The World Bank sold the equivalent of about $700 mln of a three-year of a multiple currency bond that duplicated the composition of the IMF’s Special Drawing Right or SDR. There has been much fanfare. It is the first SDR bond in more than 30 years according to reports.
The bond was issued in mainland China. Investors buy the bond in yuan, and the yield is paid in yuan. Chinese officials seem to think that the SDR bond kills two birds with one stone. First, it promotes the use and internationalization of the yuan. Second, it offers an alternative to what it perceives is dollar/US hegemony.
This is an exaggerated assessment. The bond is too small to make spark such changes. In fairness, the World Bank intends to issue several more tranches. The second largest bond underwriter in China was quoted in a press report suggesting that the size of the SDR bond market in China may grow to 5 bln SDR units or around $7 bln in the coming years. This week’s issue was the equivalent of about 500 mln SDRs. Even at $7 bln or even $70 bln, the SDR bond market does not have the scale to change the global financial architecture or make a significant contribution to the internationalization of the yuan.
Multiple currency bonds exist, but the market is small. The composition of the SDR bond does not match the liabilities of debt managers. The secondary market is non-existent. The return on the World Bank bond is a function of how the SDR basket does, but it is a yuan bond, and, outside of the novelty, not a particularly attractive one. Consider that the yield on the World Bank bond was 49 bp. The yield of a three-year Chinese government bond is 2.48% today. The US dollar, which is the largest component of the SDR (almost 42%), and the US three-year yield is about 95 bp today.
The World Bank bond was reportedly oversubscribed 2.5x, which is good but not extreme. It raises the question of who are the likely end investors of the World Bank (and others) SDR bonds? Central banks and sovereign wealth are the obvious candidates. The yuan will be included in the SDR as of October 1, and there have been reports that some central banks are in fact buying mainland yuan bonds for reserve purposes. Perhaps, if a reserve manager wanted to have some yuan exposure but was worried about the possibility of depreciation in the coming period, an SDR-linked yuan bond may be an interesting alternative, though it comes at a price (lower yield).
There are some parallels with the debate about China’s initiative AIIB (Asian Infrastructure Investment Bank). Some see it as a rival to the IMF and US hegemony. Yet, barring the lack of participation by the notably the US and Japan (Canada joined this week), it is not much of a departure from the current system. It is working with the other development banks. And, what has been largely lost in the details, is that members of AIIB pay their subscription in US dollars and the loans that it makes are denominated in US dollars.
In the bigger picture, the role of the yuan as a reserve currency can only go up. The IMF has estimated that the yuan accounts for about 1% of global reserves. Reserves are largely invested in sovereign bond markets. The size of China’s national government bond market is too small to absorb a significant part of the global reserves which are $11 trillion (of which China plus Hong Kong account for $3.56 trillion). The SDR is largely a distraction from China’s most pressing issues and the further development of its own capital markets, and, just as important, the general framework and transparency of rules and regulations.