China’s Local Government Bonds Surge in Popularity: New Index and Reforms Drive Investor Interest

Foreign investment in China’s bond market is witnessing a steady increase, yet international exposure to local government bonds (LGBs) remains notably limited. While LGBs represent a significant 28% of China’s bond market by value, they account for less than 1% of foreign holdings. This discrepancy primarily arises from ongoing concerns regarding credit risk, liquidity, and transparency that continue to deter potential investors.

Investment Opportunities in China’s Local Government Bonds

According to recent insights from LSEG, the demand for local government bonds is increasing, despite the challenges they face. While non-residents exhibit greater confidence in Chinese government bonds (CGBs) and policy bank bonds, which are often perceived as more liquid and secure, LGBs have not experienced similar traction.

Current Landscape of Foreign Holdings

As of January 2025, offshore holdings in the Chinese fixed income market are predominantly concentrated in CGBs and policy bank bonds. Together, these two categories constitute the majority of international inflows. The limited appeal of LGBs can be attributed to:

• Higher Credit Risk: LGBs are often viewed as riskier compared to their sovereign or policy-backed counterparts.
• Lower Liquidity: The lack of established benchmarks makes it difficult for institutional investors to assess LGBs effectively.
• Transparency Issues: Investors are hesitant due to the perceived opacity surrounding LGB issuance and management.

Understanding Local Government Bonds

It is important to differentiate LGBs from riskier urban investment bonds issued by local government financing vehicles (LGFVs). While both types of bonds may receive some level of local authority support, only LGBs represent official liabilities that are recorded in national and local budgets and are overseen by the central government.

Government Initiatives to Boost Investor Confidence

The Chinese government is actively working to enhance investor confidence in LGBs through initiatives such as the Hidden Debt Swap Program. Launched in 2024, this program aims to issue RMB 800 billion in new local government special bonds over five years, with RMB 4 trillion designated to replace off-budget hidden debts held by LGFVs. Additionally, RMB 6 trillion in local government debt has been approved for restructuring to promote a more transparent fiscal framework.

Growth of LGB Issuance and Market Activity

In 2024, the total volume of LGBs reached RMB 9.8 trillion, a notable increase from RMB 7.4 trillion in 2022. This rapid growth has stimulated secondary market trading, addressing previous liquidity concerns. Remarkably, the total outstanding value of LGBs has now surpassed that of CGBs, highlighting their increasing importance in China’s financial landscape.

New Benchmarks for Investors

In response to the demand for structured benchmarks, FTSE Russell and the Bank of China have introduced the FTSE BOC China Local Government Bond Index Series. This new initiative offers comprehensive coverage of the LGB market and provides reliable reference points for fund managers and ETF providers.

Conclusion: LGBs as a Viable Investment Option

Overall, the introduction of the index series and ongoing regulatory reforms signal a shifting perception of LGBs as an investable asset class. With improved transparency, attractive yield profiles, and a deepening secondary market, LGBs are progressively becoming a viable fixed income option for global investors.

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