World Bank’s SDR Bond: What It Is and Isn’t

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. 
has been much fanfare.  It is the first SDR bond in more than 30 years according to reports.  

The bond was
in mainland China.  Investors
the bond in yuan, and the
yield is paid in yuan. 
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

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
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.  


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