“Providers of major bond benchmarks still need to confirm whether the recent changes will meet different index inclusion criteria, but China already meets some of them in terms of size and credit ratings,” Jaquier wrote in a recent research note.
For example, if China were included in the JPM GBI-Emerging Markets Index, its weight would be 10% and investors would have to do some switching from other relatively low yielding bond markets with high credit ratings, such as Thailand and Malaysia, he said.
“More important would be inclusion in one of the major global bond benchmarks, such as Citi’s World Government Bond Index (WGBI). There are about $2trn of assets managed against the WGBI, so China’s inclusion could attract significant flows, even though it would remain small relative to the size of China’s bond market.”
His comments followed the February decision by Chinese authorities to remove the need for foreign investors to apply for quotas, opening up the onshore bond market to a broader range of institutional investors.
“Even though the absolute level of yield in China has come down significantly, active investors could also be enticed by the higher yield on offer on Chinese bonds compared to that on bonds from other major markets.”
For China, any impact should be positive but that would most probably be on a gradual basis over the long term, he said.
For example, opening up the Chinese bond market could attract foreign currency in order to offset the large flows of capital that have come out of the country over the past year. But the impact will likely be muted since inflows are coming in at a slower pace and in smaller size versus capital outflows, he said.
Further depreciation of the renminbi might be necessary to make Chinese bonds attractive for foreign investors as “meaningful buyers” of that incremental supply, if estimates proves to be correct that the total stock of Chinese government bonds could double by 2020.
“The currency is still perceived as somewhat overvalued,” he said.
