China to Let Overseas Banks Invest in Bond Market

China will let overseas financial institutions invest yuan holdings in the nation’s interbank bond market in a pilot program to spur currency flows from abroad.

The People’s Bank of China will start with foreign central banks, clearing banks for cross-border yuan settlement in Hong Kong and Macau, and other international lenders involved in trade settlement, according to a statement on its website today.

“It’s a big boost for the offshore renminbi market,” said Steve Wang, a credit strategist for Bank of China International Securities Ltd. in Hong Kong. It “would allow offshore holders of yuan to invest the money directly in China rather than going through middlemen. It’s a step in the right direction that really opens the domestic securities market.”

The move comes as China seeks to broaden the use of its currency. The nation approved use of the yuan to settle cross-border trade with Hong Kong in June 2009, part of a drive to reduce reliance on the U.S. dollar. The popularity of that program was limited by the investments available in the currency.

Each overseas bank needs a special account at a local lender for debt transaction clearing, according to the regulations, which come into effect from today. Overseas banks must first apply for investment quotas on the interbank market, the central bank said. Foreign central banks should disclose funding sources and investing plans in their applications, according to the central bank.

There were a total 14.3 trillion yuan ($2.1 trillion) of bonds on the interbank market as of June, including debt issued by the central government, banks and companies, the central bank said July 30. That amount accounted for 97 percent of total debt outstanding.

Yuan Deposit Growth

Yuan deposits in Hong Kong climbed 4.8 percent in June to a record as China ended a two-year peg against the dollar. Currently, trade is the main way for offshore holders of yuan to return money to China, Wang said.

The program is a step forward to internationalization of the renminbi, said Dariusz Kowalczyk, a currency strategist at Credit Agricole CIB in Hong Kong. The Chinese currency, the yuan, is also known as the renminbi.

“By opening the new avenue to invest Chinese yuan funds, the currency will become more attractive and may come under further upward pressure in the offshore market in Hong Kong,” Kowalczyk said. “Foreign central banks may decide to begin the process of diversifying their reserves into Chinese yuan.”

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