FTSE Russell is set to add Chinese government debt to its key indexes, a move that could attract more than $100 billion of foreign capital.

The inclusion will push China’s markets further into the mainstream for international investors—even as investing in Chinese assets becomes increasingly politically controversial in the U.S. amid broader tensions between the two nations over issues from trade and technology to the coronavirus.

The decision means Chinese securities will soon be included in another major market benchmark. That effectively makes them a must-own for many institutions that either passively track an index or aim to beat its performance.

FTSE Russell had already added shares trading in Shanghai and Shenzhen to key stock gauges, as have rivals MSCI and S&P Dow Jones Indices. But it was the last major holdout among bond-index compilers, after inclusions by Bloomberg LP and JPMorgan Chase & Co.

Chinese bonds are set to be added to FTSE Russell’s flagship World Government Bond Index over 12 months starting in October 2021. China’s bond market is the world’s second largest.

Tracking Developments

China’s entry into key bond benchmarks is catalyzing hundreds of billions of dollars of investment from abroad.

Indexes and expected inclusion inflows

Inflows due

to inclusion*

Capital tracking indexes*

Bloomberg Barclays Global Aggregate Bond

FTSE World Government Bond

JP Morgan GBI-EM Global Diversified

Estimates vary on the size of foreign inflows that will be generated by the FTSE Russell inclusion. Morgan Stanley analysts estimate it could produce $60 billion to $90 billion of inflows, while Goldman Sachs say the figure could be as much as $140 billion.

“The Chinese authorities have worked hard to enhance the infrastructure of their government bond market,” said Waqas Samad, chief executive of FTSE Russell and group director of information services for its parent company,

London Stock Exchange Group

PLC.

FTSE Russell said China’s overhauls had included “improving secondary market bond liquidity, enhancing the foreign exchange market structure and developing global settlement and custody processes.” Still, the index provider said it would confirm the start date in March after consulting with advisory committees and index users to verify the overhauls met investors’ needs.

This time last year, FTSE Russell held off on inclusion, saying international investors still had important reservations about investing in Chinese bonds.

Global investors have steadily increased their holdings of Chinese bonds denominated in yuan, as China has made it easier to access the market and as index companies have given their seal of approval.

Foreigners have boosted their holdings for 21 straight months through August, according to official data. Altogether they hold about 2.8 trillion yuan, the equivalent of $413 billion, of Chinese bonds. That is still barely 2.5% of an overall market worth 110 trillion yuan, including central government, local government, financial and corporate bonds.

Various factors make Chinese government bonds attractive to foreign investors, including comparatively high yields and China’s relatively stable currency, said Edmund Goh, investment director for Asian fixed income at Aberdeen Standard Investments.

A 10-year Chinese government bond yields about 3.08%, versus 0.67% for an equivalent U.S. Treasury, according to FactSet.

“We were disappointed FTSE did not include China last year,” Mr. Goh said. He said the market’s large size and the credibility of China’s central bank put the onshore market on par with developed markets for long-term asset allocation, although he said international investors are wary about risks stemming from rising tensions between the U.S. and China.

Those tensions have spilled into investing. In August, an official at the U.S. State Department urged university endowments to divest Chinese stocks and disclose Chinese assets held in their index funds, and earlier this year the Trump administration told a federal retirement plan to avoid Chinese stocks.

Write to Xie Yu at Yu.Xie@wsj.com

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