RMB fixed income in the offshore bond market: What can we expect this year?

Economy February 18, 2014 00:00

By Geoffrey Lunt

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Last year saw the usual lurid headlines forecasting impending economic doom for China in various guises.

Investors should expect exactly the same this year as the outcome is perhaps even more uncertain in the light of a nascent recovery in developed economies and a seeming determination on the part of the Chinese authorities to cool credit growth in the world’s second largest economy. 
   Nevertheless, the offshore yuan market in US dollar terms returned nearly 7 per cent, one of the best outcomes for any bond market anywhere. Where does this apparent disconnect come from?
The first explanation is perhaps simply that press reporting and general comment on China is biased. It is probably the case that bad news is likely to garner more column inches and interest than stories that claim that everything is broadly OK. 
This phenomenon may be particularly acute when it comes to China because it is a subject that is difficult to understand given the country’s significant differences in language, culture and economic system to many other parts of the world. 
Commentators may also be guilty of judging China by Western standards. They may sometimes forget that the Chinese government still holds a firm grip on the levers of the economy, which most governments have long since relinquished. 
This is why the Chinese economy actually accelerated during the global financial crisis, and why the government is in a good position to navigate the economy broadly towards the growth rate it is aiming for. 
Scepticism about the prospects for appreciation of the currency may suffer from a similar misconception – the yuan is not only underpinned by sound fundamentals, but its further appreciation against the greenback is part of broader Chinese economic policy.
The second has more to do with the nature of the offshore yuan market, which does not map the Chinese economy closely. The market is heavily skewed towards financial issuance, but a vast majority of this is either issued by the big four Chinese banks or very large global banks, of which each category has very strong fundamentals. 
The same is broadly true of corporate issuance – global issuance is from some of the world’s largest companies, while Chinese issuance is from companies with established credit track records and alternative sources of funding, as only these gain permission to issue in the offshore market. 
When this is added to the simple bond fundamentals of a relatively high credit quality and duration adjusted yield, it is not difficult to see why this market has remained resilient.
These metrics are broadly the same as we move into 2014 as they were at the beginning of 2013. In fact, both the yield and the duration of the whole market are slightly higher. 
The raison d’etre of the offshore market is to prepare the ground for the eventual opening of the Chinese bond market as a whole, so we expect the tenor of the offshore market to increase and for a proper benchmark yield curve to be established across maturities. 
Liquidity will increase as a result, which will further attract investor interest and bolster growth of the entire bond market.
The prospects for this market remain good, the risks are skewed in the investors favour and although returns are unlikely to be spectacular, there is a good chance that they will once again be stable and resilient. 
Investing in yuan bonds will not be a discretionary option for very much longer. If the Chinese government market were included in the Citi WGBI, it would make up 6 per cent of the total, but with the Chinese market growing much more quickly than others, in three to five years the weighting will be much higher. 
If we add into this mix the diversifying qualities of the yuan currency itself, and the lack of correlation to other markets, then an enduringly above-capitalisation benchmark weight could make sense.
Even if some of the well-publicised issues around the China story begin to crystallise, investors should be protected by the mathematics and the structure of the market. 
In a longer-term context, the broad thrust and implication for the bond markets are abundantly clear.
 China and its markets are opening up. Yuan bond markets are already some of the largest in the world and will become one of the most important asset classes in the world when they are all fully available to foreign investors. 
Geoffrey Lunt is director and senior product specialist for Asian fixed income at HSBC Global Asset Management.