China rushes into Korean bond market

By Kim Da-ye

Korean policymakers are keeping a close watch on China’s aggressive purchase of local bonds and stocks over the past months, as the buying spree has been much faster and greater than widely anticipated.

The government understands that the move is part of the Chinese government’s efforts to diversify its investment portfolio of its ample foreign currency holdings amid growing uncertainties over the U.S. dollar but it is concerned that Korea can face unwanted side effects.

According to the Financial Supervisory Service (FSS), China has more than doubled its holdings of Korean Treasury bonds in the past six months.

China’s holdings of Korea Treasuries stood at 3.9 trillion won ($3.3 billion) as of late June, up more than 100 percent from 1.8 trillion won recorded at the end of the last year.

The world’s second largest economy has also become the third largest investor in Korean bonds ― not just Treasury securities ― purchasing a net 2.45 trillion won’s worth between January and July this year, compared with 4.32 trillion won in bonds purchased by Luxembourg and 2.76 trillion won by the U.S. Net investment is purchase minus sales and redemption on maturity.

At the end of July, the total amount of Korean bonds foreign investors held stood at 71.91 trillion won, 4.35 trillion won ― or about 6 percent ― of which was owned by Chinese entities.

Market analysts said that China’s buying spree is likely to do more harm than good to Asia’s fourth largest economy in the long term. They point out that it can boost the local market in the short term but it can distort the market mechanism at the same time, putting monetary policies at risk.

With China buying more than a net 300 billion won of Korean Treasury securities on average ― mostly long-term bonds including three-year or five-year Treasuries ― every month, the higher demand for them has hiked the prices and sent yields down.
With demand for long-term debts being robust, there is a desire among institutional investors including insurance firms and asset management companies to purchase before others do.

As of Aug. 20, the 5-year Treasury bond was down 0.11 percentage points to yield 4.13 percent ― the lowest figure since April 2009. The 10-year bond was also 0.09 percentage points down to 4.55 percent while the 20-year bond was 0.08 percentage points down at 4.66 percent. Bond prices move inversely to yields.

The yields, in fact, should rise now because the market expects the central bank to hike the key interest rake in September. The Bank of Korea (BOK) had increased its policy rate by 0.25 percentage points to 2.25 percent in July after freezing the rate for 16 months. It kept the key rate untouched at 2.25 percent in August, but hinted at the possibility of a rate increase in the next month.

On such expectations, the market interest rates rise in advance and the Treasury security prices drop. But as foreigners, especially Chinese investors, are aggressively purchasing them and domestic investors join the trend, the yields are dropping.

Such a phenomenon raises concerns that when the BOK wields its monetary policy tool, it may not be as effective as it should be.
Local news agency Yonhap reported that Chinese investors are expanding their investment in Korea outside the boundary of the government bonds. Yonhap quoted a report by Qualified Domestic Institutional Investor (QDII) that the portion of the QDII fund invested in Korea rose to a record 4.5 percent. QDII is an arrangement set up to allow financial institutions to invest in foreign markets.
Domestic firms whose shares have been bought by Chinese asset management firms through the QDII include Hankook Tire, Samsung Fire & Marine Insurance and Shinhan Financial Group, Yonhap reported.

China diversifies portfolio

Though Chinese investors or institutions that purchase foreign debts are unknown, it is generally understood that the State Administration of Foreign Exchange (SAFE), which operates under the influence of China’s central bank, is the major force, judging by the size and nature of the investment.

Many media and experts claim that the SAFE, which traditionally held relatively safe securities such as U.S. treasury bonds, is gradually moving away from investing in the U.S. and is diversifying foreign currencies it purchases, especially those from Asian countries.

China is the largest foreign holder of U.S. treasury securities, keeping a reserve of $843.7 billion as of June 2010, according to the U.S. Department of The Treasury. The holdings had decreased from $900.2 billion in April to $867.7 in May. SAFE isn’t the only Chinese investor in U.S. treasury securities, and some remain skeptical if China is investing less in the U.S.

Meanwhile, it isn’t surprising to see Korea emerging as the right choice for China. For its healthy growth outlook and low debt levels, Pacific Investment Management Co. (PIMCO), the world’s biggest bond fund, said in June that it favors Brazil, Mexico, Poland, Russia and South Korea for investment. European bonds, which could have been good alternatives for China, lost much of their charm because of the recent debt crisis originating from southern Europe.

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