23 August 2019
Invesco's  Ken Hu says China's bond market will immediately be included in many key international bond indices if QFII and RQFII are cancelled. Photo: HKEJ
Invesco's Ken Hu says China's bond market will immediately be included in many key international bond indices if QFII and RQFII are cancelled. Photo: HKEJ

China may abolish investor schemes in SDR push

China may scrap a 13-year-old quota system that controls the amount of capital foreigners are allowed to invest in its onshore market, an investment executive said.

The move is part of efforts to boost Beijing’s chances of inclusion in the special drawing rights (SDR) of the International Monetary Fund (IMF).

“If the Chinese government is keen to enter SDR that much, they may have to make some bold moves,” said Ken Hu, chief investment officer for fixed income, Asia Pacific, of investment management company Invesco.

These include dismantling two foreign investor schemes — one for qualified institutional investors, the other for qualified investors that invest in renminbi.

Hu said the move could enable foreign investors to enter China’s bond and equity markets more freely, helping to meet the “freely usable” condition for the yuan to qualify as an SDR constituent.

SDR is a group of international reserve assets comprising the the US dollar, euro, British pound sterling and Japanese yen. It was created by the IMF in 1969 to supplement the foreign exchange liquidity of its members.

The IMF is set to conduct a five-year review of the reserve currency basket in October.

“If the yuan enters the [SDR] basket, it will mean that big central banks will put renminbi in their reserves. It will then be a big milestone to the internationalization of the yuan,” Hu said.

“China is the world biggest exporter and importer and 30 percent of the trade is settled in renminbi… the Chinese government really wants to speed up foreigners’ use of renminbi for investment purposes.”

China has been encouraging the use of the currency in cross-border trade settlement and investment and promoting it as a global reserve currency.

Still, the yuan has been far less represented in world trade in relation to the size of China’s economy and dominance in global trade.

In December 2013, the renminbi overtook the euro to become the second most used currency in global trade finance after the US dollar.

Launched in 2002, the qualified foreign institutional investor (QFII) scheme allows 267 big banks and financial institutions overseas to use foreign currency in China’s capital market.

As of March, they had used up US$72.1 billion of the US$150 billion quota.

The move to increase foreign access to the onshore market gained impetus with the establishment of the renminbi qualified foreign institutional investor (RQFII) scheme in 2011, enabling yuan held outside of China to be invested in Chinese securities.

Under RQFII, allocations worth 329.8 billion yuan (US$53.1 billion) of the 820 billion yuan quota have been granted to institutional investors in Hong Kong, Singapore, London and seven other markets with a considerable pool of yuan savings.

But Hu said authorities are likely to increase the quota for another investor scheme — a program for domestic institutional investors — to maintain theirs grip on capital outflow.

The Chinese government has been encouraging a certain degree of capital outflow to internationalize the yuan, he said.

Hu said foreign investors account for just 2 percent of China’s US$5.5 trillion bond market, the third largest in the world after the US and Japan.

By comparison, 30-40 percent of the onshore bond market in emerging economies such as Malaysia and Indonesia are held by foreign investors, he said.

“The bond market is No. 3 in the world while the equity market is among the top five. But the two markets are under-invested by foreign investors,” he said.

Hu said China’s bond market will immediately be included in many key international bond indices if QFII and RQFII are cancelled, sending a “very powerful” signal that would attract many international funds.

Easier foreign access to the Chinese onshore market will benefit ongoing economic reform, especially after the finance ministry issued a 1 trillion yuan quota for local governments to convert maturing high-cost debt into lower-yielding municipal notes to be repaid at a future date.

“There is such a big change suddenly. Domestic investors, whether institutional or retail, may not get used to it. The supply is up so much. Where does the demand come from?” he said.

“If the Chinese government can open up the capital account to more foreign investors to buy the bonds, I think many people will be interested. We [Invesco] will be interested,” he said.

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EJ Insight reporter

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