November 2015
Schroders
Talking Point
Heading for number yuan: the growth of
RMB bonds
Angus Hui, Fund Manager, Asian Fixed Income
As the yuan (RMB) recently passed the Japanese yen to become the world’s fourth most-used
payment currency, it’s worth taking stock of how far the RMB has come, its future growth path and
what this means for investors.
In September, the US Federal Reserve (Fed) held interest rates steady and decided to delay lift-off, with Chair
Janet Yellen citing, amongst other factors, the potential for ”further instability in global economic progress”.
Markets took this to mean primarily China. Yellen’s comments were a tacit admission of the importance of
China’s economy on, not only global growth, but also that of the US.
The recent brouhaha in the markets surrounding the devaluation of the RMB, triggering talk of a new currency
war, has thrust it back into the spotlight.
Our view of this tends to be in the greater context of the currency’s increasing prominence over multiple years
rather than days. In this sense, the changes that it is undergoing look set to be as far-reaching as the
economy’s transition from an investment-led to consumer-driven model of growth. And the opportunities to tap
this opening-up process will be manifold, for both passive and active investors. Just as China’s economy
cannot be ignored, neither can its currency. This will be particularly true for bond investors looking towards the
world’s second-largest economy.
Charting the ascendancy
Use of the RMB has surged as China’s economy globalises and its burgeoning middle class travel abroad. The
ubiquity of the currency was highlighted by its rise to the fourth-most used currency in the world with 2.79% of
global payments in August (by value) made in the so-called “redback”, according to payment services provider
Swift.
Its ascendancy in trade finance settlement has been in lockstep with China’s rise as a global economic
superpower – China is now the biggest export market for 43 countries; back in 1994 this number stood at just
two 1.
The volatility of the currency has been minimal and the shock 2% decline of the RMB in August, engineered by
the Peoples’ Bank of China (PBoC) was notable precisely because such moves are so rare. Even so, this
needs to be placed into context of the relative moves of the currency over the past few years. It remained
stronger than it was a year ago, in trade-weighted terms, in the week following its devaluation.
Partially attributable to the PBoC’s fixing rate, which started to creep up after August, the RMB has also
stabilised on account of the deployment of the country’s colossal US dollar reserves which, even after falling
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12% since reaching a peak of $4 trillion, still stand at $3.51 trillion.
We view its recent devaluation as part of the broader reform of the currency and offshore RMB liquidity
continues to remain stable. Even after the PBoC’s surprise devaluation of the RMB, deposits in both Hong
Kong and Taiwan – two key offshore trading centres for the currency – remained stable and there were no
significant withdrawals.
This scramble for a piece of the growing RMB payments pie has seen Hong Kong’s importance, as the primary
destination as an offshore centre, diminish. However, that has been a positive development. Multiple cities
have announced deals to be offshore dealing centres, which should continue to propel the currency’s use and
accessibility.
Too big to ignore
It comes as no surprise that China’s burgeoning RMB bond market has been growing in prominence, in
tandem with the currency. The key questions are how investors can benefit from this transition and where we
believe the best opportunities lie, in what is a fast-growing market. The government bond market in China is
the third-largest in the world, by market capitalisation. And it’s not only the government debt market that has
been growing.
Corporates in China are starting to turn to the bond market to raise financing and this extends beyond the
country’s renowned property sector. Although property developers themselves are typically perceived to share
similar credit profiles, this couldn’t be further from the truth. Many have much stronger fundamentals and are
an attractive proposition on a risk-adjusted basis. Any veritably diversified portfolio can no longer rule out RMB
assets as part of its composition.
For investors, this is going to be a huge shift, albeit one that also offers opportunities. Monetary policy in China
still offers scope for the PBoC to cut rates. The latest rate cuts, announced in August, only saw the one-year
lending rate slashed to 4.6%. Spreads over ultra-low yields found in the West is evident in that even RMB
investment grade (IG) credits are yielding over 4%.
Uncertain global conditions
China will continue to benefit from lower oil and commodity prices. This will lower input costs and also bolster
China’s current account. In this sort of environment, we foresee longer duration bonds continuing to do well
and expect high quality corporate issuers in China to outperform.
The effects of this drop in commodity prices are positive for China’s current account balance while being
negative for inflation. These are all bond-positive factors for investors and, in an environment where a
strengthening US dollar is wreaking havoc on many emerging market currencies, the RMB has been relatively
sheltered from this onslaught. Uncertainty surrounding global growth provides further impetus to investors to
take RMB bonds as a strategic long-term proposition. The on-going process of opening up China’s capital
account will also see investors become more aware of the various benefits RMB bonds can offer for the
long-term investor.
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