China: Do Not Buy RMB Bonds

Despite their glitter, is it worth investing in RMB bonds? 

  1. Re-weightings

    In the next year, foreign fund managers intend to double their bond holdings to 13% of their local currency portfolios.
  2. Why re-weight?

    First, these foreigners are attracted by the RMB bonds’ higher yields. In China, 10-year government bonds yield 2.7% - vs. 1.6% in the US, and negative yields in Japan for the same maturities. This means that China’s 10-year governments yield 69% more than their US counterparts. Secondly, China’s may be included in international bond indices, meaning that index-tracking funds would have to buy China’s onshore debt.
  3. Streamlining of the investment process

    According to the Weekend Financial Times (FT) of 1st-2ndOctober: “China’s opening of its debt market in May 2016 allows international investors to buy onshore bonds under the auspices of a so-called agent bank appointed by the government, rather than having to seek approval for an investment quota under a set of rules known as QFII.”
  4. Risks

    First, there is the currency risk. Remember how that stonking 2.7% “devaluation” of the RMB caused such a market ruckus this January? I think that the RMB is set for further softness/falls. “All politics are domestic” tipped Tip O’Neill, and rightly so. In the case of China, view the RMB’s exchange rate poker card: it can be exchanged when bartering in economic policy. For instance, in this week’s Economist we read that “China is very unequal. Shanghai…is five times wealthier than the poorest province, Gansu, which has a similarly-sized population.” Besides, according to our note of yesterday, this month’s sixth plenum will be very much about centralizing power so that Mr Xi can continue his anti-corruption drive, to mention but one driving force. So look for tradeoffs later this month and going into next year’s Party Congress, e.g. 1) stronger centralization/anti-corruption moves  for a weaker RMB. Or, 2) more anti-corruption measures for a weaker RMB. Or 3) more pro-growth measures, one being an ever-weaker RMB. Secondly, it is not clear at all that RMB bonds in fact will be included in international bond indices. According to said FT, “…earlier this year, equities were turned down for inclusion in MSCI’s benchmark global equities indices partly because foreign buyers were concerned about their ability to repatriate investments on demand.”[1] Thirdly, there are those persistent worries about China’s lacking rule of law as well as  financial stability, e.g. her debt levels. If people are so worried about China’s debt levels, then how can they be comfortable extending further credit to China in the form of their bond participation? 
  5. Investment implication

      Investing in RMB bonds is not such a wise idea, after all. Caveat emptor!
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The above notes formed part of a RTHK radio show, you can listen to the blog  more

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