Dim Sum Anyone?

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No, I’m not talking about the meal of steamed dumplings and buns, rice noodle rolls, steamed vegetables, egg tarts and other Chinese delicacies that is so popular in Hong Kong. I’m talking about the $31 billion of RMB-denominated “dim sum” bonds that may be issued in Hong Kong this year.

What’s a dim sum bond? Quite simply, it’s a Chinese yuan-denominated bond, typically with a two to four-year maturity that is issued in Hong Kong by an international company. Provided that the issuer receives approval from Chinese regulators to repatriate the yuan that it raises, the issuer may use the proceeds from the sale of dim sum bonds to meet its obligations in China. For the buyers, obtaining a higher interest rate than is available from bank deposits, as well as the ability to purchase a yuan-denominated security and to benefit from the appreciation of the Chinese currency that many expect in the coming years are the main attractions of dim sum bonds.

Since first being introduced in 2010, the issuance of dim sum bonds is increasing rapidly due to the growing amount of RMB that is now circulating in the global economy. At the end of April, there was an estimated RMB 510 billion ($78.5 billion) on deposit in Hong Kong banks, up from RMB 310 billion ($47.7 billion) at the end of 2010. Dim sum bonds provide an investment outlet for yuan that would otherwise be stuck in low-yielding bank deposits.

In 2010, 16 yuan bond issuers raised RMB 36 billion ($5.5 billion) through the issuance of dim sum bonds, but this number is expected to increase dramatically in 2011. According to an estimate from Mizuho Securities Asia Ltd., dim sum note sales may increase to RMB 200 billion ($31 billion) this year, as global investors bet on the yuan appreciating more than the currencies of Brazil, India and Russia.

To date, McDonald’s, Caterpillar and Unilever are three large international companies that have taken advantage of this new financing vehicle. McDonald’s raised RMB 200 million ($31 million) of 3 percent, three-year notes in August 2010; Caterpillar Financial Services raised RMB 500 million ($77 million) of 2 percent, two-year notes in November 2010; and Unilever raised RMB 300 million ($46 million) of 1.15 percent, three-year notes in March, 2011. By comparison, the benchmark one-year lending rate in China set by the People’s Bank of China is 6.31 percent.

In addition to the global issuers, the offshore subsidiaries of Chinese companies have also issued dim sum bonds. These include subsidiaries of Sinotruk, China Merchants, China Power International and BYD.

One of the biggest hurdles for issuers to clear is obtaining approval to repatriate the funds raised in Hong Kong, at a time when China is struggling to control the inflow of “hot money” into its economy. According to many economists, China will grow 9.5 percent in 2011. This is luring investment and boosting capital inflows that add to the record $3 trillion of foreign-exchange reserves held in China and are hampering efforts by China’s central bank to limit gains in real estate and control inflation.

Currently, foreign direct investment in yuan needs case-by-case approval from regulators. “The mainland may not want the offshore pool of yuan to return in the form of portfolio investments into equities or real estate as these markets do not need much fresh capital, but they would welcome more foreign direct investment,” said Dariusz Kowalczyk, an economist at Credit Agricole CIB in Hong Kong.

Many see dim sum bonds as one of a number of developments that will ultimately lead to the internationalization of the yuan as a global reserve currency. That may be true, but in the meantime, it is providing yet another way in which international companies can fund their China expansions by accessing relatively inexpensive Chinese sources of capital.

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