Opening up panda bond sector will pay enormous dividends

The nation's reform agenda is taking hold, building on three decades of unprecedented growth that has lifted millions of Chinese out of poverty. Despite the economic slowdown, projections that the Chinese economy will grow by more than 7 percent and create more than 10 million jobs this year are still far more favorable than the outlook in many economies.

Investors are keen to be part of China's growth story, and they are looking to the capital markets for opportunities. Foreign investors are clamoring for yuan-denominated assets while international financial centers are racing to become hubs for transactions in the Chinese currency.

In October, the United Kingdom became the first Western sovereign borrower to launch dim sum bonds, which are yuan-denominated securities issued outside the Chinese mainland. The issue generated so much interest that the bond size was increased by one-third and it was more than twice oversubscribed.

The internationalization of the yuan is also gaining traction. More and more central banks are holding yuan reserves, and the currency is the second most used in global trade finance after the dollar.

Just last month, the International Monetary Fund announced that it would consider including the yuan in its currency basket for Special Drawing Rights－an international reserve asset－that is currently comprised of the dollar, euro, yen and sterling.

There is momentum for the Chinese currency. But sustaining this momentum hinges on China's ability to achieve reforms that will liberalize its capital markets, particularly on the domestic front.

Capital markets are inextricably linked to China's growth story. Economies need an efficient mechanism to fund growth from within by mobilizing savings and generating alternate sources of capital for the private sector, the key driver of growth and jobs.

Consider that growth in member nations of the Organization for Economic Cooperation and Development has been mainly fueled by domestic savings. Vibrant, deep and efficient capital markets are fundamental for companies to develop and create products of value, generate employment and opportunities and improve standards of living.

China's capital markets are the world's third-largest. Since 2006, the government bond market has grown by an annual average of 15 percent. The size of the corporate bond market (excluding financial institutions) is 11.8 trillion yuan ($1.9 trillion).

But China must sharpen its focus on the domestic markets. As the economy opens up, the domestic markets must be deep, liquid and efficient enough to absorb international capital inflows and serve the growing financing needs of the private sector, while providing a buffer against volatile movement of capital－a key lesson of the Asian financial crisis.

An important element in deepening the domestic capital markets is encouraging the diversity of issuers and investors of panda bonds, which are yuan-denominated securities issued onshore. At present, the vast majority of panda bond issuers are Chinese entities.

The benefits of opening the domestic markets include offering Chinese investors access to diverse products, unleashing trapped domestic savings to fuel investments and providing a source of formal, reliable funding for small and medium-sized enterprises, which now depend heavily on the shadow banking system.

China is well aware that this process will require a number of reforms, and it is carefully revising regulations to be compatible with this change.

As China pursues reform, International Finance Corporation will continue to work with the government in supporting the capital markets. Our collaboration goes back to 2005 when we became the first nonresident issuer of panda bonds. We have since also issued dim sum bonds in financial centers across the world, raising more than 50 billion yuan for investment in China.

IFC stands ready to re-enter the Panda bond market. As an international triple-A rated issuer, we are committed to supporting China's domestic capital markets through a program that would allow us to regularly issue Panda bonds when market opportunities align with the funding needs of IFC clients.

There are some challenges, including the need to reconcile the different regulatory agencies overseeing domestic bond issues by international borrowers. There is also the need to factor in technical differences in accounting and credit rating matters between domestic requirements and customary practices by international issuers.

While these considerations require careful planning, the benefits will be well worth it. Regular issues by a variety of issuers, including international triple-A rated institutions such as the IFC, will send a strong signal to borrowers and investors everywhere that the panda bond markets are open for business.

The author is vice-president and treasurer at International Finance Corporation, a member of the World Bank Group and the largest global development finance institution focused on the private sector.