RMB fixed income – what can we expect in 2014?

24 January 2014   Category: News, Asia, China, Global   By Geoffrey Lunt*

2013 saw the usual lurid headlines forecasting impending economic doom for China in various guises. Investors should expect exactly the same in 2014 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 RMB market in USD terms returned nearly 7%, 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 which claim that everything is broadly OK. This phenomenon may be particularly acute when it comes to China because it is a subject which is difficult to understand given the country’s significant differences in language, culture and economic system to many other parts of the world. In a similar vein, commentators may be guilty of judging China by western standards. In this way, 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 manoeuvre 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 RMB is not only underpinned by sound fundamentals, but its further appreciation against the US dollar is part of broader Chinese economic policy.

The second is more specifically to do with the nature of the offshore RMB market. This is a 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, each of which 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 so far 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). It’s worth noting that 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. In this way, 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 interests and bolster growth of the entire bond market.

This suggests to us that the prospects for this market remain good, that the risks are skewed in the investors favour, and that although returns are unlikely to be spectacular, there is a good chance that they will once again be stable and resilient.

The important thing for investors to remember is that investing in RMB bonds will not be a discretionary option for very much longer. If today the Chinese government market were included in the Citi WGBI, it would make up around 6% of the total, but with the Chinese market growing much more quickly than others, it stands to reason that in three-to-five years time the weighting will be much higher. Moreover, if we add into this mix the diversifying qualities of the RMB 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. Putting this in a longer-term context, the broad thrust and implication for the bond markets is abundantly clear. China and its markets are opening up. RMB bond markets are already amongst 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, Asian fixed income, at HSBC Global Asset Management