Dim Sum Sri Lankan Style

Sri Lanka is hoping to follow its colonial master into unchartered waters and issue a Chinese yuan denominated bond, but optimism is high

By devan daniel.

Published on January 19, 2015 with No Comments

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Sri Lanka may become an early issuer of Chinese yuan-denominated sovereign bonds to the international financial market, not only to diversify reserves and contain exchange risks in debt repayment and trade, but also to establish itself as a regional hub for this type of debt, with European financial capitals racing each other for hub status in the bloc.

This may even open doors to the private sector to access a growing pool of global yuan denominated capital. So far only Britain has issued a sovereign bond denominated in Chinese yuan, popularly called a dim sum bond. So far, the only foreign currency bonds Sri Lanka has issued have been denominated in dollars. However many Chinese and international companies issue dim sums and over $85 billion was raised in 2014. According to Dealogic data published by the Wall Street Journal mostly corporates from Australia, Malaysia, Taiwan, South Korea, Mongolia and Italy among others made these issues. US heavy weights such as Caterpillar, McDonalds and British heavy weight BP have already raised capital in previous years via dim sum bonds.

Dim sum bonds, named after a popular Cantonese dish (which translates to ‘touch the heart’), have been popular with investors for its good returns and comparatively lower volatility. It sailed through the turbulence which roiled global markets when the US Fed announced plans to wind down its liquidity injecting bond buying programme in 2013. Britain is the only sovereign to issue a dim sum bond, but there have been quasi sovereign issues for example by the Canadian province of British Columbia.

“Dim sum investors are driven by their desire to be part of China’s economic growth than by a hunt for yields. At early stages, investor appetite was driven by yuan appreciation and given limited options for offshore Yuan investments, dim sums provide a better opportunity for investors optimistic about China’s growth story,” according to Shiran Fernando, a Senior Analyst at Frontier Research.

Dim sum bonds are denominated in Chinese Yuan (RMB) but issued offshore in Hong Kong and are denominated as CNH, as against CNY for Chinese yuan-denominated bonds issued in mainland China. Cross border trading of these bonds and liberalization of the Chinese domestic bond market are steps global investors are watching with interest. Chinese yuan exchange rates are managed and for investors there is the prospect the yuan will rise.

There is no benchmark yield for dim sum sovereign bonds, so gauging pricing can be difficult. Britain’s three year RMB 3 billion dim sum was sold at 2.7% in October 2013, which drew bids topping RMB 5.8 billion from 85 countries. The yield was much higher than for bonds in its own currency (the Bloomberg UK Sovereign Bond Index showed an effective yield of 1.70% mid-December).

Moody’s and Standard and Poor’s had given their highest ratings to Britain’s dim sum bond although the issue was not rated. China, which is rated two notches lower than Britain by Moody’s and three notches lower by Standard and Poor’s, would have paid around 2.8% for a similar issue, analysts said. According to Standard Chartered Bank, the benchmark 10-year US Treasury bond yield return forecast for 2014 was 3% while the two-year bond yield was just 0.38%. The yield on four-year Chinese government
bonds was 3.20%.

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With Sri Lanka relying heavily on Chinese loans, exchange rate risks could be minimized by having yuan in Sri Lanka’s reserves. With dim sum yields expected to rise in the medium term, the earlier the issue the better so that a net return could be made if invested wisely.

(In 2006, China was Sri Lanka’s smallest lender with $9 million. In 2013, China was the largest lender with $584 million. From 2006 to September 2014, China was the largest lender with consolidated loans amounting to $3 billion, second to Japan at $2.6 billion followed by the ADB’s $2.2 billion – Ministry of Finance and Planning)

Converting US dollars from reserves to pay Chinese debt denominated in yuan may be a cheaper option depending on how strong the US dollar is against the Chinese currency, but with the yuan expected to appreciate, the risks would have to be weighed carefully.

“(Yuan) appreciation momentum is likely to remain strong near-term on expectations of deepening reforms. More two-way volatility may be seen in subsequent quarters, likely after the trading band is widened, as China’s growth moderates,” Standard Chartered Bank said in a report.

However, some analysts argue that the US dollar is on the path of strengthening, so that puts pressure on the yuan to weaken. However, the Chinese central bank is keen on seeing some level of appreciation to maintain export competitiveness needed to sustain China’s growth, but not too much.

A significant yuan depreciation will be negative for Sri Lanka should it happen after Sri Lanka issues a dim
sum bond. But given that some imports and loan repayments are made in yuan, its depreciation could be positive for Sri Lanka, similar to how the Japanese foreign debt component has reduced due to a weakening yen.

Not everything is so uncertain though.

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The inclusion of the yuan as a reserve currency would also help spread risk and diversify returns, given China’s push to establish it as a global currency and its growing acceptance; Major European capitals are in a race to establish yuan exchange hubs. If Sri Lanka issues a dim sum bond it would have an early start in the rising global currency and latch onto China’s phenomenal growth story and also establish itself as a financial centre for dim sum bonds which would raise its profile considerably. After Hong Kong, Singapore, London and Taiwan, dim sum markets are expected to grow and develop in Paris, Germany, Luxembourg, South Korea and Australia.

“Key risks are with regards to the pricing of a possible bond given lack of sovereign issues or benchmark yields to base a suitable spread of the issue. Timing would also be critical given the impact of global monetary policy decisions in 2015 and or any unfavourable movements of the yuan” Fernando said.

“Sri Lanka has over $4 billion in debt service payment including interest payments. There won’t be a direct impact of a dim sum issuance but this largely depends on the size of the issuance which would help Sri Lanka strategize the use of its dollars and reserves,” he said.

Ashini Samarasinghe, Research Economist, Frontier Research says that according to research done on this market, dim sum bonds have low correlation when compared with most global fixed income markets. “Hence, diversification is a key benefit for both the investor as well as the issuer,” she said.

Since dim sum yields are largely affected by China’s interest rate and yield curve, the expected US rate hike this year is not expected to impact yuan denominated debt.

“However, given growth concerns of China and possible easing measures the Chinese central bank may undertake, this market could be impacted from volatility. How the yuan is impacted by other currencies, namely the US dollar, would also determine volatility,” Samarasinghe said.

With plenty of uncertainty in the global markets, just how beneficial the yuan bond would be to Sri Lanka, only time will tell. It would however further deepen political ties with the Chinese who are keen to establish the yuan as a major global currency. China has already entered into swap agreements with many countries, including Sri Lanka, but the more sovereign bond issuances, the sooner the yuan would grow its influence, so Sri Lanka’s step ought to be looked at favourably by China.This must then translate to better borrowing and trade terms: Reasonable interest rates must be charged on loans given to Sri Lanka; the 6% interest on the loan for the Hambantota Port development project is considered to be exuberant given yields paid for commercial sovereign bonds. China is also not big on donor funding, unlike Japan which continues to dispense grants. With the Free Trade Agreement being negotiated, China must consider the asymmetries of the size of the two economies and grant Sri Lanka unrestricted access to its market.

As corporates in most parts of the world have done, Sri Lankan corporates too may be able to access capital via the global dim sum market. Sri Lankan firms will receive approval to register their businesses in China’s Chengdu province and open bank accounts as well. According to a spokesperson for HSBC Sri Lanka some exporters and importers have shown a willingness to trade in the Chinese currency.

Dim sum maybe a popular dish, but it takes many forms with multiple combinations of ingredients and condiments; whatever it may be, the proof is in the eating.

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