More investor-friendly efforts give China’s debt markets a boost and help the yuan to gain ground overseas
Executives and guests attend the Hong Kong launch ceremony for Bond Connect on July 3. Bond Connect gives international investors access to the China Interbank Bond Market directly from Hong Kong. (IMAGINECHINA)
As the evolution of China’s financial markets continues, it is set to boost the yuan’s internationalization.
Within five years, China’s bond market, already worth US$9 trillion, is poised to surpass Japan’s to become the second-largest in the world. Key to the growth is a new law that requires local governments to borrow money from markets rather than banks.
In July, China’s Ministry of Finance gave the Shenzhen Stock Exchange (SZSE) the green light to issue local government bonds through the Ministry of Finance-SZSE Government Bonds Issuing System. Retail investors can now also purchase these bonds via the system.
The local government of Southwest China’s Sichuan province was first to pilot this. It issued four tranches of bonds by tender, raising a total of 30 billion yuan (US$4.52 billion). Each of the first three tranches accounts for 9 billion yuan, while the last accounts for 3 billion yuan, with maturities ranging from three to 10 years and interest rates of between 3.76 and 3.98 percent.
After the first batch of Sichuan local government bonds was issued on Aug 1, eight securities companies, including Zhongshan Securities, CITIC Securities and China Securities, commenced online distribution of more than 150 million yuan in bonds to individual and institutional investors the next day.
More than 18,000 individuals subscribed to about 70 million yuan via SZSE’s centralized bidding system. According to the stock exchange, it was “a breakthrough, given the number of individual investors involved and the amount contributed”.
“Government borrowing is an important step to implement relevant arrangements of the China Securities Regulatory Commission on stabilizing the development of the bond market of stock exchanges,” the SZSE said in a statement.
Government bonds are attractive because of the higher credit status of the issuer and the tax-free policy for interest earnings, but not many individual securities investors know about these advantages yet.
So the SZSE decided to adopt the more investor-friendly online subscription mechanism and support securities companies in selling the bonds, in order to encourage individual investors to participate.
Next, the SZSE will try to carry out work related to local government bond issuance by tender and use the stock exchange to diversify the investor base for local government bonds. However, this might take some doing.
“Behind the rapid economic development of China, there are problems like the huge local government debts,” said Kenny Wen, wealth management strategist at Sun Hung Kai Financial.
Wen said China’s local government debt has accumulated to 15.32 trillion yuan according to Ministry of Finance data. Combined with the 12 trillion yuan included in the central government’s budget, the total debt of the Chinese government is about 27.33 trillion yuan.
“Too much debt means an unstable banking and overall finance system. To solve this problem, the new policy allows local government to borrow from the market via public-private partnership,” noted Wen.
“Bringing in private equity funds can reduce local governments’ debt burden. At the same time, it also lightens the banks’ burden, making room for giving out loans to companies, especially SMEs, to solve their difficulties in borrowing money,” he said, referring to small and medium-sized enterprises.
Meanwhile, although the internationalization of the yuan may have lost some of its pace, it continues, with the currency gaining influence as foreign investors are given greater access.
“Another aspect of issuing bonds is that it can attract foreign investors and raise the demand for RMB. It is a part of the globalization of the RMB and the China bond market,” said Wen.
“There’s also a link between the MSCI inclusion and the RMB’s internationalization. The Chinese government sees the picture from a very comprehensive angle, so currency, the bond market, stock market ... every aspect is interrelated.”
Morgan Stanley Capital International, or MSCI, is an investment advisory firm that compiles stock indices. In June, it decided to add China’s A shares to its benchmark Emerging Markets Index.
Besides the passive funds that track the MSCI indices, the inclusion is expected to bring in foreign investors to the A-share market, and they will need to have yuan to buy those shares. This creates an indirect positive impact on the development of the yuan’s internationalization.
“RMB internationalization has been a gradual process,” said Tony Nash, chief economist and CEO of Singapore-based data analytics firm Complete Intelligence.
“We saw internationalization slow in the first half of last year as trade and other macro indicators slowed, but we believe things have accelerated since the second half of 2016,” said Nash. “Commodities and trade finance are areas of focus, but SMEs in Southeast Asia are also expecting to convert payables for Chinese firms to RMB over the next couple of years.”
According to Swift, the provider of a global interbank messaging network, the Belt and Road Initiative is one of the long-term enablers of yuan internationalization.
The China-led Belt and Road, launched in 2013, aims to enhance trade and infrastructure links between Asia, Africa and Europe. In May, President Xi Jinping said at the Belt and Road Forum for International Cooperation held in Beijing that China would invest more than US$100 billion in the initiative.
“The Belt and Road Initiative will eventually help to create overseas sovereign debt markets for RMB,” said Nash. “The infrastructure is largely constructed, planned and, in some cases, operated by Chinese firms, and those companies will eventually want to be paid in RMB.
“That will pull through a demand for RMB, which will diversify a portion of the sovereign debt market away from the US dollar toward RMB.”
After the stock market indices inclusion, China is also putting more effort into winning inclusion in international bond indices.
In July, Bond Connect was established to provide international investors with simplified access to the China Interbank Bond Market (CIBM) directly from Hong Kong, without having to open accounts in the Chinese mainland and look for a qualified clearing agent first.
As a sister plan to the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect, Bond Connect is open to all overseas investors who are eligible to access the CIBM. Investors can use their existing Hong Kong custodians, and only need one week to go through the application process.
Bond Connect is expected to act as a diverter for when China is included on major bond indices.
Investors have more access to the Chinese financial market than ever before, due to the government’s constant reform and opening-up. But challenges still lie ahead in managing all the channels and the unique issues they come with.
“The vehicles for RMB internationalization, not necessarily the volume of RMB transactions yet, are moving ahead rapidly,” said Nash at Complete Intelligence.
Nash sees the challenge for China’s central bank as helping global markets understand what this progress means in order to raise confidence in the yuan while reducing volatility around yuan exchange rates.
Patricia Cheng, head of China financial research at Hong Kong-based brokerage CLSA, said it helps to have additional channels to access the China market, but “at the end of the day, we’ll have to look at traffic in both directions”.
“It is a different game in China, but it doesn’t necessarily affect the market accessibility,” said Cheng. “It’s the transparency that matters — every market has its own rules of the game; foreign investors need to know what those rules are first to decide whether to play the game or not.”