China's yuan seen to play a bigger role as funding currency

HONG KONG: China's yuan is likely to be increasingly used as a financing currency for global borrowers in addition to its current role mainly as an investment tool if Beijing cuts interest rates further as expected to support the cooling economy.

Appetite for yuan assets had been high since the offshore market came into being five years ago as yields were much higher than in other markets, and as investors bet that steady yuan appreciation would bring extra FX gains.

The same reasoning had also dampened market players' interest to borrow in the yuan market as dollar-based companies would have to repay more when their yuan-denominated loans matured.

However, the sudden yuan depreciation by the People's Bank of China (PBoC) on Aug 11 has reduced the yuan's appeal. Many investment banks have since lowered their forecasts for the yuan, which has now lost about 3.5% against the dollar in the past year.

What's more, the PBoC has cut lending rates five times since last November and more easing measures are expected in the coming months to support China's sluggish economy, which will further lower funding costs in the yuan market.

In contrast, US market rates have already risen in anticipation that the Federal Reserve will raise its policy rate by the end of this year for the first time since 2006, though some investors have recently pushed expectations back.

"We had yuan investors, but few borrowers before. Now the real internationalisation can come out when people both borrow and invest in yuan market," said Andrew Fung, head of global banking and markets at Hang Seng Bank.

Beijing is also making efforts to facilitate financing activities for foreign entities by allowing more financial institutions and companies to raise funds in its US$4 trillion bond market.

China's central bank is drafting new rules for yuan-denominated bonds sold by foreigners on the mainland, known as panda bonds, and plans to ease controls on how proceeds can be used, two people with direct knowledge of the matter have told Reuters.

Bank of China Hong Kong and HSBC last week priced their Panda bonds at 3.5% for the three-year tenor debt, a price that was lower than bonds sold by domestic commercial banks.

"The issuance of panda bond is likely to be more appealing to international issuers on the back of rapid decline of onshore funding costs and narrowing interest rate gap between RMB and USD," said Xie Dongming, an analyst at OCBC Bank in Singapore.

The yuan proceeds from these issuances, which are likely to be used in the offshore market, will also help China reconcile its yuan flow system and rebuild the offshore liquidity pool, Xie said.

Yuan deposits in Hong Kong fell 1.5% to 979 billion yuan (US$154.04 billion) in August from the previous month, the biggest monthly loss since January, statistics from the Hong Kong Monetary Authority showed.

China's yuan became the fourth most-used world payment currency in August, overtaking the Japanese yen, global transaction services organisation SWIFT said on Tuesday. It is also the second most-used currency in trade finance.

WEEK IN REVIEW

China's central bank on Thursday launched the China International Payment System (CIPS), a worldwide payments superhighway for the yuan to facilitate trade settlement and investment dominated in the yuan.

Standard Chartered Bank (China) Ltd said on Thursday it had completed a yuan clearing transaction for Sweden's IKEA through the China International Payment System, the first such deal to be announced hours after Beijing launched the worldwide system.

China has the capacity to manage its economic slowdown but needs to communicate policy more effectively and guard against potential spillovers, the International Monetary Fund said on Monday. 

It added that China's currency exchange rate was in line with "medium term" fundamentals.

China is studying plans to curb currency speculation even as it seeks to quicken the process of making the yuan trade freely, Yi Gang, the country's deputy central bank governor, wrote in an article published in China Finance magazine, a central bank publication.

Investors increased bearish bets on most emerging Asian currencies in the last two weeks after Federal Reserve officials kept open the possibility of an interest rate hike in 2015, but they trimmed bearish bets against the yuan to the lowest level in two months, a recent Reuters poll showed. - Reuters