Foreign Investors Buy More Chinese Bonds

* Central banks seeking to add yuan assets in their foreign exchange reserves are likely to be the main purchasing force for Chinese bonds

* Government bonds are the top target for foreign investors

Foreign investors are building up their portfolios in China’s $11 trillion bond market despite recent volatility of the Chinese currency and a stock market slump.

By the end of July, foreign institutional investors’ holdings of yuan-denominated, domestically traded bonds increased 40% from the beginning of the year to 1.61 trillion yuan ($234 billion), data from the China Central Depository & Clearing Co. (CCDC) and Shanghai Clearing House showed.

Foreign institutions including central banks, sovereign wealth funds, insurers and other investors have been building up their holdings of yuan-denominated bonds over the past 17 months, according to CCDC. Analysts said they see the trend continuing. Foreign investors’ holdings still account for less than 2% of China’s bond market, official data show.

The Chinese government has taken a series of steps to lure foreign money into the country’s capital market, including the launch of a bond connect program last year that allows eligible offshore investors to trade and settle mainland bonds through a Hong Kong-based custodian and clearing service without any quota. This year, regulators have approved foreign-funded banks to underwrite Chinese government bonds and gave a green light for foreign rating companies to assess the quality of bonds in the China interbank bond market to entice foreign investors.

China’s yuan-denominated bonds are set to be added to the Bloomberg Barclays Global Aggregate Index next year, attracting more global money managers to allocate their portfolios to include Chinese bonds.

Foreign central banks seeking to add yuan assets in their foreign exchange reserves are likely to be the main purchasing force for Chinese bonds, analysts said. Data from the International Monetary Fund showed that yuan-dominated assets held by global central banks as foreign exchange reserves increased by $22.4 billion (150 billion yuan) in the first quarter this year. That would account for almost all of the 157.5 billion yuan increase of foreign holdings of Chinese bonds in the same period.

Government bonds are the top target for foreign investors. During the first seven months, foreigners’ holding of Chinese government bonds increased by 373.9 billion yuan, accounting for a record 7.67% of China’s total government bond market.

Xie Yaxuan, an analyst at Merchants Securities, said foreign institutions will continue increasing their Chinese bond holdings steadily. Such demand will offer support to China’s weakening yuan and stock markets.

The Chinese currency has lost nearly 5% against the dollar so far this year amid trade conflicts and a narrowing interest rate differential with the U.S.

Fu Yunjie, investment analyst at the American asset management firm Legg Mason, said global investors are focused more on long-term fundamentals of the economy such as market liquidity, domestic demand and valuation in making bond-market investment, rather than on short-term currency moves.

Contact reporter Han Wei (weihan@caixin.com)