Tuuli McCully (Aalto University) - The Drivers of Portfolio Flows into Chinese Debt Securities Amidst China’s Bond Market Development

This essay studies China’s bond market development by reviewing the main characteristics of the onshore market and important liberalization steps. It also describes recent trends in debt portfolio investment flows into China by non-resident investors. The simple theoretical framework for push and pull factors functions as a starting point for the empirical analysis on the drivers of China’s bond flows. Both static and time-varying models are estimated to help explain the importance of various push and pull factors in the Chinese bond market context. The findings point to China’s continued bond market deepening and integration with the rest of the world. China-specific pull factors, such as economic growth prospects, still play a very important role in driving non-resident portfolio investments into the country, likely reflecting the fact that the Chinese onshore bond market is still relatively isolated. Simultaneously, global push factors also play a part in driving investment into Chinese bonds, yet the results suggest that their significance is a rather recent phenomenon. Rolling RLS estimations show that there is substantial time variation in the importance of push and pull factors. Indeed, global risk aversion and US interest rates have become more significant debt flow drivers particularly since the launch of the Northbound Bond Connect in mid-2017 and the inclusion of Chinese bonds to certain global benchmark indices over the past couple of years.

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