China’s onshore bond market – a key element of government policy towards financial markets – offers offshore investors an expanding and increasingly liquid investment opportunity. Key features of this market, in our view, include interesting yields, negligible default rates, improving sovereign risk and the scope for further currency appreciation.
The government is encouraging Chinese companies to diversify their funding sources away from equity and banks, resulting in a strong rise in corporate bond issuance since 2008. In 2010 alone, issuance rose by 43%, taking the total size of the onshore market to RMB 20 trillion by the end of the year.
Funding costs are attractive
For QFII investors, there are more opportunities as credit spreads widen despite virtually non-existent default risks on Chinese local bonds and China’s sovereign ratings being on an upgrade trend. For example, the spread of five-year AA+ rated bonds over government bonds rose from 1.57% in September 2010 to 2.12% in February.
Convertible bonds have grown in popularity: issuance has risen tenfold in one year – mainly from financial institutions – and looks set to rise further. Strong demand for equity-related paper has helped to contain the financing costs, making issues attractive for large companies.
Offshore ‘Dim Sum’ bonds attract demand
An emerging offshore corporate bond market in Hong Kong – part of the strategy to internationalise the Chinese currency in preparation for full convertibility – is attracting foreign and domestic issuers, keen to tap into accumulated export proceeds settled in renminbi. Non-existent a year ago, total issuance of ‘Dim Sum’ bonds currently stands at RMB 75 billion and looks set to rise. Again, demand from investors for hitherto scarce assets is lowering the funding costs for corporates issuing in offshore renminbi as opposed to hard currency.
With inflation pressures expected to linger on through the first half of 2011, we believe that after two increases since last December, investors are expecting further official rate rises. This is currently reflected in better value across the yield curve. All the while, the appreciation of the renminbi has boosted returns for QFIIs over the last year.
Investment specialist – emerging markets (group head)