China’s bond market is the world’s third largest but still has ample room for development

China is opening its bond market further to foreign investors. In July the People’s Bank of China (PBoC) announced that certain foreign institutions – including central banks, sovereign wealth funds and international financial institutions – would have open access to the interbank debt market.

This is China’s latest measure to integrate its capital markets into the global financial system. It follows the Qualified Foreign Institutional Investor (QFII) scheme and the Renminbi Qualified Foreign Institutional Investor (RQFII) schemes, which allow approved foreign fund management and securities companies to invest in onshore Mainland securities.

A more dynamic bond market will help lessen China’s reliance on bank lending

China’s bond market has come a long way. The Bank for International Settlements calculates that at the end of the first quarter of 2015 the size of China’s bond market was about USD5 trillion, trailing only the US at USD36 trillion and Japan at USD11 trillion. But there is still ample room for development.

The bond market is small compared to the size of the Chinese economy. China accounts for 12 per cent of global GDP but its outstanding bonds amount to only 5.1 per cent of the world total. Issuance is dominated by government, rather than corporate bonds. And at the end of 2013, foreign investors held just 2.4 per cent of domestic government bonds in China – one of the lowest percentages among emerging markets.

China understands the need for a more developed bond market.

By welcoming more foreign investment, China can gradually increase the size and range of the investor base. More foreign inflows could generate a new source of funding for Chinese borrowers and prompt more Chinese companies to issue bonds at home.

A more dynamic bond market will help lessen China’s reliance on bank lending and free up Chinese banks to extend more lending to small and medium-sized enterprises, who often find it harder than big corporations to obtain funding.

Nurturing the bond market supports China’s ambition to see the renminbi join the US dollar, the euro, the Japanese yen and the British pound in the International Monetary Fund’s Special Drawing Rights basket – effectively attaining reserve currency status.

Meanwhile, for foreign investors, access to China’s domestic bond market will open up another channel to buy into the world’s second-largest economy.

Foreign central banks have already begun to diversify their currency reserves into renminbi-denominated assets. According to the most recent data from the PBoC, central banks held about USD107.5 billion of their official reserves in renminbi.

China’s stock markets tend to grab the limelight, but the development of the country’s bond market is no less significant.

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