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Dim Sum Bonds – A Tool For Investing In Yuan

Posted in Finance Articles, Total Reads: 3520 , Published on April 01, 2012

Sometime back RBI allowed Indian firms to invest up to $100 crorefrom their External Commercial Borrowings (ECB) into dim Sum Bonds. These are bonds denominated in the Chinese Yuan and are issued in Hong Kong.Dim sum bonds are attractive to foreign investors who desire investments in Yuan-denominated assets, but are restricted by China's capital control policies from investing in Chinese debt.These investments, which get their nickname from a popular Chinese delicacy, are bonds, denominated in Yuan and issued in Hong Kong. Majority of the issuers are Chinese government bodies, banks and corporations, but foreign firms including U.S. fast food giant McDonald’s Corp. and construction equipment maker Caterpillar Inc. have also raised money through dim sum bonds to fund expansion in China.

Dim Sum Bonds

Current Dim Sum Market

Dim Sum bond was first launched by China Development Bank Corp. in July 2007. It signalled China’s intentions of promoting its currency in global trade and investment through yuan-denominated bonds. Till July 2010, only Chinese and Hong Kong banks were allowed to issue these bonds, but now all banks can do the same.Dim Sum bonds sales rose from the penultimate quarter of 2010 following a decision by the Hong Kong Monetary Authority to give companies greater freedom to sell these bonds. At the same time, it became easier for corporations to settle trades in Chinese currency.

With Hong Kong’s currency pegged to the US dollar and its close to zero interest rates , the colony offers huge bargains for Chinese visitors as well as low borrowing costs that are lower than China’s, which were set at 6.56 percent in July.“That gives an incentive to foreign companies with operations in China to raise Yuan in Hong Kong”, says Augusto King, co- head of debt capital markets for Asia at Royal Bank of Scotland Group Plc in Hong Kong.

The raising of Yuan by McDonalds and Caterpillar are a proof of this statement.

These bonds are still in a nascent stage, with only around 1% of the total bonds issued being subscribed till October 2010. But its demand isexpected to grow gradually with time for some obvious reasons:

  • The Yuan has been the best performing Asian currency this year. It has rallied against the dollar, outperforming rupee which has plunged substantially against the Reserve currency

 Rising Yuan

  • In these days of financial turmoil, state-backed bonds are bound to be in demand for their risk-free return
  • Equities come with a risk, so if they lose steam, investors are inclined towards safe assets like government bonds.
  • Unlike other economies, China’s growth rate and inflation are healthy at 9.1 and 6.2% respectively. And these bonds augur well for the investors who believe China will let Yuan rise.
  • Credit Rating Agencies are rating these bonds positively, which is helping in bringing investments from the west.

The dim-sum bond market has seen a sudden spurt in the volume, with about 170 billion Yuan worth of bonds sold in first 8 months of this year. By comparison, only 35.7 billion Yuan of dim-sum bonds were sold last year and only 16 billion yuan of these bonds were sold in 2009.

Investors from Europe picked up about 14 per cent of a recent issue, while Chinese investors bought about 76 per cent and the rest was bought by Singapore buyers, signalling increased diversification of demand.

The Biggest Incentive to invest in these bonds is the distinct possibility of Yuan rising against the dollar. To spur exports, china has always maintained a low Yuan.  U.S. has pressurised China into increasing Yuan’s value over the last couple of years. But china’s huge trade surplus clearly shows remnibi is still significantly undervalued.

“We are very bullish on the Chinese Yuan as a currency,” said Tyler Mordy, director of research at Toronto-based Hahn Investment Stewards & Co. “We think that is a good bet to make, particularly now, as the Americans have renewed political strife by branding China as a currency manipulator and threatening to impose trade sanctions.”

“It’s probably the fastest-growing market I’ve seen in my career,” says Tee Choon Hong, a 20-year banking veteran now at Standard Chartered Plc. (STAN)

Dim Sum bonds were issued in Hong Kong by 36 banks as of 14th November this year. The number was at 14 till last year.

Downfalls of Dim Sum Bonds

Although China is being pressurised by major economies for letting the Yuan to float, it is very unlikely that China will change its stance substantially.

In a recent global sell-off global investors went back to the dollar assets, selling off other assets, which included Dim Sum Bonds, reinstating the fact that dollar is still seen as a safe bet and other investments will take time to mature.

Investors are cautious about these bonds right now, because of the small market size of only around $30 billion. Because of this limited supply of bonds and a great demand, the yields are very low at around 1-2%.These rates are easily outperformed by other emerging market bonds.

China’s export might take a hit in this global turmoil, resulting in lowering of currency, which will affect the performance of these bonds.

Being a very nascent market, it’s not very highly regulated.Businesses without credit rating or very low ratings also rushed to the market. Majority of them lacked the proper documentation needed to protect investors that are commonly seen in developed markets like the U.S.

Future of Dim Sum

As discussed, the main incentive of investing in these bonds is the possibility of Yuan rising. With Current Chinese Economy looking healthy and growing, Dim sum bonds do have a bright prospect.

But to go a long way, regulations are to be brought in the market to protect investors and nurture belief towards the bonds. It is unlikely that China will allow Yuan to appreciate substantially. This will weigh on the minds of the investors.

Still, dim sum bonds are expected to be a major investment in the coming years, as it is the only way for foreign investors to invest in the Chinese Bond market.

“Yuan internationalization will be one of the most important episodes of Hong Kong’s history in the next 20 years,” Song says, inevitably serving up a culinary metaphor. “With more issuers tapping the market, Dim Sum bonds will become big meals for many.”

This article has been authored by Ankit Johri, MBA Capital Markets, NMIMS Mumbai.

Image: Keattikorn / FreeDigitalPhotos.net

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