SDR Bonds May Have Limited Impact, Lower Interest Rate Than China Govt Bonds, Economist Says
Yicai Global
/SOURCE : Yicai
SDR Bonds May Have Limited Impact, Lower Interest Rate Than China Govt Bonds, Economist Says

(Yicai Global) Aug. 17 -- The World Bank's plan to issue bonds backed by the International Monetary Fund's special drawing rights reserve asset may have limited impact despite diversifying China's financial market instruments, the chief economist of one investment bank has said.

The World Bank is the first body to gain approval from the People's Bank of China to issue SDR-backed bonds in the world's second-largest economy. The first batch will total SDR2 billion (CNY18.5 billion or USD2.79 billion).

"This is a landmark development for China's bond market and for the SDR as an international reserve asset," World Bank Group President Jim Yong Kim said in a statement last week. "We are very pleased to support China's growing role in global financial markets."

Ms. Liang Hong, chief economist at China International Capital Corporation Ltd., wrote in a research report that the notes could help bondholders to diversify their portfolios and reduce risks associated with exchange and interest rates, though participants would face adjustments in the SDR currency basket every five years. These are complex issues that will significantly limit the expansion of China's SDR market, she said.

The SDR-denominated bonds will be settled in yuan. The underwriters include Hongkong and Shanghai Banking Corp., Industrial and Commercial Bank of China Ltd., and China Construction Bank Corp. and China Development Bank Corp.

In the absence of an effective yield curve, the question of how to price the bonds has become a major focus. In theory, the interest rate should equal the rate of treasury bonds plus the expected gain from the yuan's appreciation against the SDR over the same period, as well as the credit spread of the bond issuer, Ms. Liang said. But because of an anticipated decline in the yuan, the interest rate would be lower than that of Chinese government bonds over the same period.

China's central bank has said the interest and principal of the first batch of SDR bonds will be paid in yuan. Ms. Liang noted that this would spur the yuan's use in financial settlements. Although it would be unable to outstrip the dollar in the near term, the yuan has ample room and huge potential to be used more widely in international trade, given the size of the Chinese economy.

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