China’s ageing population may become a problem for the world’s second largest economy but it could help transform the USD13 trillion bond market into an international asset class.
To understand why, it's important to look at the relationship between demography, saving and a nation's balance of payments position.
In China, the proportion of the people of working age – those aged between 15 and 64 – peaked about a decade ago at 64 per cent and will decline to 52 per cent by 2030, according to UN projections.
As the population grows older, its overall spending increases – mainly on health care and retirement. Indeed, pension expenditures have been growing at a faster annual rate than pension revenue since 2012.
And the median annual shortfall in China’s pension gap is expected to reach RMB1.41 trillion in 2050 from the current RMB50 billion1.
To plug that gap, the country will need to draw in its savings; they are expected to fall below 40 per cent of GDP by 2030 from a peak of 46 per cent.
This, combined with an increase in the country's spending, mean it is only a matter of time before China finds itself running a current account deficit – consuming more than it produces.
That will be an important development for China's debt market.
For when that happens the country will have to finance that deficit by borrowing more from abroad. In other words, it will turn from an exporter of capital to an importer.
Aware of this looming change, Beijing has been implementing a series of measures designed to liberalise capital markets and attract overseas investment.
And crucial to these reforms is the opening up of China’s onshore bond market.
Moves by global index providers to incorporate Chinese bonds in their mainstream benchmarks create a binding need for investors to include the asset class.
Since the 2017 launch of the “Bond Connect” programme which allows foreign investors to trade in Hong Kong without onshore accounts, Chinese authorities have also introduced the “Delivery versus Payment” settlement feature that has significantly reduced settlement risks.
Beijing has also given foreign institutional investors a three-year tax exemption on bond interest until November 2021. Furthermore, the People’s Bank of China plans to relax rules on repo and other derivatives trading for foreign investors.
These steps, along with additional proposed measures to open up the market, will ensure that RMB bonds become a bigger feature of international portfolios.
Foreign ownership of such bonds rose to a record USD271 billion in the first quarter from USD160 billion at end-2018. This was partly in anticipation of moves by global index providers to incorporate Chinese bonds in their mainstream international bond benchmarks.
The Bloomberg-Barclays’ Global Aggregate bond index began featuring Chinese RMB bonds in April, a move that should encourage other providers to follow suit. All in all, China’s index inclusion is likely to generate inflows of almost USD300 billion in the coming years.
International investors currently hold just under 3 per cent of the asset class, but the Peoples Bank Of China (PBOC) expects this figure to more than triple to 10-15 per cent over the next decade.