Historic move as Chinese bonds join Bloomberg index

Onshore Chinese bonds will be included in the Bloomberg Barclays Global Aggregate Index over the next 20 months from Monday, a move expected to attract hundreds of billions of dollars in foreign inflows.

In January, Bloomberg announced the inclusion of yuan-denominated government and policy bank securities issued by the China Development Bank, the Agricultural Development Bank of China, and the Export-Import Bank of China in its flagship Global Aggregate index family beginning April 1 over 20 months.

This means Chinese bonds will be fully accounted for in the Global Aggregate Index by November 2020.

By then, China is estimated to have a weighting of approximately 6.06 percent in the index, and the yuan will be the fourth largest currency component, after the dollar, the euro and the Japanese yen.

Upon full inclusion, the index will contain 159 Chinese government bonds and 205 Chinese policy bank bonds, totaling US$3.3 trillion in market value, according to data as of January 31, Bloomberg said in a statement.

"It represents an important milestone for China as it continues to strengthen and liberalize its capital market and looks to attract more international investors," said Mark Leung, CEO of JP Morgan China.

China's bonds posted returns at the high end of the global market: the return on equity of the Bloomberg Barclays China Aggregate Index was 3.45 percent in 2018, compared with 0.01 percent for the US index.

But foreign investors are still in the early stages of investing in onshore Chinese bonds, holding only about 2 percent of the total, said Li Bing, head of Bloomberg China.

"The inclusion of new instruments or issuers within benchmarks inevitably leads to diminished sponsorship from existing index securities assuming managers are index-neutral and the total assets benchmarked remain unchanged," JP Morgan said in a statement.

"The obvious winners are the newly index-eligible China bonds, which are poised to receive US$122 billion in sponsorship over the next 20 months from Global Aggregate (index) managers," JP Morgan said.

Deutsche Bank analyst Liu Linan said that about US$120 billion of overseas investment would flow into the domestic bond market over the next 20 months — US$48 billion of that by the end of this year.

Over the next five years, overseas inflows into the domestic bond market will reach US$750 billion to US$850 billions and overseas investors' holdings in the Chinese market will climb to 5.5 to 6 percent.

"Bloomberg's inclusion of China onshore bonds is a major change for global capital markets and will soon propel the onshore market past Japan as the second-largest in the world," said Hayden Briscoe, head of Asia Pacific fixed income at UBS Asset Management. 

"Purely from the weight of money and the shift in global capital markets, this is the biggest change in global capital markets that we have seen for some time, and we believe it is something that all investors should be paying attention to."

The bond index inclusion marks another important milestone in China’s financial market liberalization and the internationalization of the yuan, according to the Australia and New Zealand Banking Group.

The inclusion of yuan to the International Monetary Fund’s Special Drawing Right on October 1, 2016, cemented the yuan as an official reserve currency, alongside the dollar, euro, yen and pound sterling.

Onshore Chinese equities were included in the MSCI indexes from May 31 last year. And now for the first time, onshore China bonds are officially in a major global bond index.

"Inclusion in other major bond indexes is only a matter of time. Alongside equity index re-weighting and further FX reserve allocation into the yuan,"said Khoon Goh, head of Asia research at ANZ.

"The expected pick-up in foreign portfolio inflows will help offset the narrowing in China’s current account surplus and support the yuan."