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The Dim Sum Bond Opportunity

December 19, 2011 | About:
China’s floating currency has long been a source of concern among Westernized nations. The yuan’s floatation is not currently pegged to the to the U.S. dollar, which seems to be the international standard. The sale of the first dim sum bond by China Development Bank Corp in July 2007 was a sign to the world of China’s interest in internationalizing the yuan. Through 2010 only Hong Kong and China banks were allowed to issue bonds in yuan. Now banks throughout the world are able to issue them. That recent policy change is a more solid indicator of China’s intentions with relation to its currency.

The popularity of the dim sum bonds is a relief for the Hong Kong economy, whose stock market fell 21% during the third quarter of this year. Exports have declined as well for the first time in two years. Though Hong Kong’s economy is not in a position to boast, there are advantages for foreign companies looking to raise yuan in Hong Kong. The Hong Kong dollar is pegged to the U.S. dollar along with the Federal Reserve’s diminishing interest rates. This provides a bargain for mainland China and remarkably lower borrowing rates, making it advantageous for companies looking to hedge their bets against China’s currency.

With the internationalization process moving forward despite analysts’ predictions, investment in the yuan could well pay off in the long term. For those still wary of FOREX trading, ETFs allow a more acceptable rate of risk. The WisdomTree Dreyfus Chinese Yuan ETF (CYB) offers just such a safe haven. The day to day movement is perhaps more volatile than one would expect from a WisdomTree ETF, but the trending provides the desired stability. The CurrencyShares Chinese Renmimbi Trust (FXCH) is more stable, but its assets are a fraction of CYB’s.

Enthusiasm for dim sum bonds has slowed in recent months, but the market still has some life left yet. Just last month, the largest renmimbi-denominated bond issuance was completed by Chinese state-owned steel maker Baosteel in the amount of Rmb 3.6 billion. For most analysts, the fact that there is a large surplus of renmimbi deposits offshore means that the dim sum bond market will continue to expand.

One reason that China might be looking to hedge foreign exchange risk is the relative weakness of the U.S. dollar. This makes it an opportune time for China to promote the use of the yuan on a global scale. The U.S. and Europe have been pushing for a convertible yuan, though the rapid change might be taking place faster than anticipated. Yuan-based trade is a step in the right direction and dim sum bonds are leading the way.

Even more analysts predict that the Chinese government will not make moves to further internationalize the yuan in the midst of the darkening economic conditions. The analysts do expect the offshore yuan market to continue developing. Even Chinese analysts feel that the current economic conditions, domestic and international, are not suitable for seeking to internationalize the yuan. China’s growth is expected to decline, resulting in the loss of foreign investment at a rapid rate.

Still, with less-than-optimistic predictions, the yuan is pushing forward. At the end of November China opened its currency to direct trading of the yuan against the Australian and Canadian dollars. The new currency pairs will facilitate trade and investment. This latest addition is a significant part of internationalizing the yuan.

The Chinese government is placing pressure on Hong Kong to further develop the year’s offshore market, and offering up assistance as well. China has issued rules governing yuan foreign direct investment on the mainland as of October. This new rule has allowed 16.53 billion yuan to flow into projects with 70% of the funds coming from Hong Kong. The new foreign direct investment policy aims to create more convenience and transparency. Yuan bond issuance is expected to reach 260 to 310 billion yuan in 2010.

Analysts believe that an internationalized yuan could be the most significant economic development since the formation of the euro. The massive increase in renmimbi bonds aligns with the decrease in euro bond issuance. Euro bonds are currently at their lowest level since 2003. This might necessitate a switch away from investing in the euro. The yuan bond market’s growth provides a better opportunity for return.

About the author:

Mary Posey
I am an avid fan of financials and investing. I regularly contribute to Seeking Alpha as well.

Visit Mary Posey's Website


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