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Starting tomorrow, China will begin collecting value-added tax on interest income from newly issued bonds, ending a long-standing exemption that has been in place since the 1990s. This change is expected to steer investor focus toward older treasury bonds, stocks, mutual funds, and debt listed in Hong Kong.
A recent notice from the finance ministry indicated that VAT will now be applied to interest earned from new central and local government bonds, as well as bonds issued by financial institutions. Bonds issued before the policy change will remain exempt from VAT.
Market analysts believe this move will benefit credit bonds and certificates of deposit. Domestic investors might increasingly turn to the southbound Bond Connect to purchase Hong Kong bonds, which aren’t affected by the new tax rules.
An interest rate analyst from BNP Paribas explained that some banks may shift their investments toward mutual funds, which continue to be free from both VAT and income tax. The analysts suggest that policymakers might be using this tax adjustment to encourage investments in equities and credit bonds.
An industry expert at Nanyin Wealth Management estimates the yield gap between new and existing bonds will be around 5 to 10 basis points. In the near term, investors are likely to flock toward older bonds, which could slightly lower their yields.
Over time, however, new bonds are expected to become more attractive due to increasing momentum and pricing power. The expert foresees minor adjustments in the yield curve, possibly up to five basis points.
A bond trader from a mutual fund company noted that to compete with tax-exempt older bonds, newly issued 10-year treasury bonds may need to offer yields 6 to 8 basis points higher.
Liu Xin, the chief fixed-income investment officer at BlackRock, commented that the tax resumption will encourage investors to compare bond prices more carefully, especially in yuan-denominated assets.
He also pointed out that well-planned and predictable tax policies will reduce policy risks and promote the international use of yuan bonds. While this change probably won’t significantly alter the overall bond market direction, it is likely to favor existing bonds in the short term.
Additionally, BNP Paribas mentioned that this policy could help increase government revenue. With stable fiscal budgets and bond issuance, VAT collection is projected to generate around 4 billion yuan (approximately $557 million) in 2023, increasing to 25 billion yuan ($3.5 billion) by 2026.
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