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For China’s bond market, 2015 might be remembered as the year the panda ate the dim sum.
As the International Monetary Fund looks all but certain to include the renminbi in its basket of global reserve currencies, the future of the offshore renminbi “dim sum” bond market (named after the bite-sized food) — renminbi-denominated bonds issued outside china, principally in Hong Kong — looks to be in peril. The onshore market appears to be primed for growth, including the “panda” segment for non-Chinese borrowers.
The dim sum market was launched in 2007 but did not really gain traction until 2010, when restrictions were loosened and international institutions also began to issue renminbi-denominated bonds. For investors, the market was initially seen as a currency play, but in recent years it has been maturing and the breadth of borrowers has widened from top quality state-backed bonds all the way down the ratings spectrum to high-risk single-B issuers.
Both demand and issuance, however, were dented by the equity rally that began in the summer of 2014, which caused a massive shift in asset allocation away from debt. By April 4, when the Shanghai Composite had risen 88 per cent from the previous summer, the People’s Daily, a state controlled newspaper, declared that the rally was merely “the start of a bull market”. By June 12, stocks had risen by another third, before collapsing by two-fifths within a few weeks.
Bond issuance dried up during the equity boom as companies turned to equity capital markets. According to Dealogic, Chinese corporations raised Rmb122bn in equity from January to June, versus just Rmb58bn a year before. The pricking of the stock bubble wiped out trillions of dollars worth of wealth, hurting all asset classes.
The stock market stabilised in midsummer, but on August 11, just when it appeared bond issuance could recover, the People’s Bank of China surprised everyone by devaluing the renminbi. “That obviously spooked the market quite a bit,” says Ken Wei Wong, head of Asian debt syndicate at Barclays.
Within three weeks of the devaluation, returns on dim sum bonds plummeted from 2.92 per cent for the year to date, to zero, according to Barclays. US dollar investors were nursing losses. Yields in the index, dominated by short-term debt, shot up from 4.40 per cent to above 6 per cent, a record high, reflecting demand for currency risk compensation. While the August devaluation had been relatively small — the currency fell about 3 per cent in a week. It followed the 2014 depreciation of the renminbi — the first time the currency had fallen in a decade. Both events gave investors pause for thought.
“With what happened in August the entire thing has been derailed from the perspective of the foreign investor,” says Dhiraj Bajaj, portfolio manager at Lombard Odier, a Swiss private bank.
According to Morningstar, a fund tracker, foreign investors withdrew a record $1.78bn from China offshore bond funds in August. “Some funds were decimated,” Mr Bajaj said. “Everyone ran away.”
As of mid-November, dim sum issuance was on track to be just half the Rmb33bn record in 2014, according to Dealogic. Issuance in the offshore market, also shaken by the equity boom and bust, has fallen by 11 per cent, to Rmb443bn.
Once again, the market appears to be finding its footing. But despite Beijing’s reassurances that China will not engage in a competitive devaluation, markets are pricing in a 3 per cent decline for the offshore exchange rate over the coming 12 months, according to Helen Huang, fixed-income analyst at HSBC.
The investors most interested in buying dim sum bonds these days, she says, do not need to worry much about currency risk: Chinese investors.
Issuance and demand could both come back, of course, but the PBoC may have sounded the death knell in September when it opened up the panda market to two foreign banks— the Hong Kong units of HSBC and Bank of China. The move signalled Beijing’s desire to internationalise the use of the renminbi and, eventually, to converge the two exchange rates into one. Within weeks, the governments of South Korea and British Columbia also expressed an interest in selling panda bonds.
A key reason for their new found attention: lower yields. The PBoC has cut benchmark interest rates six times in the past 12 months. “Yields have come down massively in the onshore market, more than the offshore market,” said Barclays’ Mr Wong. “Issuers can fund themselves domestically. They have no need to fund outside of China.”
Dying or not, it is worth keeping an eye on the dim sum market. Suanjin Tan, a portfolio manager and China bond specialist at BlackRock, says it is a good place to find mispriced bonds, as “state-owned companies have been asked to issue in uneconomic terms, just to support the market”.
“We like the fact that we get mispricing,” says Mr Tan. “But it’s ignored by a lot of international investors.”