China prepares bigger opening to its $9 trillion bond market

Bloomberg

After China finally got a start on seeing its local stocks into global equity indexes, focus turns to what could be an even bigger deal — winning inclusion into the world’s benchmark bond gauges.
China is preparing the final touches for the next stage in that campaign — a “Bond Connect” program with Hong Kong that will allow international investors to
buy Chinese debt in the city, a mirror of two stock connect facilities with domestic equity markets.
Market participants expect an official announcement on the start as soon as July 3.
“We estimate that more than $1 trillion of additional global fixed-income investments could eventually be allocated to Chinese domestic bonds over the next decade, and Bond Connect moves us a step further in that direction,” Kenneth Ho, head of Asia credit strategy research at Goldman Sachs Group Inc., wrote in a note earlier this month.
Wary of the pitfalls that tripped up emerging-market nations that quickly dismantled cross-border financial controls, China for decades has maintained tight restrictions on foreign investment. While regulators are determined to keep tight oversight of domestic money moving abroad, the Communist Party leadership has sought a global role for the yuan — which entails allowing, and even encouraging, foreigners to increase its use. An influx of overseas money would not only help diversify funding for an economy loaded down with debt, but potentially spur market reforms such as improved corporate governance. MSCI Inc.’s decision on selective onshore-equity inclusion last week offered a step in that direction — read more here.
China’s bond market is the third-largest in the world, with the yuan equivalent of $9.4 trillion outstanding, yet has minimal foreign investment thanks to difficulty of access. Nomura Holdings Inc. analysts estimate about $109 billion of domestic bonds are held by overseas buyers, or less than 2 percent. China’s stock market capitalization is about $6.9 trillion, according to data compiled by Bloomberg.
“It will take time for foreign capital to increase its share of the China bond market, based on experience of other countries when opening up their bond markets,” Nomura analysts including Hong Kong-based Albert Leung wrote in a note last month. “It took about 10 years for foreign investor holdings in Japan’s bond market to increase to 7 to 8 percent from around 2 percent.”
Inclusion in major global bond indexes would be a “major positive,” the Nomura analysts concluded, though timing is uncertain.