China’s Beaten-Down Bonds Set to Enter FTSE Russell Index

Foreign investors are likely to have a new channel to invest in China’s government bonds.

FTSE Russell will announce whether it will add the nation’s sovereign debt into its indexes after U.S. markets close on Thursday, a year after rejecting the notes. Morgan Stanley puts the odds of inclusion this time round at 90%.

With yields near zero for most developed nation bonds, the 3.1% offered by China’s benchmark 10-year bond has been pulling in investors from Singapore to the U.K. Inflows into the nation’s debt market from overseas investors jumped nearly 40% a year since 2017 to a record $383 billion by the end of June, central bank data as of the end of June showed. That’s yet to have much impact on the bonds given foreigners account for less than 3% of the $16 trillion market.

According to Morgan Stanley, inclusion by FTSE Russell will likely spur inflows of as much as $90 billion from September 2021. FTSE Russell is the last of the three main index compilers to consider adding Chinese debt after Bloomberg Barclays and JPMorgan Chase & Co. Bloomberg LP owns Bloomberg Barclays and Bloomberg News.

Last time around, FTSE Russell cited the need for greater secondary market liquidity, as well as increased flexibility in foreign exchange execution and the settlement of transactions to meet inclusion criteria. In April the index compiler acknowledged that China had addressed calls to increase market accessibility and provided investors with greater currency trading options and improvements to liquidity.

“All of this additional flexibility and feasibility of hedging are making offshore investors more comfortable about entering into the onshore bond market for capital investment,” said George Sun, head of global markets for Greater China at BNP Paribas China Ltd.

Despite inflows from foreign investors, Chinese bonds are poised to fall for a fifth straight month in September, making them the worst performer in the Asia Pacific region. The notes have been under pressure amid concern about tighter liquidity, a cautious central bank that has refrained from cutting interest rates and growing appetite for riskier assets as an economic recovery gathers pace.

As a result, China’s 10-year government note offers a yield premium of about 240 basis points over U.S. peers, near a record high. That could help attract “persistent and large” fund inflows, Citigroup Inc. said in a note this week.

Optimism that the nation’s debt will be added to the FTSE Russell index has been among factors driving a rally in China’s currency, which is on track for its biggest quarterly gain since 2008.

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“China’s bond market internationalisation is happening regardless of FTSE Russell inclusion which is but an endorsement of a structural shift well underway,” said Wilfred Wee, a portfolio manager at Ninety One Singapore Pte Ltd.

— With assistance by John Liu, Fran Wang, John Cheng, and Jing Zhao

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