China's economic clout

How China is seen increasingly shaping Asian bond markets

There are caveats though: the Sino-US trade war and the fact the renminbi is not yet fully convertible.
The US must make way for China in Asia's bond markets.
The US must make way for China in Asia's bond markets.

In a matter of years – how many is unclear but perhaps sooner than many people think – China’s monetary policy will exert a much bigger influence on Asian bond markets than they do currently, say senior market professionals.

For now, though, these markets still look mainly to the US and, while the Sino-US trade war continues and the ability to freely trade the Chinese currency remains curtailed, that looks likely to remain the case, they add.

“In future, just as Asian economies will be increasingly influenced by China, the pricing of Asian bonds will likely be more strongly influenced by Chinese treasuries,” Brad Gibson, co-head of Asia Pacific fixed income at AllianceBernstein, predicts.

This could conceivably happen in as little as three to five years, Gibson said at the recent Fixed Income Leaders Summit in Hong Kong this month.   

Over this period, so long as China continues to open up its very large and growing financial market, it is easy to see China’s government bonds becoming a reference rate for other Asian government bond markets, Gibson said. And since Asian corporate bonds are benchmarked to their respective government bonds, China will exert an indirect influence on them and Asian local currency bonds too. 

China’s $13 trillion bond market is already the world’s third-largest and is tipped to overtake Japan to become the second largest behind the US, spurred by the inclusion of Chinese bonds in some of principle international indices tracked by fund managers.

Notable in that respect is the inclusion this April of Chinese bonds in the Bloomberg Barclays Global Aggregate Bond index, to be phased in over 20 months.

These indices, in turn, could act as a transmission mechanism for China's growing influence on wider bond market sentiment, Gary Ng, an Asia economist at Natixis, told FinanceAsia.

The more Chinese bonds are included in such widely tracked benchmarks for global bond markets –according to Bloomberg, renminbi bonds will be the fourth-largest currency component of its index once fully accounted – the more Chinese bond prices will exert an influence on them.

That, in turn, will increase the influence of Chinese monetary policy on the international stage, Ng said, and reinforce the influence that is also channelled through China's growing trade and investment links to help shape regional bond market sentiment.

China has been Southeast Asia’s top trading partner for nearly a decade. China is also the biggest trading partner of South Korea and India.

A wide range of Asian countries are also involved in China's Belt and Road Initiative, its grand plan to connect with other nations through infrastructure projects like ports and railway.

Crossholdings of financial assets and the renminbi's growing importance is another way Asian government bonds will increasingly come under the influence of Chinese government bonds, Alex Leung, director of Hong Kong asset management firm Da Wan Asset Management, told FinanceAsia.

As an example of the increasing international importance of the Chinese currency, the People’s Bank of China (PBoC) and Monetary Authority of Singapore (MAS) on May 13 renewed for another three years a bilateral currency swap agreement between both nations, which has been in force since 2010.

This agreement makes Rmb300 billion ($43.3 billion) available to eligible financial institutions in Singapore.

OBSTACLES

Still, for now, Asian government bonds are mainly influenced by US Treasuries as the world’s safe-haven asset.

It is common, for example, to reference the yield on many Asian government bonds to US Treasury bonds.

So whenever there is a need to de-risk, there will be selling of Asian government bonds and buying of US Treasuries, said Vincent Au, head of investment at Hong Kong wealth advisory firm ALPS Advisory.

For that to change, the renminbi needs to become a globally accepted reserve currency like the US dollar and be more convertible, Au said. 

When that might happen is hard to predict – it could be as early as three years, it could be more than 10 years, he added.  

Chinese corporate bonds are no safe haven at the moment, Gibson said. “The protections foreign investors are used to are not yet [there] in the onshore market.”

For China to supplant the US as the biggest influence on Asian bond markets, China must also be the leading financier in Asia, Au said.

China already wields the biggest economic clout in some Asian nations – China has become the biggest lender in Pakistan and is the foremost investor in Cambodia and Laos – but it is far from dominant as a whole.

And there's the Sino-US trade war, which promises to slow the growing Chinese influence on Asian bond markets.

By discouraging Asian countries from doing business with China, the US may impede China’s influence in Asian capital markets, Leung said. US tariffs on Chinese goods will chase manufacturing out of China to Southeast Asia, which will reduce China’s wider economic influence, Leung said.

In the long-run it's not too much of a stretch to see Asian financial markets becoming more linked with China's.

It's just that getting there won't be plain sailing.

As Gibson put it: “This is the direction we are heading but these tectonic shifts in markets are not always smooth and fault lines can create bouts of volatility.” 

This article has been corrected in paragraph 21 

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