OREANDA-NEWS. Last week's decision by the People's Bank of China (PBOC) to allow most foreign financial institutions to invest in the domestic interbank bond market without any quotas could ultimately improve domestic market depth and liquidity, market disclosure and corporate funding channels, says Fitch Ratings. That said, the extent to which overseas financial institutions will be willing to invest remains to be seen - given existing capital controls, the macroeconomic outlook on China, and exchange-rate expectations.

In the short term, Fitch does not believe that the PBOC decision will result in a significant influx of foreign participation in the domestic interbank bond market, which accounts for over 90% of China's total domestic bond market. This is especially the case as foreign investor confidence in the direction of the yuan and concerns over the structural slowdown in the economy may weigh on interest. Other issues relating to the level of disclosure and transparency in China's domestic interbank bond market may also deter some foreign investors.

Over the longer run, though, the decision to liberalise foreign access should help to accelerate the development of China's overall domestic bond market - the world's third largest. Only 1.6% of the CNY35trn (USD5trn) of outstanding bonds issued are held by foreign investors. Furthermore, nearly 80% of the domestic bonds are issued by entities supported by government.

Over the much longer-term this could be positive for the Chinese banking sector as risks are shifted away from banks - thereby lowering systemic risks. Chinese commercial banks are currently the dominant participants in the domestic bond market, holding over 60% of total outstanding bonds. A further 6% is owned by insurance companies and 14% by funds. Improving the breadth and depth of China's bond market would ultimately help diversify risks from the banking system to other financial market participants, especially foreign investors. Increased foreign participation may also result in greater demand for international ratings for domestic bonds, with the potential to improve disclosure and transparency.

This latest move by the PBOC follows decisions last year to open access to the domestic interbank bond market to institutional investors - including central banks and sovereign wealth funds - and to allow certain foreign banks access under a pre-set quota.