LUXEMBOURG Feb 27 Bankers and policymakers across Europe want a slice of the growing market in China's offshore currency, but a slowing economy and the yuan's recent slide may make investors wary.
In barely five years, China's gradual liberalisation of its renminbi, or yuan, currency has inspired a slew of investment funds based in Hong Kong or elsewhere, including those aimed at the retail market.
"Dim sum" bonds are designed to be traded outside China and there is a large turnover in the offshore renminbi in the big foreign exchange trading centres such as London.
Luxembourg, Paris and Frankfurt are also competing with Asian centres for a share of this offshore trade.
Investors have been attracted by China's earlier double-digit economic growth and by the renminbi's careful management on an appreciation trend. They can generally only access the currency through these off-shore instruments.
But a recent fall in the renminbi suggests the central bank is keen to wipe out a speculative bubble in Chinese assets and make its currency more competitive as the U.S. withdrawal of monetary stimulus batters other emerging market currencies, potentially making their exports cheaper.
This pressure to restrain renminbi appreciation may slow China's offshore currency expansion.
"Over the next few months, you will see some tension between the hot money and the internationalisation of the renminbi," Frederic Neumann, co-head of Asian economic research at HSBC, told a conference in Luxembourg this week.
China's yuan briefly fell on Thursday and remained below the official fixing for a third straight day. Normally closely managed, it has fallen a hefty 1 percent in the past two weeks.
Unlike countries such as Kazakhstan and Nigeria, which have let their currencies fall as their dollar supplies dwindle, China has $3.8 trillion in central bank reserves to support it.
But analysts think the central bank is now aiming to inject more two-way volatility into the market and prepare it for more reforms, stamping out speculative bets on the currency.
Overstretched investors were positioned for further yuan gains, rather than the fall.
"It was a shock, the people (buying the yuan) were 30 times leveraged," said Stefano Chao, Investment Manager at AZ Investment Management, in Shanghai.
The move dents China's image as a relative safe haven for debt investors, because of its double-A rating, one of the highest for emerging market sovereigns.
Dim sum bonds have turned into a 400 billion yuan ($65 billion) market in little over three years, mainly out of Hong Kong. But investors are less likely to buy into the market if they can no longer get guaranteed currency appreciation.
Another attraction of buying the offshore renminbi has been the prospect of the onshore currency eventually becoming fully convertible, being bought up by central banks as a reserve currency and merging with investors' offshore holdings to become one of the world's most active currencies.
But international investors are far less upbeat about the speed of this change than Chinese investors. An investor survey by State Street this week showed that while 30 percent of onshore investors see the renminbi as one of the top two traded currencies by 2020, no offshore investors do.
China's growth has also slowed to the 7 percent level widely seen as the minimum required to underpin social and economic change, and investors are worried about defaults within the large shadow banking sector.
"There is a continuing and growing fear outside China about how well this transition from an export-led economy to a consumption-led economy will occur," said Michael Metcalfe, head of global macro strategy at State Street Global Markets.
"The fear is there will be a rapid slowdown in growth."
Reflecting caution among European and U.S. investors, most dim sum bond investors and issuers are based in Asia.
But with China still a magnet for foreign direct investment, an increasing amount of it denominated in renminbi, financial centres outside Asia also want part of the action.
According to research by consultancy PwC published this week, 63 percent of China's $118 billion FDI was settled in renminbi last year, compared with only 12 percent in 2011, and a larger share of outward FDI is in renminbi.
It has overtaken the Swiss franc to become the world's 7th most used currency for payments, acording to global transactions organisation SWIFT.
Hong Kong is by far the largest centre for offshore deposits, according to the PwC survey, with deposits in Taiwan, Singapore and Macau also dwarfing Luxembourg, Paris or London. The United States is nowhere to be seen in this competition.
The European offshore renminbi centres are struggling for liquidity without their own clearing banks, although Britain and China have been discussing one.
The key, according to speakers at this week's Luxembourg conference on the offshore renminbi, is for western companies to be far more open to investment and payments in China's currency - particularly as Chinese tourists increase, with their well-known love for luxury goods.
That may already be starting to happen. "Chinese customers on the Champs Elysees, more and more they can use a credit card in renminbi, and that's very important," said Bernard Poignant, China advisor at Paris Europlace.