Recently, China raised ~€4 billion in total from Europe. As a part of the issue, China, for the first time issued bonds at a negative yield. In yesterday’s piece we had a look at what negative interest rates for banks and debt are. If you missed that you can read by clicking here. So what does it mean when we say China is borrowing at a negative interest rate and why is this bond issue in hot demand even if investors are getting less money in the future than they are investing today? Let’s quench your thirst.
Crux of the Matter
China Borrows At Negative Interest Rate
Recently, China raised ~€4 billion in total from Europe. As a part of the deal, it issued a bond with a negative yield (of –0.152% for a 5-year tenor) for the first time. It also issued 10-year and 15-year securities with positive yields of 0.318% and 0.664% respectively.
Bonds are ‘fixed-income’ securities issued by central banks, governments, or companies. The interest received per annum on bonds is fixed. Moreover, they are considered a safe investment option and thus there is always a demand for it among investors.
What Are Negative Yield Bond?
Yield is the return an investor receives for the investment in bonds. It includes both, interest payment and appreciation in bond value – generally bonds have positive yield.
So in negative yield bonds, an investor gets less money on maturity than the purchasing price.
In China’s issue, China is the borrower and investors are financial institutions, individuals, etc. Let’s say an investor invests €100 in China’s negative yield bond. At maturity, the investor will receive ~€99.85 (yield is -0.15%).
If investors are getting less money than they invested why are they even investing?
Reason For High Demand
You must note that China issued these bonds in (or raised money from) Europe. Due to Covid-19, bond yields in Europe and developed countries are even lower than what China is offering. Yields in developed countries and Europe are between -0.5% and -0.75% in comparison to China’s bond yield of -0.15%.
Better to receive €99.85 than €99.5 or €99.25 on an investment of €100, right?
Investors consider bonds as a safe investment instrument that prevents capital from significant erosion. As global nations continue fighting Covid-19, most of the economies are still reviving, and China is the only country to report positive GDP growth of 4.9% in the Jul-Sept 2020 period. Also, experts say investors have a positive outlook on China’s growth.
There is an expectation that the new US government may impose fresh lockdowns in the economy as Covid cases are picking up in various US states and European countries, whereas China seems relatively safe now from that perspective. This is expected to lead to volatility in the financial markets in coming days, pushing up demand for safety of capital alongside flows into risk assets.
- Simple interest is a fixed percentage of the principal amount that the borrower must pay. It is fixed. Compound interest is added to the accumulated interest of previous periods, so borrowers must pay interest on interest as well as principal borrowed.
- State Bank of India started as Bank of Bengal. This was one of the three banks founded by a presidency government along with the Bank of Bombay and the Bank of Madras. The three merged to form the Imperial Bank of India and renamed to the State Bank of India in 1955 after Independence.
- Zero interest-rate policy (ZIRP) is a concept of a very low nominal interest rate. The United States cut the Fed Funds rate to nearly zero due to the Covid-19 pandemic and weakening economy. ZIRP is considered to be an unconventional monetary policy instrument and can be associated with slow economic growth, deflation, and deleverage.