China is planning a return to the dollar-denominated bond market after a hiatus of more than a decade.
The move is puzzling given that market participants say the country doesn’t suffer from a lack of funding. In fact, the country’s own domestic bond market is worth more than $9 trillion, more than twice the size of Germany’s bond market, according to the Bank for International Settlements.
“No way will dollar-denominated bonds become an important part of China’s fixed-income market as far as the Chinese government is concerned,” said Jan Dehn, head of research at the Ashmore Group, an emerging-markets money manager.
Yet the world’s second-largest economy could be using this fledgling sale as part of its steady march to open its financial markets to the world and revamp its underdeveloped financial infrastructure, observers said.
One thesis considered by market participants is that China might be aiming to create a dollar yield curve for Chinese debt issuers. A line that charts the yield across maturities, corporations can use it as a benchmark to gauge the appropriate interest rate when they sell debt. Moreover, such an instrument would allow international investors to compare Chinese bond yields with that of Treasurys and other emerging-market dollar bonds.
“A sovereign yield curve is a piece of financial infrastructure. One of their benefits is that it enables us to have a clear understanding of the spread for Chinese government bonds [against U.S. sovereign debt],” said Dehn.
Though the country’s bond market is one of the world’s largest, it lacks sophistication. Reports suggest Chinese corporations can earn a triple A grade, the highest rung an issue can reach, from local ratings firms with little trouble. Thirty-nine percent of domestic corporate paper is graded AAA, according to Bloomberg,yet only two U.S. companies sport the gold-plated rating
And with the yuan strengthening against the greenback 5.7% year-to-date, Beijing might also feel now is an apt moment to open the door to international investors.
“The timing is ripe [for China] to continue its efforts to liberalize its capital markets,” said Jonathan Shelon, chief operating officer at Kraneshares, which provides exchange-traded funds offering exposure to China’s financial markets.
Foreigners currently own around 2% of China’s debt as the country’s policy makers have shown a reluctance to flog its bonds abroad. Opening up its debt markets has been unpalatable to its financial regulators as it puts the country at risk of so-called “hot money” flows, which can surge and ebb sharply and have played a role in past emerging-market currency crises.
In the past, the country has struggled to prevent money from leaving the country. China’s central bank previously ran down its hefty foreign-exchange reserves significantly to prevent the yuan from weakening after concerns that China’s debt-fueled growth engine was losing steam.
That pressure has abated, with reserves rising for a sixth straight month in August—a situation aided by a broadly weaker dollar DXY, -0.38% But others argue China’s financial regulators remain paranoid that keeping the door ajar for foreign investors could end the currency’s recent stability.
“They are still concerned about the reversal in the U.S. dollar. Most of the improvement has been due to the weak dollar trend and strong administrative measures to direct outward investment“ said Sacha Tihanyi, senior emerging markets strategist for TD Securities.
After domestic regulators cracked down on foreign acquisitions, the river of outflows from China turned into a more manageable trickle. But analysts caution that those interpreting Beijing’s decision to issue a dollar-bond as a sign of a new dawn could be frustrated as the country’s officials have placed an importance on widening the use of the yuan among global investors and its export-focused businesses.
As such, China would rather have foreign investors pick up its yuan-denominated sovereign paper. This could allow it earn the coveted-status of a reserve currency and help mitigate the problem of leaky flows that have given a headache to its central bank, which has been entangled in a battle against foreign-exchange speculators betting on the yuan to depreciate.
“It’s an advantage to issue in one’s currency,” said Dehn.
But as the size of the issuance expected is relatively small, and the thought process of China’s policy makers remains opaque to even seasoned observers, investors are unclear of the ultimate significance of the government’s recent move.
“I don’t think anyone would know [the real reason.] From the Chinese perspective, this could be business as usual,” said Tihanyi.
By Sunny Oh