China Insights – Central Government Bonds

In this issue of ESLJ China Insights series, where we aim to explain the Chinese local bond market and its peculiarities, we are discussing the second of the four main segments that constitute the market, Central Government Bonds (CGBs).

Like the US Treasuries, CGBs are considered as risk-free sovereign bonds, carrying explicit central government guarantees. Relatively liquid, up to 50Y, they represent the second most actively traded segment after policy banks.

Because of their historically “default-free” nature, together with policy bank bonds, they are the only bonds included in global bond indexes and are preferred by foreign investors as they initiate their exposures to Chinese bonds.

In 2020, inflows into CGBs have tripled compared to the year before, amounting to about RMB566bn*, and it is still growing due in part to a robust post-Covid economic recovery and the recent inclusion of CGBs into major global bond indices, with the last confirmation being the inclusion in the FTSE World Government Bond Index from October 2021.

However, foreign participation in CGBs is still low, especially considering the size of the Chinese bond market (second in the world) and comparing it to other major government bonds, both in developed and emerging markets. As at the end of 2020, foreigners only own 9.7% of the CGB market, compared with over 30% in the US and 25% in Indonesia, for example**.

Despite foreign investors purchasing a net USD18.8 billion of Chinese government debt in January 2021 (the highest monthly inflows since data have been available), the CGB market is still immature and mostly contained onshore. Until recently, the largest Chinese debt issuers have been State Owned Enterprises (SOEs) and local governments, while issuance of CGBs has been modest. Whilst the situation is evolving and the central government is taking over more borrowing responsibilities, outstanding CGBs still represent less than 20% of China’s GDP, compared to outstanding U.S. Treasuries representing 100% of US GDP***.

Below we highlight some interesting characteristics of Chinese CGBs that make them potentially a compelling investment opportunity for foreign investors.

Attractive yields
Over the past 15 years, Chinese government bond have offered attractive yields compared to many developed markets.

Low correlation
Chinese government bonds have demonstrated low correlation to other bond markets and major asset classes. This is justified by the fact that China’s monetary policy has maintained an independent status from other major economies and its economic growth is little affected by what is going on in other countries.

Safe-haven asset
CGBs have shown resilience in periods of market stress.

Resilience in times of market stress
China bonds have behaved like a safe-haven asset during major crises and periods of market stress. In the chart below, we show the total return of asset classes in GBP terms.

We are strong believers in the investment opportunities still to be unlocked in the Chinese bond market, however, because of the complexity of the system, operational hurdles and cultural and language barriers, it is paramount that investors partner with experts with on-the-ground expertise and a long-term consistent approach. In the next ESLJ China Insight, we will turn our attention to Local Government Bonds.

* China Central Depository & Clearing as at March 2021
** AsianBondsOnline quarterly report, March 2021
*** Wind, July 2020.

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