China’s bond market can be split into three categories: the offshore USD and CNH (“Dim Sum”) markets; and the onshore CNY market. In 2011, China kicked off liberalization of the onshore market by including them in the Renminbi Qualified Foreign Institutional Investor program (RQFII).
Despite steadily increasing the RQFII quotas, by 2015 non-Chinese investors still owned less than 2% of this massive onshore bond market. This could be set to change after the launch of “Bond Connect” in 2017, a channel enabling international investors to trade, without quotas, on global trading platforms, with their assets held at global custodians, and with offshore cash accounts. We expect derivatives and two-way trading to follow in time.
The People’s Bank of China (PBoC) estimates that 15% of the onshore bond markets could become foreign-owned: the average for major developed and emerging bond markets sits at 39%; even Japan’s bond market, which is domestically-oriented and offers very low yields, is 8% foreign-owned.
The investment case is well rehearsed. China is now the second-largest economy in the world and sovereign fundamentals are strong: it has a high savings rate and sovereign debt at less than 60% of GDP, it remains a net external creditor to the world, runs a persistent current account surplus, and is increasingly powered by domestic consumption rather than investments and exports.
We argue that the onshore, CNY bond market is the better way to take exposure to this long-term China opportunity in fixed income. As well as simply being 10-times larger than the offshore markets, it includes more corporate issuers from a wider diversity of sectors, and therefore offers more exposure to the dynamics of domestic China with much lower correlations to international markets. Moreover, adjusted for credit quality, yields are somewhat higher onshore than offshore.
Private sector leverage has been rising steeply in China, but is now levelling-off. The banking and shadow-banking sectors are being de-risked and corporate sector debt-servicing capacity has been improving as productivity and profitability improves. While we expect a more laissez-faire attitude from regulators to defaults among non-systemic onshore borrowers, over the long-term this should improve the overall quality of the market and instill greater discipline.
There are now four ways into the China onshore bond market
Onshore Market: Foreign Investor Access
Source: Neuberger Berman. For illustrative purposes only.