Plans by the World Bank to sell special drawing right (SDR) bonds in China are facing market headwinds thanks to expectations of low yields, investors said, although state-owned banks will likely take up any slack in demand. The issue would be the first SDR bond in 35 years and is part of a wider push in China to increase the net supply of such bonds, helping boost demand for Chinese yuan and diminish reliance on the US dollar in global reserves.
The bonds will be settled in renminbi, but Chinese traders said they expected limited demand. "The first wave of SDR bonds will be held until maturity; liquidity will be relatively poor," predicted an analyst report by China International Capital Corporation. China's central bank said earlier in August that the World Bank will issue 500 million SDR ($700m) in bonds as part of a 2 billion SDR programme.
The IMF has agreed to include the yuan in its SDR basket from October 1 this year. It will take up 10 percent of the basket and sit alongside the dollar, the euro, the pound and the yen. Inclusion was seen as a major diplomatic victory for Beijing, which is trying to increase the global stature of its currency for use in trade and as a reserve currency. But the victory is largely symbolic so long as SDR bonds remain lightly used. IMF data shows that SDR holdings made up only 3.24 percent of global official currency reserves at the end of 2014.
No official yield range has been published for the SDR bond issue and no final date for their sale has been set either. The World Bank has discussed the potential yield at length with the underwriter, a spokesperson said, noting the issue would provide a hedge against currency risk.
However, Chinese dealers said the yield on the bonds would be too low to attract much demand from commercial traders, reflecting in part low-to-negative interest rates in Japan, the United States and Europe. The latest SDR interest rate posted by the IMF stood at 0.05 percent. A source close to World Bank bond underwriters predicted the SDR bonds would carry a coupon of between 0.3 percent and 0.6 percent.
A coupon of less 1 percent would be a new low in the domestic market, traders said. "That coupon is too low. We prefer allocating offshore US dollar bonds with higher yields under normal circumstances, but, still, we will buy some to support the innovation and renminbi internationalisation," said a Beijing-based investor with a major state-owned Chinese bank.
ICBC, the lead bookrunner on the offering, calculated that investors could get an annualised return of 2.5 percent in renminbi on the basis of currency forwards on the four other currencies in the SDR basket, assuming a coupon of 0.5 percent. However, domestic investors can buy far more liquid three-year China Development Bank bonds yielding around 2.7 percent, without having to tangle with currency swaps and forwards, which remain underdeveloped in China. Still, investors said Beijing will not let an auction intended to support the internationalisation of the currency fail for lack of demand. If commercial buyers hold back, the central bank will order major state-owned banks to buy up the issue, as they have done in other offshore bond issues.
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