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Offshore RMB Sovereign Debt And Chinese Exchange Rates

Growing Appetite for "Dim Sum Bonds"

On October 14, 2014 in a milestone event, the U.K. treasury became the first western nation to issue sovereign bonds denominated in the Renminbi, China's currency. Oversubscription by investors led to a final issuance of more than RMB3 billion RMB ($490 million) with a tightened yield of 2.7%. Majority of the investors originated from Asia, followed by Europe. This issuance marked another step in the maturation of the modest RMB500 billion ($81.6 billion) offshore RMB bond market, also known as "Dim Sum bonds".

The U.K. Treasury's issuance of Renminbi denoted sovereign debt marks a substantial step in the global integration of China's financial markets and a movement toward liberalizing China's exchange rate. The issuance of sovereign bonds provides a benchmark for risk free rate in the selected currency denomination by which all other bond issuances in the same currency will refer to. Thus, the nature of this sovereign issuance, particularly by a developed central bank with the approval of the Chinese government, is critical in building credibility of the RMB and facilitating the growth of foreign RMB markets.

RMB Market SizeRMB Market Size

Economic Importance of Offshore Currency Markets

International trade, the current account, and currency markets are closely tied concepts. Since 1994, the Chinese government tightly controlled the Renminbi and fixed its exchange rate against the US dollar. This gave rise to "China bashing" as global parties criticized China's mercantilist trade strategy, where China artificially undervalued the Renminbi through US dollar purchases to promote exports and retain domestic industry.

As China joined the WTO in 2001, Chinese trade flows grew rapidly, arguably driving much of the nation's exceptional GDP growth. China became the largest global surplus country in the mid 2000's, accounting for 1/5th of total global surplus between 2005 and 2008, with a current account surplus of 11% of 2007 GDP. By 2005, "China-bashing" resulted in the government letting the RMB appreciate against the dollar slightly. However, for China's exchange rate to become truly flexible and the Renminbi fully accepted in international markets, China must develop its currency markets both domestically and nationally to generate sufficient capital flows with little regulatory friction. Thus, the development of offshore financial markets for the RMB, including RMB denoted bonds issuances, is critical to both Chinese and global economic growth.

Despite China being the largest contributor to international trade flows and the second largest nation by economic size, the ubiquity of the Renminbi as a medium of international trade remains far from reality. China's financial markets remain isolated and heavily regulated even as the Chinese government reiterates its official policy of liberalizing its capital account (i.e., imports less exports, savings less investment). The RMB only became the seventh largest payment currency in early 2014.

As the Chinese economy further integrates with the global economy, RMB internationalization and exchange rate flexibility will be much more conducive to long run stability than the current currency regime. Politically, currency internationalization further elevates China's power as the RMB moves toward becoming the global reserve currency and primary medium of trade. This will challenge the dominance of the US dollar established since Bretton Woods after World War II. Domestically, the RMB and exchange rate liberalization in light of the open Chinese current account will ease China's monetary policy constraints. The central bank will better be able to control domestic inflation and economic activities rather than heavily manage foreign dollar reserves and limit injections to the money supply.

Final Comments

The coverage of foreign Renminbi bond issuances by media remains relatively weak. Though many focus on these issuances as milestones, less describe the economic significance of greater maturity of foreign RMB markets. Offshore currency markets are a common feature to developed nations, creating both benefits and limitations. It is in this author's opinion that offshore RMB issuances act as important reflections and indicators of Chinese policy on trade and exchange rates.

For Further Readings

These articles and academic papers may be of interest for investors who wish to learn more:

Asian Development Bank Institute (Working Paper): "Issues for Renminbi Internationalization: An Overview"

Asian Investor (Article): "Offshore RMB Bond Market Coming of Age"

World Bank (Report): "Reaching "Win-Win" Solutions with the Rest of the World", p409-417 (China's Integration into Global Markets"of the World", p409-417 (China's Integration into Global Markets"

Acknowledgements

The inspiration for this article is an Economics of China course at University of Western Ontario taught by Prof. Terry Sicular