(Yicai) Aug. 7 -- China will reinstate value-added tax on interest income from newly issued bonds starting tomorrow, ending a decades-long waiver, in a move that is expected to push investors toward older treasury bills, mutual funds, equities, and Hong Kong-listed debt, according to analysts.

China will impose VAT at 6 percent on interest income from treasury bills, local government bonds, and financial institution notes issued after today, the finance ministry said in a surprise notice on Aug. 1. Bonds sold before then will retain the VAT exemption, in place since the 1990s, until maturity.

Financial institutions expect the policy to benefit credit bonds and certificates of deposit. Chinese mainland-based investors may increasingly turn to the Bond Connect scheme to buy notes in Hong Kong, which are unaffected by the new tax rules.

An interest rate analyst at BNP Paribas wrote in a report that some banks are likely to shift capital toward mutual funds, which also remain exempt from both VAT and income tax. The analyst added that policymakers may be using the tax change to encourage flows into stocks and credit bonds.

Wang Qiangsong, head of research at Nanyin Wealth Management, estimated the interest rate gap between new and existing bonds will range from 5 basis points to 10 bps. In the short term, investors are expected to rush to buy older bonds, pushing down their yields slightly.

Over time, however, new bonds are likely to gain traction thanks to stronger upward momentum and more pricing power. Wang expects small yield curve adjustments of up to 5 bps.

A bond trader at a mutual fund provider told Yicai that to stay competitive with tax-exempt older bonds, newly issued 10-year treasury bills may need to offer yields 6 bps to 8 bps higher.

Liu Xin, chief fixed-income investment officer at BlackRock Fund, told Yicai the reinstatement of VAT on bond interest income will prompt investors to compare pricing more carefully across yuan-denominated bonds.

Still, Liu noted that predictable and sustainable tax administration will help lower policy risk and support the internationalization of yuan-denominated assets. While the change is unlikely to alter the overall direction of the bond market, it favors existing bonds in the near term, he added.

BNP Paribas also noted the policy will help boost fiscal revenue. With stable fiscal quotas and bond issuance, VAT collection is expected to bring in about CNY4 billion (USD557.3 million) this year, rising to CNY25 billion (USD3.5 billion) in 2026.

Editor: Emmi Laine