Sunday, 14 December 2008
Panda Bonds Could Help China Avoid the Risks of US Treasury Bonds
The Panda bond is RMB-dominated and issued by foreign financial institutions (governments, companies, and international organizations). Panda bond’s buyers should be Chinese financial institutions, mainly commercial banks. Overseas financial institutions, short of USD, can buy USD from Chinese counterparts with RMB after getting RMB fund. Besides paying regular interest in RMB, bond issuers would repay principal in RMB to the bond holder (Chinese commercial banks) when the bond matures.
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Panda Bonds Could Help China Avoid the Risks of US Treasury Bonds
Yu Yongding
14 December 2008
China is deeply trapped in the global financial crisis, and will unavoidably suffer heavy losses. China’s foreign exchange currency reserve has reached about $2 trillion, and is yet growing by about $300 billion every year. With the worsening of the US financial crisis, the gain and security of China’s foreign exchange reserve is facing increasingly serious threat. Undoubtedly China must realize trading balance as soon as possible, which is in the eleventh “Five-year Plan”. But if China cannot adequately reduce its current account and capital account surpluses over the short or medium terms, then it must find a way to guarantee the security, liquidity, and profit of its current foreign exchange reserve.
Issuing panda bonds may be a way out
The US issued Deutschmark and Swiss Franc bonds called “Carter Bonds” during Jimmy Carter Administration. In 2007 some domestic institutions suggested that Beijing allow foreign companies to issue Yuan bonds, and several months ago, it was suggested that foreign financial firms be allowed to issue panda bonds. Recently Japanese economists appealed that the US should issue Yen bonds and bonds of other currencies, named “Obama Bonds”. Issuing panda bonds would not only reduce China’s risk of increased holding of US national debt and promote RMB’s globalization, it would also help to relieve the liquidity crunch of other countries and promote financial stability.
The Panda bond is RMB-dominated and issued by foreign financial institutions (governments, companies, and international organizations). Panda bond’s buyers should be Chinese financial institutions, mainly commercial banks. Overseas financial institutions, short of USD, can buy USD from Chinese counterparts with RMB after getting RMB fund. Besides paying regular interest in RMB, bond issuers would repay principal in RMB to the bond holder (Chinese commercial banks) when the bond matures. Panda bond issuers can buy the RMB they need with USD from foreign exchange markets. For example, the Asian Development Bank (ADB) can buy 10-year RMB bonds from China’s interbank bond market, and then buy USD from China’s central bank with RMB. After the transaction, ADB will get a pool of USD at the price of new long-term RMB liability, while China’s central bank will reduce its holding of USD and get back RMB. Of course, risk exists in China’s purchase of RMB bonds, and many technical problems need to be solved. I hope to see serious discussion on this so this chance is not missed.
Lending USD to foreign financial firms by issuing panda bonds will not only eliminate risks of purchasing US national debt, especially exchange rate risk, but also promote the internationalization of RMB.
Besides issuing panda bond, China must, of course, consider other ways of reducing its foreign exchange reserve. For example, Chinese commercial banks can grant RMB loans to overseas commercial banks. After getting RMB loans, foreign commercial banks can buy USD from China’s central bank and then repay both RMB principal and interest to Chinese commercial banks year by year. Chinese financial firms can consider buying European and Japanese financial assets, such as stock. Besides diversifying financial assets, China can also buy precious metals and other strategic materials with its foreign exchange reserve. In fact, the proportion of gold in China’s reserve is much lower than it is in western countries. China also needs to increase its strategic petroleum reserve.
In a word, China can no longer increase its foreign exchange reserve by $300 billion every year, and should diversify its current foreign exchange reserve, regardless of short-term gain or loss. During the once-every-100-year global financial reserve crisis, avoiding loss is already a great victory. If only China doesn’t lose its shirt!
(The author is the Director of the Institute of World Economics and Politics of the Chinese Academy of Social Sciences. This article is excerpted from his article first published on China Business News in Chinese.)
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