The net increase of foreign institutions' holdings of domestic RMB bonds has risen for 10 consecutive months -
why foreign investment continues to increase their positions in China
Guan Tao
Statistics from Bond Connect show that at the end of January 2022, foreign institutions increased their holdings of domestic RMB bonds by 66.3 billion yuan to 4.07 trillion yuan, an increase for 10 consecutive months.
Among them, the bond custody volume of foreign institutions in CCDC increased by 50.1 billion yuan to 3.73 trillion yuan, increasing for 38 consecutive months.
Although the current economic situation has become more complex and changeable, the country is facing "triple pressures", and foreign inflation is high and monetary policy tightening expectations are strong, international investors are still full of confidence in my country's long-term economic growth prospects and choose to continue to increase their holdings of RMB assets.
What is the reason behind this and how do you view this phenomenon?
The China-US interest rate spread has converged within expectations
From a full-year perspective, the difference in GDP growth between China and the United States in 2022 may hit a new low since the 1990s.
However, judging from the trend, China's economic growth is high and then low, while the US economy may slow down quarter by quarter.
Compared with the gradually weakening effect of the US stimulus policy, there are many positive factors for my country's economic growth this year.
Regarding the factors that caused the downward pressure on economic growth in the second half of last year, the five "correct understandings" and "first establishment and then breaking down, steady and steady attack" of the Central Economic Work Conference held at the end of last year were corrected in a timely manner, and some structural blockages will usher in relief. , to further release economic vitality.
The convergence of the Sino-US interest rate differential will affect the inflow of foreign capital to a certain extent.
High inflation in Europe and the United States and tightening monetary policy will gradually push up the yield of government bonds, while the market generally expects that my country will maintain a slightly loose monetary policy, and the yield of my country's government bonds may be easy to fall and difficult to rise.
As of February 15, the yield spread between China and the US 10-year treasury bonds fell by 51 basis points from the end of last year to 74.5BP, which was lower than the "comfort zone" of 80BP-100BP.
However, the convergence of the China-US interest rate differential has been expected.
Affected by this, in January, the net increase in overseas holdings of domestic RMB bonds fell by 5% month-on-month and 70% year-on-year.
Even so, foreigners rarely reduce their net holdings of renminbi bonds.
Because for the world's second largest economy, RMB bonds may still be "under-allocated" in the allocation of foreign investors.
According to data from the China Central Clearing and Clearing Corporation, the bond custody volume of overseas institutions accounted for only 4.24%, far lower than the 30% in the United States.
In addition, the structure of RMB bonds held by foreign investors is relatively simple. Among them, treasury bonds and policy financial bonds account for 68% and 29% respectively. There is still a lot of room for development of corporate and corporate credit bonds in the future.
Security and liquidity promote foreign investment
"Great changes unseen in a century" and the epidemic of the century continue to affect the global economy.
There are many overseas risks foreseeable this year, such as the tail risk of the epidemic, the US mid-term elections, inflation risks (energy crisis, food crisis and supply chain disruption) and Fed tightening.
Domestically, on the contrary, many policies and economic situations point to stability.
This is attractive to foreign investors looking to reduce volatility in their asset allocation.
First look at security.
During the epidemic, there have been repeated overseas epidemics, the narrowing of the Sino-US interest rate gap, and the substantial increase in foreign investment holdings of ChinaBond.
Investors at home and abroad have expressed that RMB assets have a safe-haven attribute.
At present, the dislocation of the Sino-US economic and policy cycles may "naturally" form a weak or even negative correlation between assets.
Overseas, high inflation and Fed tightening may trigger further selling of U.S. Treasuries, and rising yields will undoubtedly put pressure on equity market valuations.
On the domestic front, the People's Bank of China has reached a consensus on "internal first", and practical actions such as the RRR cut at the end of last year and at the beginning of this year show that it is imperative to stabilize growth.
In terms of exchange rates, the International Monetary Fund (IMF) has repeatedly warned that emerging markets should be wary of foreign capital fleeing from the Fed's tightening, and China will also be affected, but it also praised China as the "ballast stone" of emerging markets.
The strong RMB exchange rate has also further increased the motivation for foreign capital to stay in China.
However, to a certain extent, this will also increase the monitoring pressure of the regulatory authorities on the foreign exchange market and cross-border capital flows, which can be described as "sweet troubles".
Look at liquidity.
As early as 2019, China's bond market has jumped to the second place in the world, after the United States.
In January this year, the average daily transaction volume of the inter-bank market reached 5.3 trillion yuan, far exceeding the amount held by foreign investors.
Coupled with the increasingly perfect bond derivatives market, foreign capital does not have to worry about the liquidity of RMB assets.
In addition, in recent years, my country's financial two-way opening has been continuously expanded. The "14th Five-Year Plan" proposes to comprehensively improve the level of opening up, promote the liberalization and facilitation of trade and investment, and the level of two-way communication has increased significantly.
In February 2020, Chinese government bonds were included in the JPMorgan Emerging Markets Government Bond Index; in November 2020, Chinese government bonds and policy financial bonds were fully included in the Bloomberg Barclays Global Aggregate Index; in October 2021, Chinese government bonds were included in the FTSE World National Debt Index.
In just two years, treasury bonds have been included in the three major global bond indices, further enhancing the attractiveness of RMB bond assets.
At present, except for Japan, the monetary policies of developed countries are almost all one-way tightening. Even the European Central Bank recently changed its tune and said that it needs to be alert to high inflation.
This will have a certain adverse effect on the exchange rates of emerging economies' currencies.
The IMF study found that the broad US dollar index compiled by the Federal Reserve has a strong negative correlation with capital flows in emerging economies, and the strengthening of the US dollar in 2021 has begun to inhibit capital inflows into emerging economies.
In addition, the yield of the 10-year US Treasury bond still has room to rise, coupled with the potential international financial turmoil caused by the tightening of monetary policy, most emerging economies are not having a good time.
Rational view on the relationship between exchange rate and foreign investment
Although the factors affecting the RMB exchange rate and foreign investment in RMB assets partially overlap, the mechanism of action and the strength of the impact are different.
Taking the interest rate gap between China and the United States as an example, domestic investors are still the main force in determining the yield of treasury bonds, and more emphasis is placed on the decision of the People's Bank of China.
Foreign capital, on the other hand, pays more attention to global asset allocation, focusing on the Fed’s decision and the potential trend of U.S. bond yields, which has a relatively limited impact on RMB bond yields, and at the same time needs to take into account exchange rate changes.
At the same time, at different stages, the aforementioned logic will also change as the consensus of investors changes.
Taking 2018 as an example, the divergence of Sino-US monetary policies and trade disputes led to the continuous depreciation of the RMB and the continuous narrowing of the Sino-US interest rate gap, but foreign capital still bucked the trend and made a net inflow.
This is because the devaluation of the renminbi will reduce the profits of stock foreign capital, but it will reduce the cost of incremental foreign capital.
In addition, the RMB exchange rate has a stable foundation. China has a relatively high current account surplus and relatively small external liabilities, especially in foreign currencies, and is able to cope with the exchange rate fluctuations brought about by the tightening of global dollar financing.
A stable exchange rate environment will help reduce the exchange rate risk cost of foreign investment in RMB bonds.
It is undeniable that the foreign exchange demand of foreign capital to purchase RMB assets is a part of the total foreign exchange demand. If it encounters foreign capital replenishing the US dollar market, it will still have a marginal ability to disturb the RMB exchange rate.
(The author is the Global Chief Economist of BOC Securities)
Guan Tao
Guan Tao