- Inclusion will push China to open capital account, says ANZ
- Chinese bonds offer new market in time of shortage: Invesco
The yuan’s likely ascent to the IMF’s Special Drawing Rights will stave off depreciation concerns in the short term, boost the bond market and oblige President Xi Jinping to push ahead with efforts to loosen capital controls.
So say economists digesting International Monetary Fund Managing Director Christine Lagarde’s announcement late Friday that her staff have recommended the Chinese currency be added to the SDR, a move Standard Chartered Plc estimates will lure more than $1 trillion to Chinese assets in the next five years. The IMF executive board, scheduled to meet on Nov. 30, must approve any changes to the basket, a requirement that adds a political layer to the decision. The U.S. has 17 percent of the votes on the IMF board.
“If you are in the SDR, you have to promise to open up the capital account,” said Liu Li-Gang, chief China economist at Australia & New Zealand Banking Group Ltd. in Hong Kong. “In the medium term, the yuan is bound to appreciate because of potential large inflows, and China’s reformers would like to use these external forces to accelerate liberalization. The IMF report suggests that the yuan’s entry into the SDR is more or less done.”
Deutsche Bank AG predicts that IMF inclusion will spur 4 trillion yuan ($628 billion) of inflows over the next five years, while AXA Investment Managers has an estimate of $600 billion. This compares with about 44 trillion yuan of outstanding Chinese onshore bonds, fewer than 2 percent of which are held by overseas investors. With such a low base and expectations of further easing of capital controls, Goldman Sachs Group Inc. projects overseas investors may pour $1 trillion into Chinese debt in the coming years.
“Global fund managers may need to pay attention to China’s bond market, the third-largest in the world,” said Ken Hu, the Hong Kong-based chief investment officer for Asia Pacific fixed income at Invesco Ltd., which manages some $791 billion globally. “With the European Central Bank buying back government bonds and an improvement in the U.S.’ current-account and fiscal deficits posing a shortage of government bonds, it’s exciting that China is able to provide a brand new market.”
China’s interest rates are higher than that of major developed nations, with its 10-year sovereign yield at 3.13 percent, compared with 2.27 percent for U.S. Treasuries and 0.56 percent on Germany bunds. Most investors are significantly underweight on China relative to its share of global gross domestic product and trade, and the nation has made it easier to move funds in and out of the country, wrote Bloomberg economists Tom Orlik and Fielding Chen.
“Chinese policy makers will implement more market-opening measures in order to boost global yuan usage,” said E Zhihuan, deputy general manager for economic and strategic planning at Bank of China Hong Kong. “China must accelerate developing the offshore and domestic financial markets as the yuan joins the SDR. It has to deepen and widen the market to meet demand from global central banks and sovereign funds.”
The nation will accelerate moves to liberalize its foreign-exchange and interest rates, People’s Bank of China Deputy Governor Pan Gongsheng said at a forum on Saturday, according to the Xinhua News Agency. The Communist Party’s plan for the next five years proposed increasing the yuan’s convertibility in an orderly manner.
The currency strengthened 0.9 percent in the last two months, swinging from a 2.6 percent plunge in August. It fell as much as 0.11 percent on Monday to a seven-week low of 6.3808 per dollar in Shanghai as terror attacks in Paris bolstered demand for the greenback. The yield on 10-year sovereign bonds was unchanged at 3.16 percent.
In Hong Kong’s offshore market, the yuan was 0.1 percent weaker as of 10:35 a.m. local time. Twelve-month non-deliverable forwards for the currency were little changed, after a 0.42 percent slide on Friday that marked their biggest decline in two months.
The PBOC said in July that foreign central banks, sovereign wealth funds and global financial organizations will no longer need pre-approval to trade bonds, interest-rate swaps or conduct repurchase agreements in the onshore market. It will also allow overseas central banks to trade all onshore currency products, including spots, forwards, swaps and options, the PBOC said on Nov. 6.
China’s market hasn’t drawn a flood of investment partly because of capital controls and a lack of secondary activity. While the market is the world’s third-largest, annual trading as a ratio of total outstanding debt is 1.1, compared with 4.7 in the U.S., according to Bloomberg calculations. The absence of a developed and reliable ratings industry muddies the waters as well, with a lack of defaults and the reluctance of ranking companies to downgrade making it difficult for foreign investors to assess credit risks.
“While there might a short-term positive reaction, it should prove transitory given that the outcome is well priced and being added to the SDR is unlikely to speed up the pace of reserve diversification into Chinese assets,” said Jason Daw, head of Asia currency strategy at Societe Generale SA in Singapore. “We continue to see an upward bias to dollar-yuan over the coming months and expect it to reach 6.80 by mid-2016.”
While the central bank on Aug. 11, when it devalued the yuan, moved toward a more market-based system to set the currency’s daily reference rate, it still restricts moves to a maximum 2 percent on either side. The authority has also been suspected of propping up its exchange rate regularly after the devaluation, a strategy that led to a record $93.9 billion decline in foreign-exchange reserves in August.
“The yuan is still influenced in a major way by policy makers, and this will not change overnight,” said Louis Kuijs, head of Asia economics at Oxford Economics in Hong Kong and a former IMF economist. “Policy makers are unlikely to let the currency appreciate in a major way against the dollar. ”
— With assistance by Justina Lee, Tian Chen, and Fion Li