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Foreign Investors to Purchase $48 Billion in Chinese Bonds in Next Two Years: Analysts

| Oct 31, 2016 10:56 PM EDT

Foreign investors are expected to come and invest in China and one of the best places to do business is the Shanghai Free Trade Zone.

A fourfold surge in the purchase of Chinese bonds by foreign investors is expected to occur in the next two years as global central banks are set to diversify their reserves, according to 11 analysts surveyed by Bloomberg News.

Some analysts said that the buying rush will be led by monetary authorities and supranational organizations which are expected to buy about $48 billion each in 2017 and 2018, more than four times the $12 billion of the whole last year.

This year, the inflows have slowed to $8 billion as investor confidence sagged due to the 4.2 percent decline of the yuan.

"There's still huge potential for reserve managers to slowly diversify their reserves into the yuan," Paul Mackel, head of emerging-markets currency research at HSBC Holdings Plc, said. "The appetite from real money managers, such as pension funds and mutual funds, is again very, very high. If China is eventually included in major bond indexes, it could bring an average $80 billion-$100 billion annually over the coming years."

But capital inflows are mildly affected by China's move to open its bond markets in preparation for yuan's entry into the International Monetary Fund's Special Drawing Rights on Oct. 1.

Eswar Prasad, a Cornell University professor and former head of the IMF's China division, however, said that the situation will change over time as the renminbi will take as much as 10 percent of the world's $11 trillion of foreign-exchange reserves in 10 years.

Nine out of the 11 respondents polled by Bloomberg have staked their odds that national debts will be added to major bond indexes by 2018. The median estimate in the survey also said that in the next ten years, the inclusion would help bring $750 billion of inflows.

Earlier this year, PBOC Deputy Governor Pan Gongsheng said that the country will exert efforts to include the domestic notes in global measures such as those compiled by Citigroup Inc. and JPMorgan Chase & Co.

Investors have profited from Chinese sovereign bonds in all but one of the past 11 quarters, with a total return of 25 percent, despite the scarcity of assets. The stocks of Shanghai Composite Index, which the mainland's benchmark, fell by 12 percent this year while the government tries to curtail the rising property prices and implements a crackdown on illegal banks to prevent capital flight.

Data from China Central Depository & Clearing Co showed that inflows have started to pick up, driven by the SDR, as foreign investors' holdings of Chinese onshore sovereign debt hit a record $6 billion in September.

China's higher yields have also attracted many investors. These include the 2.70 percent yield from China's benchmark 10-year sovereign debt, which is higher compared with 1.72 percent in South Korea, 1.85 percent in the U.S. and close to zero in Germany. On Monday, Oct. 24, the offshore yuan was traded at 6.7859 a dollar.

"The IMF's acknowledgment of the yuan as a freely usable currency enables central banks to count yuan assets as part of their official reserves, rather than just foreign-currency assets," Becky Liu, senior greater China rates strategist at Standard Chartered Plc, said. "The nature of reserves investment is to get exposure to reserve currencies, instead of hedging everything back to the dollar."

In addition to this, some private financial players are also moving into China. Pacific Investment Management Co. may be moving into the country in a year or two, Asia Pacific head Eric Mogelof said.

Earlier this year, the government approved Bridgewater Associates to set up a wholly owned investment-management business in China, the first foreign hedge fund manager to get approval, Shanghai-based consulting firm Z-Ben Advisors, said.

Although delayed by secondary trading, China is bent on opening its $8 trillion bond market. The country's annual trading as a ratio of the total outstanding debt is 1.9, which is lower compared to the U.S. with 4.7, according to calculations made by Bloomberg based on official data.

"There is certainly a lot of work to do, including improving market infrastructure, liquidity and ratings, but the obstacles should be able to be removed soon," Wu Qiong, a Hong Kong-based analyst at BOC International Holdings Ltd, said. "Once China is included in global indexes, it's likely to see very impressive growth of holdings by foreign fund managers."

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