US economy

Beijing finds anti-Trump weapon in global indices


A trade war is raging between the US and China, but somebody forgot to tell foreign portfolio investors. Surging inflows of foreign capital have headed to the Chinese bond and stock markets and helped to stem the depreciation of the renminbi against the US dollar.

Donald Trump has accused China of rigging the world’s trade system to favour its own companies, dumping products at below cost price and stealing intellectual property. He has slapped tariffs on $250bn in Chinese exports to the US and warned Beijing last month that the US trade deficit with China is “just not acceptable”.

The rupture is so deep that some commentators foresee a new cold war.

But foreign fund managers appear unfazed, or perhaps they expect China to prevail. Their total holdings of Chinese stocks and bonds — denominated in renminbi — stood at $462.2bn at the end of September, up $122.5bn from a year ago, according to official statistics.

Putting those inflows into context reveals their importance to China’s economic resistance. For the first time in nearly 40 years since Beijing began to open its economy to the outside world, monthly portfolio inflows into bonds and stocks are drawing level with foreign direct investments. The FDI level was $91.8bn in the first nine months of this year.

The other key support is to the renminbi. The inflows swell the foreign currency reserves of the People’s Bank of China, the central bank, furnishing a bigger war chest with which to defend the Chinese currency against the strong US dollar. The PBoC spent $17bn in September alone on propping up the redback.

For the foreign investors, the country’s $12tn bond market — the world’s third largest — has been the main draw. Some $66.2bn has flowed into Chinese domestic bonds since the start of the year, bringing total holdings to $277.2bn at the end of September.

A variety of motivations lie behind the shift. One obvious pull has been the superior yields on offer relative to Europe, said Hu Kun at the Bank of China in London. China’s 10-year government bond was yielding 3.57 per cent compared with 0.47 per cent for Germany’s 10-year bond. The US 10-year bond was at 3.2 per cent.

More important, though, has been the prospect that Chinese bonds will soon join influential international benchmark indices. Renminbi-denominated securities are set to be added to the Bloomberg Barclays Global Aggregate index over a 20-month period beginning next April, with 386 Chinese securities being included for a weighting of about 5.5 per cent.

Further inclusions are expected to follow for the JPMorgan Government Bond index: Emerging Markets (GBI-EM) and the Citi World Government Bond (WGBI) indices. If these transpire, bond investors will be obliged to load up on Chinese domestic paper, further swelling inflows.

Indeed, the current inflows bear the hallmarks of pre-emptive allocations aimed at getting in ahead of the expected rush. The focus of the inflows has been government bonds and, to a much lesser extent, paper issued by policy banks, such as the China Development Bank and the Export-Import Bank of China. Both of these are slated for index inclusion.

Another key driver, said Miranda Carr, executive director at Haitong Securities in London, had been central banks’ desire to bring the composition of their reserves closer into line with the composition of the Special Drawing Rights basket at the IMF. The renminbi occupies a 10.9 per cent weighting in the SDR basket, having joined in 2016.

However, more exotic parts of China’s domestic bond market — especially a huge but murky corporate bond market — have been left relatively untouched by foreign investors. One problem is that local credit rating agencies have applied absurdly optimistic standards, giving top ratings to companies that rank among the most highly leveraged in the world.

This, however, is changing as Beijing allows international credit rating agencies to assess more Chinese corporations, injecting a much-needed dose of realism and potentially pushing yields out to attractive premiums over government bonds.

In the stock market, foreign inflows have held steady over the year in the face of declining prices. This again is mainly because of index inclusion. Global index provider MSCI brought in 235 Chinese A-shares into its flagship EM index earlier this year, obliging fund managers that follow the $1.9tn index to buy some of them.

Foreign holdings of domestic A-shares stood at $185bn at the end of September, similar to levels at the start of this year even though the market has been one of the world’s worst performers in 2018.

Even as the US piles on the trade pressure, China is discovering the utility of opening up to global capital. Its accession to the IMF’s SDR basket, inclusion in powerful investment indices and a willingness to ease some controls is paying valuable dividends.

james.kynge@ft.com



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