Devaluation Watch May Force China to Pay Premium on Dim Sum Debt

  • Yuan will weaken 5.1% by end of 2017, analyst survey signals
  • China finance ministry to sell 14 billion yuan debt this week

China is set to pay more to sell sovereign bonds in Hong Kong than in the onshore market for the first time, as investors brace for the possibility of another yuan devaluation.

The Ministry of Finance will sell 14 billion yuan ($2.2 billion) of Dim Sum notes in the city this week, including 2 billion yuan to individuals. The yield on offshore yuan securities due 2020 was 3.39 percent on Nov. 20, 25 basis points higher than debt of the same maturity in Shanghai, suggesting the government will have to pay more to borrow outside of the country.

A surprise Aug. 11 devaluation has reversed the consensus that the yuan will appreciate steadily and driven offshore borrowing costs to records. Bank of America Corp. says central bank intervention to support the currencywill be pared once it is admitted into the International Monetary Fund’s basket of reserves, while JPMorgan Chase & Co. said the concern it will slide after the decision is just a conspiracy theory.

“Some investors are cautious because they are worried the yuan will devalue again after joining the SDR,” said Frank Huang, head of trading at Sinopac Securities (Asia) Ltd. in Hong Kong. “The landscape has changed after the devaluation in August: the offshore yuan yields are now higher than the onshore ones.”

The August turmoil, which sparked the yuan’s steepest plunge in two decades, prompted analysts to cut forecasts for the currency. The added pressure of the slowest economic growth in 25 years and a potential Federal Reserve interest-rate increase have added to the concern.

The yuan will weaken 5.1 percent to 6.73 a dollar by the end of 2017, according to the median estimate in a Bloomberg survey. The forecast on May 20, when the finance ministry last sold Dim Sum bonds in Hong Kong, was for a 1.6 percent gain. The onshore yuan slipped 0.06 percent to 6.3886 in Shanghai on Monday, while the rate in Hong Kong was 0.1 percent weaker at 6.4289.

David Tepper, the billionaire owner of Appaloosa Management, said last week that a yuan devaluation may be coming as the currency is massively overvalued. His comments follow similar forecasts from some of the biggest hedge fund managers, including Crispin Odey, founder of the $12 billion Odey Asset Management, who predicts China will devalue the yuan by at least 30 percent.

The bond auction on Nov. 26 will include 5 billion yuan of three-year debt, 3 billion yuan of five-year bonds, and 1 billion yuan each of of 10- and 20-year notes, according to a tender notice posted on the Hong Kong Monetary Authority website. Apart from the 2 billion yuan that will be sold to individuals, there will be a section made available to overseas central banks as well.

PBOC Curbs

Demand for the debt is also at risk of being affected by recent moves to curb the supply of funds to offshore lenders, with the People’s Bank of China said to have asked domestic agent lenders to stop providing cross-border yuan financing. It also halted bond repurchases that allow banks to channel yuan to offshore markets. The measures, aimed at closing the yuan’s rates at home and overseas, drove the one-week Hong Kong Interbank Offered Rate up 18 basis points to 4.64 percent on Nov. 18, the highest since Oct. 9.

“The higher interbank cost means it’s more expensive for those who want to source yuan and buy the bonds," said Ngan Kim Man, deputy head of treasury at China Everbright Bank Co.’s Hong Kong branch. "However, there would still be some fundamental buyers such as central banks and sovereign wealth funds because sovereign Dim Sums aren’t frequently available and they are relatively safe."

Potential Inflows

The yuan’s impending coronation as the IMF’s fifth reserve currency will draw between 4 trillion yuan and 7 trillion yuan into Chinese assets over five years, up to half of which will come from reserve managers, according to Standard Chartered Plc. The potential flows should alleviate concern over outflows, said Pacific Investment Management Co.

Daniel Chan, a Hong Kong-based analyst at Brilliant & Bright Investment Consultancy Co., said the sovereign yields aren’t attractive anymore, given the chances of yuan depreciation. He said this will be the first time since issuance started in 2009 that he won’t subscribe.

“I used to buy Dim Sum sovereigns as part of the portfolio for my children because of the yuan’s steady prospects," he said. "Now the yuan is likely to depreciate further and I can get higher interest rates from fixed deposits."

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