China seeks antidote for outflows by allowing more overseas debt

[BEIJING] China is seeking an antidote for the capital outflows that are weakening the yuan by making it easier for companies to borrow abroad and bring money back into the country. It may be swimming against the tide.

The National Development and Reform Commission will remove a quota system for companies to issue certain international bonds and loans and require only registration rather than applications for such borrowing, it said Wednesday. Whether issuers will respond is up for question. Dollar-denominated bond sales from the nation's firms have dropped 17 percent this year after central bank interest rate cuts and the yuan devaluation last month made financing onshore more appealing.

The NDRC's latest move is consistent with efforts to offset outflows that have weakened the yuan 2.5 per cent this year, including opening up the local stock and bond markets to global investors. The trouble is that much of the money leaving the world's second-largest economy is an unwinding of previous dollar liabilities due to a depreciating Chinese currency and rising US interest rates.

"Whether this will work eventually depends on individual companies," said Tommy Xie, an economist at Oversea-Chinese Banking Corp in Singapore. "The rising currency volatility and narrowing interest rate differential make offshore debt less appealing now." Daiwa Capital Markets forecasts the yuan could slide as much as 15 per cent by the end of 2016. Chinese companies that borrowed in foreign currency at a record pace in the past three years are buying dollars to protect against losses, according to Kevin Lai, chief economist Asia ex-Japan. In reports as early as March 2014, Daiwa outlined how fake export invoicing, metals purchases and disguised foreign investment had driven US$1 trillion of hot money inflows.

Even if the rule change does get some offshore funds onshore in the short term as companies repatriate overseas financing, it also poses new risks, according to Raymond Yeung, an economist at Australia & New Zealand Banking Group Ltd. "In the long term, the capital will flow out to repay the debt." The extra cost to Chinese companies of issuing onshore yuan notes compared with offshore securities has dropped to 3 basis points from 53 basis points at the start of the quarter, according to indexes compiled by Bank of America Merrill Lynch. The average yield on local notes is now 4.69 per cent compared with 4.66 per cent on overseas debentures. Total issuance of onshore yuan corporate bonds has jumped 21 percent this year to 5.02 trillion yuan (S$1.1 trillion).

The Aug 11 yuan devaluation has left Chinese firms more cautious about overseas financing, as the drop in the currency pushes up servicing costs on foreign debt.

"Probably not many Chinese companies would be interested in offshore bond sales even after the rule change," said Xu Hanfei, a bond analyst at Guotai Junan Securities Co in Shanghai.

The tweaks come amid mounting speculation China will do more to counter outflows. The country's foreign-exchange reserves tumbled an unprecedented US$93.9 billion last month as the central bank intervened to keep the devaluation from leading to sharper slides.

The Federal Reserve's "pending policy normalisation" and the dollar's strength mean there may not be "many silver linings left for China to count on," according to the Daiwa report. The brokerage now predicts the yuan will drop to 7.50 yuan per dollar by the end of next year. The currency closed Wednesday about 6.37.

China is also using the policy change to fulfill vows to liberalise its capital account as it tries to meet requirements for the yuan to be used as an international reserve currency, according to Nomura Holdings Inc.

"It's good timing to do it now because the move will have minimal shock to the economy," said Zhao Yang, the chief China economist at Nomura in Hong Kong. "This is consistent with other recent measures to open up the capital account such as the Hong Kong-Shanghai stock connect and measures to allow foreign central banks to invest in China's interbank bond market."

BLOOMBERG