Banks’ Yuan Debt Costs 30% Cheaper in Hong Kong: China Credit

Banks’ Yuan Debt Costs 30% Cheaper in Hong Kong
The yuan strengthened 1.7 percent in September, the most since 2005, and has appreciated a further 0.6 percent this month to 6.6520 per dollar in Shanghai amid U.S. calls for China to allow faster gains. Photographer: Nelson Ching/Bloomberg

Banks are paying about 30 percent less interest on yuan-denominated debt sold in Hong Kong than they pay in Shanghai as faster currency appreciation fuels overseas demand for the securities.

The average yield in the city is 1.77 percent, according to data from the Treasury Markets Association, which tracks 19 outstanding issues that have maturities of no more than four years. That includes bonds sold by state-controlled lenders including China Development Bank and Bank of China Ltd. The average rate in China for one- to three-year bonds issued by government-linked companies is 2.60 percent, according to Bank of America Merrill Lynch’s China Quasi-Government Index.

China is encouraging domestic lenders to sell debt in Hong Kong to broaden the appeal of holding its currency overseas as it seeks to reduce reliance on the dollar for international trade and finance. Yuan deposits in the city more than doubled to a record 130 billion yuan ($20 billion) in the first eight months of 2010.

“The demand for renminbi assets is much higher offshore,” said Arthur Lau, a Hong Kong-based fixed-income fund manager at JPMorgan Asset Management, which oversees $1.3 trillion. “The issuer has an advantage and everyone expects the deposits, the funding side, will continue to grow at a very fast pace.”

Strengthening Yuan

The yuan strengthened 1.7 percent in September, the most since 2005, and has appreciated a further 0.6 percent this month to 6.6520 per dollar in Shanghai amid U.S. calls for China to allow faster gains. It will rise 5.2 percent more by the end of 2011, according to the median forecast of analysts surveyed by Bloomberg News.

China raised its benchmark lending and deposit rates for the first time since 2007 after the markets closed yesterday. The one-year deposit rate will increase to 2.5 percent from 2.25 percent, the People’s Bank of China said on its website. The lending rate will rise to 5.56 percent from 5.31 percent.

Yuan forwards were little changed, with the 12-month non-deliverable contract trading at 6.4442, compared with 6.4358 before the announcement. That indicates traders are betting on a 3.3 percent appreciation in the coming 12 months.

Pressure for the yuan to gain may increase after the boost in interest rates, Dariusz Kowalczyk, a Hong Kong-based senior economist and strategist for Credit Agricole CIB, said in an interview yesterday. Data to be released in Beijing may show inflation climbed to 3.6 percent in September, median forecasts in a Bloomberg News survey show.

Asset Bubbles

“The market was unprepared,” he said. “Probably there will be more portfolio inflows into China and the currency will gain in the non-deliverable forward market. They have must have decided to be tougher on inflation and stimulate savings, because otherwise there will be asset bubbles.”

In the same way that yuan bonds command a premium in Hong Kong, so too does the currency. The spot rate in the city’s offshore market was 6.4915 as of 3:24 p.m. local time, 2.5 percent more than the onshore rate. That’s the biggest gap since Bloomberg began tracking the rate two months ago. Overseas entities can only buy yuan on the mainland if they have investment proposals or trade transactions approved by Chinese regulators.

China’s debt market is “basically closed” to global investors because investment quotas are all being used to buy equities, according to Pacific Investment Management Co., which runs the world’s biggest bond fund. That leaves Newport, Beach, California-based Pimco with no alternative but to gain exposure via offshore markets, Chief Operating Officer Douglas Hodge said in an Oct. 14 interview.

Cheaper Funds

Asia Development Bank raised 1.2 billion yuan by selling 10-year bonds in Hong Kong yesterday. The 2.85 percent notes were priced at 1.43 percentage points less than the current 4.28 percent yield on 10-year debt it sold last year in China’s domestic bond market, according to Chinabond and Bloomberg data.

“It is likely to be cheaper offshore than onshore because you offer it to a more diversified group of investors so you are addressing a bigger demand,” ADB Treasurer Thierry de Longuemar said in an interview yesterday. The Manila-based lender may sell more yuan debt in Hong Kong within a year, he said, predicting that the yield gap between China’s onshore and offshore debt markets will close as capital controls are relaxed in the coming decade.

China Development Bank plans to sell as much as 5 billion yuan of notes due November 2013 in Hong Kong. The offering priced to yield 2.7 percent, according to Bloomberg data. That compares with the 2.87 percent yield investors demand to hold its similar-maturity bonds trading in the domestic Chinese market, according to Chinabond prices.

“It’s cheaper to raise funds in Hong Kong,” Gao Jian, vice governor of China Development Bank said at an Oct. 18 briefing in Hong Kong. The lender is China’s second-largest issuer of bonds after the Ministry of Finance.

Global Average

Financial institutions worldwide pay an average 2.49 percent on one- to three-year debt, according to Bank of America’s Global Broad Market Financial Index, which tracks more than 1,000 bonds globally from issuers including France’s Credit Agricole CIB, Australia & New Zealand Banking Group Ltd. and Barclays Plc.

The Export Import Bank of China’s 3 billion yuan of 3.4 percent notes due September 2011 in Hong Kong yield 2.49 percent, according to Treasury Markets Association prices. That compares with a 3.26 percent rate on 15 billion yuan of notes due November 2011 it issued in China, according to Chinabond.

The average yield on bonds due October 2011 that the Chinese government sold in Hong Kong is 1.62 percent, according to TMA data. That compares with the 1.97 percent yield investors demand to hold similar-maturity notes listed in Shanghai and Shenzhen, according to Chinabond prices. The yield rose one basis point yesterday.

Bond Risk

Chinese government dollar bond risk fell to a two-year low last week, according to traders of credit-default swaps. Five-year contracts on the nation’s debt have dropped 20 percent in the past month, according to CMA prices. The swap contracts rose 5 basis points to 62 basis points yesterday, CMA prices show.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to debt agreements.

Yuan Opportunities

International Finance Corp., the World Bank’s private investment arm, plans to sell about 100 million yuan of five-year bonds in Hong Kong, according to Nina Shapiro, IFC’s Treasurer. IFC set up a yuan-denominated bond program in Hong Kong to fund projects that support rural development in the country, the company said in an e-mailed statement yesterday.

“There’s a lot of money coming from outside China, including in Hong Kong, that would like to be invested in the yuan because of the future appreciation,” said David Marshall, an analyst at CreditSights Inc. in Singapore. “There is big money looking for that opportunity in Hong Kong and few available investments.”

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