not just China, but broader EM markets. Renminbi bonds, once borderline inaccessible, will potentially grow to eclipse their smaller peers. We are confident this will provide us with further tools with which to navigate the domestic Chinese bond market.