Why do smart people do obviously ‘irrational’ things? It must be the incentive structure, so for them they do not seem irrational. So, I am wrecking my brain over China’s decision to issue EUR-denominated bonds (and a few weeks ago USD-denominated ones), in light of its goal of CNY and CGBs internationalization, 40-50bps over the CGB curve (swapped in EUR).
The rationale China is putting forward is that enables it to diversify its investor base on the back of the trade tensions! Seriously? Do they really mean that or are they getting a really bad advice? Wasn’t the intention to actually go the other way as a result of the trade war? Didn’t China want to be become more self-reliant? In any case, China does not need foreign currency funding given its large, positive NIIP. China has the opposite problem. It has too much idle domestic savings and not enough domestic financial assets. This, among other things, creates a huge incentive for capital flight which, despite its closed capital account, China is desperately trying to prevent.
In that sense, China does need foreign investor but to invest in CGBs (and other local, CNY-denominated bonds) to act as a buffer to the potential domestic capital outflow as the capital accounts gates slowly open up. It is for this reason that BBGAI and JPM have started including CGBs into their indices this year.
It is for this reason SAFE decided to scrap the quota restrictions on both QFII and RQFII in September. It is for this reason that Euroclear signed a memorandum of understanding with the China Central Depository & Clearing to provide cross-border services to further support the evolution of CIBM. That opens up the path for Chinese bonds to be used as collateral in international markets (eventually to become euro-clearable), even as part of banks’ HQLA.
All these efforts are done to make access to the local fixed income market easier for foreign investors. And now, what does China do after? Ahh, you don’t need to go through all this, here is a China government bond in EUR, 50bps cheaper (than if you go through the hassle of opening a Bond Connect account and hedging your CNY back in EUR).
This not only goes against China’s own goals regarding financial market liberalization but also against the recent trend of other (EM) markets preferring to issue in domestic currency than in hard currency. And while other EMs may not have had the choice to issue in hard currency from time to time, China does. And while the investor base for other EMs between the domestic and the hard currency market is indeed different, and the markets are very distinctive, China does not have much of an international investor base. Issuing in the hard currency market may indeed ‘crowd out’ the domestic market. Especially when you come offering gifts of 50bps in a negative interest rate environment.