Fixed income
China’s evolving fixed income landscape – a new phase for onshore bonds?
5 min read 14 Apr 25
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The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.
The China onshore bond market, the second-largest globally, has grown to USD$24.1 trillion as at December 2024[1]. Historically, foreign investors have focused on China government and policy bank bonds due to considerations around access and liquidity. However, this dynamic has evolved as authorities have accelerated efforts to open the market. In addition to the Qualified Foreign Investor (QFI) scheme, foreign investors now have greater access through the China Interbank Bond Market Direct and the Bond Connect Scheme, which are free from quota restrictions and provide more flexibility for capital repatriation.
Other developments, including China’s inclusion in global indices, streamlined trading and registration procedures, and increased access to hedging tools have helped to further integrate China’s bond market into global fixed income portfolios. These structural improvements have led to a surge in foreign ownership of domestic bonds, which has doubled since 2019. However, foreign participation remains relatively low, at just 2.7%1 of the total bond market as of December 2024, leaving room for further growth.
“The China onshore bond market’s low correlation with global fixed income markets and relatively stable risk-return profile continue to make it an attractive diversification tool for international investors.”
Potential greater foreign participation
Given this modest level of foreign participation, there is significant room for growth. The China onshore bond market’s low correlation with global fixed income markets and relatively stable risk-return profile continue to make it an attractive diversification tool for international investors. Furthermore, as China continues its currency internationalisation efforts, global demand for CNY-denominated assets is expected to rise.
Examining the long-term performance of the China onshore bond market – represented by the Bloomberg China Aggregate Index – we see a pattern of stable upward movement in both local currency and USD terms. The CNY has exhibited lower volatility compared to major currencies, reflecting China’s managed exchange rate regime. This has historically provided a level of insulation from sharp swings in global interest rates, making China’s bonds a useful counterbalance in multi-asset portfolios.
In contrast, the Bloomberg Global Aggregate Index has shown more pronounced fluctuations, with bonds from developed markets experiencing greater performance divergence amid shifting monetary policies. This divergence reinforces the case for China’s bond market as a long-term diversification opportunity.
Attractive yield opportunities in credit markets
With China’s onshore bond yields now at record lows, the non-government credit segment is increasingly viewed as a more compelling opportunity. While interest rates are expected to remain low amid muted inflationary pressures, the credit market offers a meaningful yield premium over government and policy bank bonds.
A significant share of China’s credit market is dominated by state-owned enterprises (SOEs) and Local Government Financing Vehicles (LGFVs). LGFVs, in particular, play a central role in financing regional infrastructure and public welfare projects-spanning sectors such as utilities, industrial development, and transport. Their strategic importance has made them a core part of the onshore credit market.
Despite concerns over local government debt levels, certain LGFVs continue to present attractive opportunities, particularly those with strong government backing and access to onshore liquidity. Meanwhile, financial issuers-including banks and insurance companies-remain key players in China’s onshore credit market. Given the higher cost of financing offshore and strong domestic demand for credit issuance, the growth of China’s onshore credit market is expected to continue, providing a broadening opportunity set for investors.
ESG in the China bond market
China has set ambitious climate goals, aiming to peak carbon emissions before 2030 and achieve carbon neutrality by 2060-a transition that will require substantial financing through the bond market. To support this, the issuance of green, social, sustainability-linked, and transition (‘ESG-labelled’) bonds has surged.
Authorities have worked to align China’s green bond classification system with international standards, making these instruments more attractive to foreign investors. New regulations have also been introduced to enhance transparency, improve reporting requirements, and reduce concerns around ‘greenwashing’.
As of September 2024, China’s outstanding ESG-labelled bond market stands at $356 billion, making it one of the largest globally. While industrials, utilities, and financial issuers have traditionally led the market, LGFVs are also becoming active issuers of green debt to finance policy-driven infrastructure projects. These include projects focused on renewable energy, sustainable transport, and climate adaptation measures in urban areas.
Beyond ESG-labelled bonds, many Chinese issuers contribute positively to environmental and social goals through their core businesses. Examples include urban metro and railway projects, which improve infrastructure efficiency and reduce congestion in major cities. Additionally, financial institutions providing inclusive financing to underserved communities and local government-backed social housing initiatives represent opportunities for investors looking beyond traditional ESG-labelled issuance.
Despite growing investor demand for ESG investments, selectivity remains critical. The LGFV segment, for example, stands to benefit from government-led debt restructuring initiatives, including the recently announced local government debt-swap programme. However, careful credit analysis is required to assess long-term viability and sovereign support levels.
Embracing change
As China undergoes economic restructuring, shifts in domestic consumption patterns, industrial policy, and financial regulation are reshaping the operating landscape for bond issuers. Investors should monitor these changes closely, as they impact credit risk, refinancing conditions, and sectoral investment opportunities.
Much has been written about the technology rivalry between the US and China, with trade restrictions affecting China’s access to advanced semiconductor technology. However, Chinese firms continue to expand their global reach, particularly in areas such as artificial intelligence, renewable energy technology, and high-end manufacturing.
“Chinese firms continue to expand their global reach, particularly in areas such as artificial intelligence, renewable energy technology, and high-end manufacturing.”
Over the past decade, China’s manufacturers have significantly upgraded their technological capabilities, enhancing global competitiveness in key industries. This shift has supported increased high-tech exports, despite geopolitical headwinds. As these changes unfold, bond investors must remain adaptable, identifying sectors and issuers that are well-positioned for long-term resilience.
The role of policy support
While China’s headline economic indicators point to more moderate growth relative to the past decade, these figures do not fully capture the structural shift from investment-led to consumption-driven expansion.
Recent policy meetings have reinforced the government’s commitment to stimulating domestic demand, including expanding the consumer goods trade-in programme and enhancing the social safety net, such as increasing pension payments. With household consumption as a percentage of GDP still below that of many developed and emerging economies, there is room for further growth in domestic spending as a key driver of economic stability.
As China’s economy continues to transform, so too does its domestic bond market. Structural reforms, improved market accessibility, and shifting investor preferences are shaping the opportunity set for global investors. While challenges remain, those who take a long-term approach and remain selective in their positioning may find compelling investment opportunities in China’s evolving fixed income landscape.
1Source: Wind, M&G Investments, December 2024
This article was first published, in Chinese, in the Hong Kong Economic Journal.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.
The content of this page reflects M&G’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. All information included in this page has been written for informational and educational purposes only and does not constitute an offer or solicitation to invest into any security, strategy or investment product. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G does not accept liability for the accuracy of the content.