As Investor Funds Withdraw, China's Repo Market Opening Accelerates... Will 'Yuan Carry Trade' Become a Trend?

원본보기 아이콘

Recently, amid the significant potential demand for yuan carry trades (borrowing yuan to invest in dollar assets) leveraging the interest rate differential between the U.S. and China, there is a forecast that if China opens its domestic repo (repurchase agreement) market to foreigners, trading could increase substantially. However, concerns about potential instability in the foreign exchange market suggest that Chinese authorities are likely to adopt a gradual approach by progressively raising the repo trading limits.

According to a recent report from the Bank of Korea's Hong Kong representative office, the People's Bank of China (PBOC), which mentioned allowing foreign investors to participate in the repo market last January, reportedly completed the consultation process, including gathering market opinions, last week. Foreign participation in China's repo market has been under review since 2019, but progress has been slow. Currently, only overseas central banks, government investment institutions, and yuan clearing and settlement banks are permitted to participate, making it limited.

However, as foreign investment funds have been flowing out like a receding tide due to declining investment attractiveness in China’s global market, authorities are interpreted to have accelerated the 'sudden approval' process. The Bank of Korea explains that the move to speed up and fully allow foreign participation aims to stimulate foreign investment in Chinese bonds, which has been sluggish. From China’s perspective, enhancing convenience for foreigners investing in the mainland market is expected to have a positive impact on liquidity supply.

This change is expected to alter the current carry trade trend in the long term. Over the past decade, the yen carry trade gained popularity, fueled by the extreme yen depreciation, but with the Bank of Japan's (BOJ) interest rate hikes now a foregone conclusion and the yuan continuing to weaken, some market views suggest the trend is shifting toward yuan carry trades. Carry trades involve borrowing currency from countries with low interest rates to invest in assets of countries with higher interest rates.

Opening the repo market is likely to accelerate this trend change. Due to the collateralized nature of repo transactions, yuan can be procured relatively cheaply compared to unsecured credit borrowing.

The Bank of Korea’s report also states, "If the Chinese repo market opens to foreigners in the Hong Kong financial market, the scale of related transactions is expected to increase significantly, and derivative transactions will also expand." It explains, "Foreign investors will be able to procure yuan through repo transactions and enjoy more diverse investment opportunities such as carry trades." In fact, last year, the volume of repo transactions within China reached approximately $23.18 trillion, marking a 21% increase compared to the previous year.

According to Bloomberg, the People's Bank of China announced that as of the end of last year, more than 1,100 foreign institutions from over 70 countries or regions had accessed the Chinese bond market. Bloomberg noted, "All of these are potential investors who could access the repo market," but added, "From China’s perspective, there remain technical issues to resolve and differences in operational methods compared to other countries’ markets."

Kim Min-gyu, the Bank of Korea’s Hong Kong representative, said, "Considering potential problems that could arise if foreign repo transactions increase rapidly, Chinese authorities are likely to allow participation by gradually expanding the repo trading limits for overseas financial institutions." He added, "Although the official implementation date has not yet been set, once details such as the repo trading limits for participating institutions are finalized, it is expected to be implemented soon."

© The Asia Business Daily(www.asiae.co.kr). All rights reserved.