August 2, 2016 4:35 am JST

SDR bonds are China's next step to take yuan global

YUSHO CHO, Nikkei staff writer

SHANGHAI -- With the yuan set to enter the Special Drawing Rights currency basket in October, China looks to create a market for SDR-denominated bonds as a step toward internationalizing the country's currency.

The government-linked China Development Bank as early as this month will issue $300 million to $800 million in notes denominated in the International Monetary Fund's reserve currency, with maturities of around six months. This will mark the first float of SDR-denominated bonds by an individual financial institution.

The China Development Bank has informed domestic and foreign banks about the float, with Japan's three megabanks among those expressing interest. Other major Chinese banks apparently are planning SDR bond offerings as well. The government will open trading of these instruments on the interbank market.

The float is part of Beijing's efforts to make the yuan a global currency used widely in international transactions and investment. The IMF decided last year to add the yuan to the set of currencies used to determine the SDR's value, which now consists of the dollar, euro, pound and yen. SDR-denominated bonds suffer relatively little loss of value even if some currencies in the basket depreciate.

The yuan will not become a global currency overnight. And Beijing wants to avoid liberalizing yuan-denominated financial transactions all at once, which would throw financial markets into chaos. China hopes that expanding the market for SDR-denominated bonds, whose value will be based partly on the yuan, will shore up the currency's international position. Some say the government also aims to end overreliance on the dollar for cross-border trade settlement and foreign currency reserves.

People's Bank of China Gov. Zhou Xiaochuan argued in 2009 that the SDR should be the main global currency, citing loss of trust in the greenback after the 2008 financial crisis. He also touched on broader use of the SDR at last month's meeting of Group of 20 finance ministers and central bankers in the Chinese city of Chengdu.

President Xi Jinping hopes to cite a successful SDR bond float as progress toward the yuan's internationalization when G-20 leaders meet next month in Hangzhou, China. But whether a substantial market exists remains an open question. The SDR's value is based on multiple currencies, making hedging against currency risk complex and costly. The government's decision to opt for short-term bonds was likely based on the assumption that buyers would hold the notes until maturity.

Investors are also unimpressed with the coupon. The bonds likely will pay an annual rate of just 1% or so, a major bank said, though this will depend on demand. Given the costs involved, many banks likely would end up losing money. Cultivating a market for the instruments will require heeding investors' opinions.

Beijing's strong push for SDR-denominated bonds could lead to some purchases by Chinese banks and foreign banks operating in the country. But the lack of past floats by U.S. or European financial institutions suggests that potential demand is thin.

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