Unlocking the potential investment opportunities in China's local government bonds 

Over recent years, China’s bond market has gradually been opening up, providing foreign investors with greater access to what is now the world’s second-largest bond market^[1]. While foreign participation in the Chinese fixed income market has been growing, non-residents’ investments remain predominantly concentrated in certain bond types, such as Chinese government bonds (CGBs) and policy bank bonds^[2]: approximately 60% of the offshore funds invested in Chinese bonds are allocated to these two categories, which are generally considered by international investors as safer, more liquid and easier to access than other Chinese fixed income sectors.

Foreign investors’ holdings of onshore Chinese bonds reflect a similar pattern: as at January 2025, about half of these holdings were in CGBs, followed by 26% in negotiable certificates of deposit and 20% in policy bank bonds. 

In contrast, local government bonds (LGBs) currently account for less than 1% of total foreign holdings, despite the fact that LGBs represent the largest segment (28%) of China’s fixed income market in terms of outstanding value. The limited foreign investor demand for LGBs is driven by concerns over credit risk, liquidity and transparency, which continue to hinder broader international participation.

From a credit risk perspective, LGBs are perceived to carry slightly more risk than CGBs and policy bank bonds. Some investors remain cautious about the fiscal health and repayment capacity of China’s local governments. Liquidity constraints are another factor, as LGBs’ market depth and trading volume have yet to match those of CGBs, making them less attractive to investors who require higher liquidity. Additionally, the lack of standardised investment tools poses a challenge: for example, there are fewer benchmarks for LGBs, making it difficult for investors to evaluate these bonds’ performance and to incorporate them into asset allocation models.

Market concerns regarding China’s local government debt largely stem from a slowing real estate sector, declining land revenues and challenges faced by local government financing vehicles (LGFVs). However, it is important to distinguish between LGBs and urban investment bonds issued by LGFVs, as they carry different levels of risk and government backing.

LGBs are issued directly by provincial and municipal governments, such as those in Jiangsu, Guangdong and Shandong, under central government oversight. These bonds represent explicit liabilities of local governments and are formally incorporated into both central and local government budgets, with annual issuance quotas approved by the National People’s congress. 

By contrast, urban investment bonds are issued by LGFVs at the provincial and municipal levels. As at end-February 2025, according to LSEG data, these bonds had an average option-adjusted spread (OAS) of 98 bps, significantly higher than the 20 bps for LGBs. While LGFVs often receive strong local government support, their debts are not considered direct government obligations. 

This distinction means that although LGFVs may have implicit backing, local governments are not legally required to repay their debts. As a result, LGBs have historically shown a stronger credit track record, with market concerns focusing more on the fiscal sustainability of certain regions rather than systemic credit risks.

Source: FTSE Russell. Data as of 28 February 2025. Par amount and market value are in CNY billions. Past performance is no guarantee of future results.

To reduce the uncertainties associated with local government finance and to enhance market confidence, the Chinese government has introduced a series of measures aimed at improving transparency and strengthening debt management.

Debt Restructuring Initiative: Since 2024, the central government has been implementing a multi-year debt restructuring initiative, known as the ‘Hidden Debt Swap Program’. Under this program, RMB 800 billion in new local government special bonds will be issued annually for five years, with a total of RMB 4 trillion earmarked to replace off-budget hidden debt held by LGFVs. Additionally, RMB 6 trillion in local government debt has been approved for restructuring, bringing liabilities under a more transparent fiscal framework. While these measures aim to alleviate financial pressure on local governments, their long-term effectiveness remains a key area of focus for the market.

Issuance Expansion and Liquidity Boost: China’s local government bond market has been expanding steadily. As of end of February 2025, the outstanding face value of LGBs reached RMB 48.1 trillion, accounting for 32.1% of the total onshore Chinese bond market, surpassing the RMB 34.9 trillion face value of Chinese government bonds and RMB 26 trillion of Chinese policy bank bonds. The annual issuance volume of LGBs has increased from RMB 7.4 trillion in 2022 to RMB 9.8 trillion in 2024, a rise of 32.4%. Increasing issuance volumes have also contributed to a more active secondary market and improved liquidity.

Yield and Duration: On average, LGBs offer higher yields than CGBs, making them attractive to investors seeking enhanced returns. As of February 2025, the average yield on 10-year LGBs was 20-30 bps higher than that of comparable CGBs, primarily reflecting differences in credit risk and liquidity. LGBs also provide a longer duration (an average of 9 years, compared to 6.1 years for CGBs). This longer duration may address the investment needs of institutions such as life insurance firms and pension funds. For investors looking to optimise their Chinese fixed income exposure, LGBs therefore present an alternative worth considering. 

In summary, increasing issuance, policy support and an improving market infrastructure are gradually transforming the investment environment for LGBs. As a result, investors’ interest in this asset class is growing.

Source: FTSE Russell. Data as of 28 February 2025. Past performance is no guarantee of future results.

In view of the growing importance of LGBs in China’s bond market, there is an increasing need for standardised investment tools. To address this, FTSE Russell and Bank of China have introduced the FTSE BOC China Local Government Bond Index Series, providing a transparent and systematic benchmark to help institutional investors evaluate the market’s performance and risk/return characteristics. The key features of the index series include:

• Comprehensive market coverage – The index series reflects the overall trends in China’s local government bond (LGBs) market, providing a reliable investment benchmark.
• Attractive yield and risk profile – It offers a quasi-government fixed income allocation option in the Chinese market, but with a higher credit spread than CGBs.
• Longer Duration – It provides an average duration of 9 years, compared to 6.1 years for CGBs and 4.7 years for policy bank bonds, making LGBs suitable for long-term investors such as life insurance and pension funds.
• Enhanced liquidity – It serves as a benchmark for ETFs and active/passive funds, with a minimum amount outstanding of RMB 10 billion for individual issues. Coordination in index design between FTSE Russell and our partner Bank of China also supports improved liquidity conditions.
• Diverse index offerings – The index series includes short-term, medium-term, long-term and composite indices, enabling investors to select the most suitable benchmark based on their investment objectives.

This index series provides market participants with a clear and measurable reference point, allowing institutional investors to incorporate LGBs into their portfolios more effectively.

Source: FTSE Russell. Data as of 28 February 2025. Past performance is no guarantee of future results.

As China continues to enhance the transparency and marketability of the LGB sector, the investment environment for these bonds is evolving. Recent policy measures aim to address investors’ concerns over local governments’ fiscal management, improving the overall investability of LGBs.

With China’s bond market opening further, the potential for LGB investments continues to grow. The newly introduced FTSE BOC China Local Government Bond Index Series offers investors a comprehensive set of benchmarks for their LGB holdings, supporting the development of ETFs and fixed income funds centred around this expanding asset class. 

1. See China is now the second-largest FTSE WGBI market | LSEG

2. Policy bank bonds in China are issued by three main state-owned policy banks - the China Development Bank, the Agricultural Development Bank of China and the Export-Import Bank of China.