China bolsters Panda bond diplomacy ahead of IMF yuan decision

[BEIJING] China is expanding the small part of its credit market open to foreign borrowers as it seeks to win global reserve status for its currency.

HSBC Holdings Plc and BOC Hong Kong Holdings Ltd each issued 1 billion yuan (US$158 million) of panda bonds last month, taking the number of foreign issuers of onshore notes in the Chinese currency to just five since the nation first allowed such securities in 2005. The latest sales come just weeks before the International Monetary Fund is expected to decide whether the yuan meets requirements for inclusion among reserve currencies in its Special Drawing Rights basket.

President Xi Jinping is moving to liberalize financial markets to bolster the case that the yuan is freely usable, one of the IMF's requirements. The People's Bank of China in July made it easier for foreign central banks and sovereign wealth funds to invest in the nation's credit market. While overseas issuers still account for only 0.02 per cent of onshore bonds and foreign investors hold only 1.8 per cent of the market, there are signs the steps are paying political dividends. The US softened its stance on the yuan last month and now supports its inclusion in the IMF's basket if it meets existing criteria.

This "is just sending another signal that China is opening up its capital account, which is part of the requirement for the yuan to be included in the SDR basket," said Yang Zhao, China economist at Nomura Holdings Inc. "In the short term, there won't be much real impact on capital flow."

China must balance steps to win greater clout for its currency with efforts to prevent sudden flows of capital into or out of the country. The odds that the yuan will win SDR inclusion next month are more than 70 per cent, according to China International Capital Corp. The currency has already overtaken Japan's yen to become the fourth-most used for global payments.

That's fueling demand for yuan just as a rally in the onshore note market amid central bank rate reductions cuts borrowing costs to five-year lows. The 4.67 per cent average yield on corporate debentures in China is also lower than the 6.46 per cent on offshore yuan notes known as Dim Sum bonds, according to Bank of America Merrill Lynch indexes.

The yuan has fallen 1.9 per cent against the dollar this year after an August devaluation. Further drops would reduce the effective cost to foreign borrowers to service the debt.

"The outlook for yuan depreciation and the PBOC's accommodative monetary policy is encouraging foreign companies to borrow in yuan," said He Xuanlai, a credit research analyst at Commerzbank AG in Singapore. The outstanding amount of panda bonds may rise to the equivalent of US$25 billion in three years from US$1.5 billion currently, He said.

The market could top $50 billion in the next five years, according to the World Bank's International Finance Corp. The IFC plans to sell yuan-denominated bonds as soon as this year after opening the panda securities market in 2005, said Hua Jingdong, vice president and treasurer, in an interview in Lima on Oct 9. "Once the Chinese yuan becomes part of the SDR, central-bank reserve managers and institutional investors will automatically want to accumulate yuan-denominated assets," Mr Hua said.

HSBC sold its panda securities due in three years at 3.5 per cent, and will use the funds to support business outside China. "China's onshore market offers enormous potential, and the opening up of the market presents a significant opportunity for both international issuers and Chinese investors," said Alexi Chan, global co-head of debt capital markets at the bank.

BOC Hong Kong also sold its three-year onshore yuan debentures at 3.5 per cent, and said it will use the proceeds offshore. "Within the coming one to two years, the lower onshore funding costs will spur more panda bond sales by foreign financial institutions," said Winston Ye, head of overseas business development at the lender.

Standard Chartered Plc's Hong Kong branch said on Sept 24 it had applied for 1 billion yuan of onshore bond sales. Singaporean lender Oversea-Chinese Banking Corp may issue panda notes based on market conditions and funding needs, said Ang Suat Ching, head of funding and capital management.

"Many international commercial banks have expressed substantial interest in panda bonds," said Zhang Jiameng, senior analyst at China Chengxin International Credit Rating. "It's a milestone for the internationalization of China's bond market."

BLOOMBERG