OREANDA-NEWS. Fitch Ratings says in a new report that issuance activity in China's Dim Sum Bond (DSB) - or offshore yuan market - will remain hostage to yuan depreciation concerns in the short term. But activity could revive as the yuan stabilises, and potentially take off in the longer term if projects associated with China's One Belt-One Road (OBOR) initiative deliver significant demand.

New issuance of DSB fell by 42% yoy in 2015, and concerns over further yuan depreciation kept new issuance activity at bay during 1Q16 - resulting in total outstanding DSBs falling for the first time to USD83.4bn by end-1Q16 from USD86.7bn at end-2015.

Notably, foreign corporates have stayed away from the DSB market since July 2015, and Chinese corporates since November 2015. However, issuance by financial institutions, particularly global banks, continued strongly during 2015 and into 1Q16 notwithstanding the spike in DSB yields.

DSB yields rose significantly after the Chinese government allowed the yuan to depreciate from August 2015. At the same time, onshore bond yields continued to fall in line with the People's Bank of China's (PBoC) interest-rate cuts during 2015, making it a straightforward decision for local Chinese entities to issue onshore bonds instead of DSB.

The 100bp-150bp yield premiums on DSBs over onshore bonds as of end-April 2016 illustrates that the DSB market is dominated by investors seeking to profit from tactical FX opportunities. Accordingly, a dichotomy exists between the deep onshore yuan marketed characterised by high liquidity and a lack of alternative options for local bond investors, and the shallow offshore DSB market where investors are highly sensitive to yuan movements and do have alternative options.

DSB market growth is likely to be supported by yuan internationalisation over the medium term - including the yuan's inclusion in the IMF's SDR basket of currencies from October 2016, and China's OBOR initiative.