China's plan to open its domestic bond market to foreign investors may, at first glance, seem an offer with few takers. But in a world of low-to-negative interest rates, it could prove a lucrative investing opportunity.
China has the third-largest securities market in the world, after the U.S. and Japan. Yet foreign investor participation is only about 2 percent, even after authorities made access easier for offshore central banks, sovereign wealth funds and other global financial organizations last July.
Opening the door to commercial lenders, insurance companies and fund managers will not only promote global use of the yuan ahead of its inclusion in the International Monetary Fund basket of reserve currencies, but also go some way to achieving Beijing's aim of cutting state-owned firms' reliance on bank loans at a time lenders' bad debts are spiraling.
Previously, foreign investors wanting to buy domestic yuan bonds using foreign currencies had to go through the qualified foreign institutional investor scheme, or QFII, and getting the requisite rubber stamps could take up to a year. A scheme launched in 2011 that permitted international investors to purchase Chinese stocks and bonds with yuan raised offshore -- the Renminbi Qualified Foreign Institutional Investor program, or RQFII -- was another avenue through which foreigners could buy securities onshore.
According to Standard Chartered strategist Becky Liu, the PBOC's opening of the market makes QFII and RQFII practically ``obsolete,'' although they do remain the primary avenue through which overseas investors can buy mainland stocks.
And for all the headlines about the rising risk of default, Chinese bonds do pay pretty good returns. Ten-year sovereign notes yield 2.9 percent versus 1.8 percent in the U.S. and minus 0.06 percent in Japan.
The number of defaults China has had is also small compared with the U.S., where dozens of companies miss their obligations to creditors every year.
Even with all the doom and gloom surrounding the yuan, the Chinese currency has, in the main, been a largely stable bet:
Of course, there's a strong chance that more companies in China, and even state-owned ones, will be allowed to fail. It's hard to imagine that all of the nation's bloated property developers, steel and shipbuilding companies can survive.
It's also little comfort that only local ratings companies are permitted to score onshore bonds. Most notes tend to be rated at least AA and it's not uncommon for the same security to have a top investment-grade rating at home and a junk rating internationally. Moody's, for example, rates China Railway Construction at A3, its seventh-lowest investment grade, while Dagong Global Credit Ratings has it at AAA.
Still, at a time when interest rates globally look like they'll be low for a while, Chinese bonds have a certain appeal. At a minimum, as the world's second-largest economy and one of its fastest-growing ones, it's a market many investors can't afford not to be part of.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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