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FTSE Russell confirms inclusion of Chinese government bonds to flagship World Index starting October

Index provider FTSE Russell said on Tuesday that it would go ahead with its plan to include Chinese government bonds in a flagship bond index starting in October, marking the latest milestone in the opening up of China’s $16 trillion bond market to foreign capital.

The index provider, owned by the London Stock Exchange Group, said it would add Chinese government bonds to its World Government Bond Index (WGBI) over the course of three years from the end of October. China’s weight in the index will be around 5.25 per cent, the sixth largest following the US, Japan, France, Italy and Germany.

FTSE Russell said it had studied recent reforms to make international investors’ participation in Chinese bond markets easier following its decision not to include Chinese debt in its government bond index two years ago.

The 36-month phase-in is longer than the one-year process FTSE had flagged in September. FTSE said “a more conservative” schedule was appropriate because of feedback from market participants, which had included concerns from Japanese investors around settlement and liquidity.

“We commend China on the great progress it has made in market reforms,” said Chris Woods, head of policy and governance at FTSE Russell.

“We will revisit progress on a regular basis and continue to work with the People’s Bank of China to ensure that its reforms continue to yield tangible improvements to market structure.”

Chinese government bonds were previously included in index suites from JPMorgan and Bloomberg Barclays, but FTSE WGBI inclusion is expected to have a larger effect due to the size of passive flows tracking it. HSBC said that with roughly $2.5 trillion tracking the WGBI, some $130 billion in inflows could be expected, given China’s eventual 5.25 per cent weighting.

Investment bank Goldman Sachs said on Tuesday it was raising its forecast for inflows into Chinese debt to between $150 billion and $180 billion this year, from $120 billion to $140 billion before FTSE Russell’s announcement.

According to Liu Jie, strategist at Standard Chartered, the inclusion will attract $130 billion – $156 billion foreign capital into Chinese government bonds.

As the average yield of 3.09 per cent on Chinese government bonds is significantly higher than the average yield of 0.52 per cent on all bonds in WGBI, the inclusion of Chinese government bonds will bring the average yield to 0.65 per cent, said Liu.

Foreign investors’ net buying of Chinese government bonds is expected to increase from 571 billion yuan in 2020 to 840 billion yuan, which will account for 31 per cent of the net CGB issuance in 2021, significantly higher than 14 per cent in 2020 and an average of 16 per cent for the period lf 2015 – 2019, said Standard Chartered.

By the end of 2021, the proportion of foreign investors’ holdings of Chinese government bonds will increased to 11.5 – 12 per cent from 9.1 per cent at the end of 2020, said the bank.

Pan Gongsheng, deputy governor at the People’s Bank of China said in the FTSE Russell release that the central bank would promote the further opening of China’s bond market.

Foreign investors held a record 2.06 trillion yuan ($318.7 billion) of Chinese government bonds (CGBs) in February, even as premiums over U.S. debt shrank as a bond sell-off dented global markets.

Greater appetite for Chinese debt comes as Beijing further opens up its financial markets to overseas investors, including through Bond Connect, allowing qualified foreign investors to buy Chinese bonds without setting up an onshore business.

Foreign investors hold roughly 3.6 per cent of China’s domestic bond market and are gradually adding to their portfolios. They are attracted by the relatively high yields offered and as a means of diversification of risk. China’s 10-year government bond yield was 3.26 per cent on Tuesday, almost double that of the 10-year Treasury note at 1.75 per cent.

As of the end of February, foreign investors’ holdings of Chinese bonds reached 3.7 trillion yuan ($563 billion), according to Pan Gongsheng, deputy governor of the People’s Bank of China and director of State Administration of Foreign Exchange.