China's aim to be part of major bond indexes a challenge

BEIJING • If China found MSCI Inc a tough nut to crack, compilers of global bond indexes may prove even harder to please.

While policymakers have allowed global funds greater access to the US$6.4 trillion (S$8.6 trillion) interbank debt market, investors flag restrictions such as a ban on onshore foreign-exchange trading, unclear tax rules and curbs on bringing home profits.

"Bond investors are going to be much, much more driven by technicalities, or issues like repatriation, settlement and taxes," said Mr Luke Spajic, Singapore-based head of portfolio management for emerging Asia at Pacific Investment Management. "Scrapping quota restrictions is all about entry, which gets investors excited. However, exit is equally important and arguably a greater concern in times of market stress."

The MSCI rejection sounds a warning for China as policymakers look to attract funds to support a fragile economy amid record bond issuance, a declining yuan and an estimated US$1 trillion of capital outflows in the past year.

The nation will push for the inclusion of domestic notes in global measures such as those compiled by Citigroup, JPMorgan Chase and Barclays, People's Bank of China (PBOC) deputy governor Pan Gongsheng said this month.

The stakes are high: HSBC Holdings estimates that inclusion in major bond indexes could help draw as much as US$150 billion to Chinese government debt, compared with a probable US$30 billion for MSCI equity gauge inclusion.

Even though the requirements of bond investors - and index compilers - may be harder to satisfy, China is closer to finding a solution for access to its debt market than it is for stocks, Mr Spajic said. He earlier estimated that next year or 2018 would be a realistic target for Chinese bonds to enter global measures.

The PBOC in February said all medium to long-term foreign institutional investors can access the interbank bond market without quotas. Last month, the State Administration of Foreign Exchange (Safe) released currency exchange rules for the scheme. On June 14, the central bank said the first group of money managers had registered.

While the Safe rules increase the chances for China to be included in the indexes, the steps are not without limitations, said Mr Chen Yang, rates strategist at Bank of America Merrill Lynch. Procedures requiring the filing of tentative investment amounts first and currency trading is restricted, he said.

"Chinese regulators should turn the market totally free, although I don't expect (they will) before they are ready," said senior portfolio manager Woon Khien Chia at Nikko Asset Management Asia. "The licensing, monitoring of inflows and limits on net foreign exchange... don't give investors total freedom."

Capital account convertibility is a prerequisite for President Xi Jinping's efforts to turn the yuan into an international currency. Yet investors still face lengthy government reviews in many types of cross-border investments.

JPMorgan said in March that it had placed China's onshore government bonds on review to be included in its emerging-market indexes.

Overseas entities held 680 billion yuan (S$139 billion) of onshore debt at end-March, 70 per cent more than at the end of 2013, when the PBOC started to release the data. By comparison, foreign holdings of equities grew 66 per cent to 571 billion yuan.

BLOOMBERG

A version of this article appeared in the print edition of The Straits Times on June 21, 2016, with the headline 'China's aim to be part of major bond indexes a challenge'. Print Edition | Subscribe