Beijing's bid to rival US as debt haven at risk after crackdowns

To a world full of fixed-income investors starved of safe assets with attractive yields, China's government bonds had become a tempting sight in recent years.

However, red flags are now being hoisted. A series of government crackdowns on everything, from property developers to technology firms, is triggering questions about whether a sudden change in regulations could harm foreign investment in the securities.

While positive inflation-adjusted interest rates and relatively tame volatility are keeping some fund managers bullish on China's sovereign debt, the regulatory risk is combining with a lacklustre credit rating to dampen the allure. That is making Chinese bonds a less likely candidate to challenge US Treasuries as global haven assets, impeding Beijing's push to promote the renminbi's worldwide usage and dent the dollar's dominance.

"I can't help but feel a higher regulatory risk for the nation's bonds," said Mr Akira Takei, a global fixed-income money manager at Asset Management One in Tokyo who has yet to buy the securities. "Although I don't expect any restrictions to be introduced in China's government bond market, I have to examine how tighter regulations outside the bond market will impact overall investment in China."

The stature of renminbi bonds had risen in tandem with China's growing influence on the global economy and as foreign exchange reserve managers bought more of the securities. Yet now, amid growing isolation from the United States and a far-reaching effort to close the domestic wealth gap, the shifting landscape of the rule of law in China threatens to undermine their attractiveness for investors in search of a haven.

The country's notes ranked sixth among nine debt markets analysed by Bloomberg for haven qualities in a study that took into account factors such as net foreign assets and volatility. Japanese bonds topped the rankings, followed by Swiss and Canadian securities. British gilts placed last.

Chinese bonds scored minus 2.72 for rule of law in Bloomberg's study, the lowest among all the markets. The securities also fared poorly for credit ratings in the analysis, scoring minus 1.63 to tie for the bottom place with Japanese debt.

The property industry has become a prime example of the risks to investment in China as tighter restrictions on lending and soaring borrowing costs led developers to struggle with funding, raising concern over their solvency. Kaisa Group Holdings has recently joined troubled industry giant China Evergrande Group in seeing its cash crunch reach the point where it hurt investors in high-yielding wealth products.

In the context of the nation's government bonds, one key concern is that a sudden change in rules could make it harder for investors to sell their holdings or repatriate proceeds.

"If capital movement regulations are tightened, for example through the introduction of restrictions on transactions in market access, overseas investors are likely to suffer disadvantages," wrote Mr Minoru Nogimori, an economist at the Japan Research Institute, in a report.

Despite those risks, overseas investors have kept putting billions of dollars in China's government bonds. Their holdings have grown by 513.7 billion yuan (S$110.2 billion) in the first 11 months of the year, the most ever for this period, according to data from ChinaBond going back to 2014.

According to Ms Frances Cheung, a rates strategist at OCBC in Singapore, inflows are likely to continue, given China's bonds remain appealing from the perspective of real-yield differentials.

Among the nine markets analysed by Bloomberg, only China offers positive inflation-adjusted yields.

Those yields and the nation's willingness to open up its financial sector to foreigners suggest the importance of China's debt is more likely to grow, regardless of whether it is seen as a risk asset or haven.

Mr Manabu Tamaru, a portfolio manager in Tokyo at Barings, said: "I recognise a risk of a sudden regulatory change."

But, he added, it is unlikely that sovereign bonds would be a target because that "would trigger an exodus of foreign funds".

"So I think bond investors are in a safe position," he said.

For Ms Tracy Chen, a Philadelphia-based portfolio manager at Brandywine Global who bought Chinese debt for the first time last year, the securities act as an "alternative safe haven", as the second-largest bond market that is still under-invested in by foreigners.

"We view the recent regulatory tightening and deleveraging in the property developer sector as painful in the short term, but beneficial for long-term growth," she said. "To us, it is China's version of ESG and should signal higher quality growth going forward."

ESG refers to investments that take environmental, social and governance principles into consideration.

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A version of this article appeared in the print edition of The Sunday Times on December 12, 2021, with the headline Beijing's bid to rival US as debt haven at risk after crackdowns. Subscribe