HONG KONG Aug 29 (Reuters) - A big challenge to the dim sum bond market is stagnant growth in yuan liquidity in Hong Kong, as offshore funds flow back to China via pilot schemes targeted to attract global investors.
Pressure will be especially heavy in September when the fledgling market comes back from thin summer supply, possibly with a 10 billion yuan ($1.63 billion) government bond, while Beijing expedites the opening up of its financial markets.
The quota approved for the Renminbi Qualified Foreign Institutional Investor (RQFII) programme that allows foreign investors to put money in China's bonds and equities saw a 75 percent jump to 17 billion yuan in July from a month earlier.
Under this scheme, financial institutions who are eager to flee emerging market volatility are able to find a place to make investments with decent returns. In recent weeks, emerging markets have reeled from hot money outflows due to an expected winding down of U.S. Federal Reserve monetary stimulus.
Against this backdrop of Fed tapering and turbulence, the 25 trillion yuan onshore bond market looks appealing.
The 10-year treasury bond whose yield is hovering around a two-year high, is offering a return of more than 4 percent, 500 basis points higher than dim sum government bonds with the same tenor.
"Expansion of the RQFII scheme is a real threat to the dim sum bond market. When we had a meeting with Chinese regulators some time ago, we suggested they pay attention to the offshore yuan pool when granting new licences," said a banker in Hong Kong.
The dim sum bond market experienced a rare barren patch in the past two months and is expected to see strong pipelines from September. China's Ministry of Finance will also return to the market to sell the second tranche of its 23 billion yuan bonds.
Hong Kong's yuan deposits fell in June, snapping eight consecutive months of expansion to stand at 698 billion yuan. It is expected to grow only mildly to 700-750 billion yuan by the end of the year.
That compares with a 270 billion yuan quota for RQFII and possibly another 100 billion yuan RQFII quota for Taiwan investors alone.
That said, the good news is Chinese regulators are making efforts to relax rules and make it easier for the yuan to flow out of the world's second-largest economy.
The State Administration of Foreign Exchange (SAFE) said on Tuesday that qualified domestic institutional investors (QDIIs) can use whatever foreign currencies they want when investing abroad.
This means domestic investors will be able to transfer their yuan funds abroad to make investments, which is actually the launch of Renminbi QDII, the counterpart of RQFII that carries opposite fund flows.
"It will increase the supply of RMB in Hong Kong and looking forward, there should be more measures to encourage yuan outflows," said Ngan Kim Man, Hang Seng Bank's Head of RMB business strategy and planning department.
A Citigroup index measuring returns of offshore yuan bonds in U.S. dollars have eked out meagre returns since June in contrast to sharp falls in a Barclays index measuring returns of Asian local currency government bonds.
WEEK IN REVIEW:
* The Hong Kong Monetary Authority (HKMA) said on Monday its renminbi Real Time Gross Settlement system and Shenzhen Financial Settlement System began a trial run of linkage in January, allowing extension of operating hours of cross-border renminbi payment services between Hong Kong and the mainland.
* In the first seven months, daily average transaction processed during the extended settlement hours amounted to 4.5 billion yuan, which nearly doubled from the second half of last year's daily average transaction of 2.6 billion yuan before the launch of the new arrangement, the HKMA said.
* Luxembourg climbed to second place in the euro zone for RMB payments in July which was mainly driven by financial transfers, said global transaction services organisation SWIFT on Tuesday. The RMB remained the 11th mostly used global currency in July with a market share of 0.87 percent.
* China Asset Management (Hong Kong) listed its second Renminbi Qualified Foreign Institutional Investor (RQFII) A-share exchange traded fund (ETF) on the Hong Kong Stock Exchange on Monday. The ETF tracks CES China A80 index.
* Chinese asset manager E Fund Management (HK) launched its RMB Mainland China Bond Fund last Thursday, investing in bonds with a credit rating higher than BBB-. The fund has an RQFII quota of 1 billion yuan and offers subscription and redemption in RMB, HKD and USD.
* The HKMA and Bank Negara Malaysia (BNM) held a bilateral meeting on Wednesday and decided that private-sector led dialogues to discuss developments in RMB business would be initiated to facilitate greater trade and investment activities.
CHART OF THE WEEK:
Yield spread between onshore and offshore government bonds widens: link.reuters.com/byx62v
RECENT STORIES: CNH Tracker-Yuan cross currency swap rates face downward pressure Dim Sum offers shelter from EM storm-IFR
More stories about the CNH market Daily onshore yuan reports Daily China money market reports
Offshore yuan rate Onshore yuan rate Offshore yuan dealt Onshore yuan on CFETS Offshore yuan bonds THOMSON REUTERS SPEED GUIDES
($1 = 6.1202 Chinese yuan) (Reporting by Michelle Chen; Editing by Jacqueline Wong)