Yuan Hong Kong Premium Widens on Supply Limits, Bond Sales: China Credit

The premium investors pay to obtain yuan in Hong Kong’s offshore market is widening, after shrinking to zero last month, as the central bank limits supply and demand for the currency to buy renminbi bonds in the city grows.

The yuan traded in Hong Kong at 6.5835 per dollar, 0.13 percent more than the 6.5921 as of 2:30 p.m. today in Shanghai, and cost 0.6 percent more on Jan. 10. The Hong Kong rate was cheaper between Dec. 21 and Dec. 28, after the premium reached a record 2.7 percent on Oct. 19. Hong Kong Monetary Authority rules released on Dec. 23 allow lenders to buy the currency onshore for customers’ purchases of goods no longer than three months before the transaction.

The government and companies sold a record 35.7 billion yuan ($5.4 billion) of renminbi bonds in Hong Kong in 2010 at a cheaper cost than in Shanghai, reflecting expectations for yuan gains as China leads the global economic recovery and U.S. President Barack Obama steps up pressure for faster appreciation. Last month’s rules seek to curb the involvement of short-term speculators in the currency after inflows of so- called hot money helped drive inflation to a two-year high.

“The spread between the onshore and offshore rates may increase modestly as demand for the currency outside of the mainland increases compared to how much market players are sending into Hong Kong,” said Robert Minikin, a senior strategist in the city at Standard Chartered Plc, the third- largest underwriter of offshore yuan bond sales last year.

The premium may widen to 0.6 percent in coming quarters, Standard Chartered wrote in a Jan. 10 note. The report, co- written by Minikin, said the level depends on cross-border fund transfers that are “closely controlled.” Sales of yuan- denominated bonds in Hong Kong, known as dim-sum debt, will increase, adding to appreciation pressure, the report said.

Global Currency

China is encouraging use of the yuan in global trade and finance instead of the dollar after Premier Wen Jiabao said in March he is “worried” about holdings of assets denominated in the greenback. The internationalization process faces a challenge from the offshore market, which will have its own interest and exchange rates, Xia Bin, a Chinese central bank adviser, said at a book signing in Beijing on Jan. 14.

Daily volumes in the offshore market average about $600 million, the Standard Chartered report said. The trading compares with about $50 million a day estimated by the bank in October. Overseas entities can only buy yuan on the mainland if they have investment proposals or trade transactions approved by regulators. Capital restrictions limit transfers from onshore.

Non-deliverable forwards show traders are betting on a 2 percent gain in the yuan in the coming 12 months, less than the 4.6 percent median forecast in a Bloomberg survey of 21 strategists. The outlook compares with a 1.1 percent drop predicted for Brazil’s real by year-end, a 1.6 percent decline for Russia’s ruble and a 4.1 percent advance for India’s rupee.

Appreciation Pressure

China raised lenders reserve requirements by 50 basis points to 19 percent late on Jan. 14 after consumer prices climbed 5.1 percent from a year earlier in November, the fastest pace since August 2008. The yield on the 3.77 percent government bond due in December 2020 rose three basis points to 3.94 percent. The one-year interest-rate swap, the fixed cost needed to receive the floating seven-day repo rate, rose 12 basis points to 3.39 percent, according to data compiled by Bloomberg.

The cost of insuring the government’s dollar debt for five years was little changed at 76 basis points on Jan. 14, up from a 2 1/2-year low of 52 on Oct. 13, according to CMA prices in New York. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if the government fails to adhere to debt agreements.

Trade Settlement

International import and export transactions settled in renminbi totaled a record 126.5 billion yuan in the third quarter, 160 percent more than in the previous three months, China’s central bank said Nov. 2. Hong Kong’s yuan deposits jumped 28.8 percent to a record 279.6 billion yuan in November.

Last month’s HKMA rules ordered banks to run checks to ensure that customers are buying or selling yuan for trade settlement purposes rather than to speculate and ruled that the transactions be conducted within three months. That makes it harder for Chinese companies to arbitrage by buying yuan inside China and selling it for a profit in Hong Kong. The HKMA ruled banks must not have a position that can profit from swings in the currency larger than 10 percent of assets or liabilities.

Funding Access

The regulator also set up a standing 20 billion yuan swap line with China’s central bank to ensure supply of the currency for trade settlements, while insisting that companies must use up their own supply of yuan before tapping the funds. The yuan is a denomination of China’s currency, the renminbi.

The fund is “more of a last resort emergency measure that can’t be accessed unless banks in question have exhausted all yuan liquidity at their disposal,” said Donna Kwok, an economist at HSBC Holdings Plc., the No. 2 underwriter of yuan bonds sold in Hong Kong.

Dim-sum debt issuance, which doubled last year from 16 billion yuan in 2009, may double again in 2011, according to HSBC. Borrowers raised 4.5 billion yuan in three issues so far in 2011, data compiled by Bloomberg show. The International Bank for Reconstruction & Development, part of the World Bank, sold 500 million yuan of the debt on Jan 5.

Dim-Sum Bonds

Yields on dim-sum bonds, named after the Cantonese brunch food, average 1.52 percent, according to Treasury Markets Association data, which tracks outstanding issues including notes sold by China Development Bank Corp. The average yield paid on three- to five-year bonds sold by government-linked companies in China is 3.92 percent, according to Bank of America Merrill Lynch’s China Quasi-Government Index. The Bank of China Hong Kong offshore yuan bond index has risen 0.7 percent since it was started on Dec. 31.

Li Ka-shing, Hong Kong’s richest man, is planning to sell yuan-denominated shares in a Chinese real-estate investment trust in Hong Kong, people familiar with the knowledge of the matter said last month. Regulators are also working on a plan to allow offshore deposits to be invested back into mainland capital markets, known as the mini-Qualified Foreign Institutional Investors program.

China said Jan. 13 it will let companies conduct overseas mergers and acquisitions in yuan to expand the currency’s international role. The Bank of China Ltd., the nation’s fourth- largest lender by assets, said Jan. 12 U.S. branches began offering yuan deposits.

“It seems that demand for offshore yuan products is far above supply so we may indeed need to wait longer for the convergence in interest rates,” said Frances Cheung, a senior strategist in Hong Kong at Credit Agricole CIB. She said on the foreign exchange rate, a premium to average around 1 percent, with periods of a discount of as much as 0.5 percent.

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net.

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