The trade imperative

Similar to the decision to open swap lines between the Australian and Chinese central banks in CNY, the recent announcement that the Reserve Bank of Australia will diversify 5% of its holdings into Chinese government bonds makes good political and (in terms of encouraging trade) business sense.  

But are they a valuable instrument? In terms of currency value, the Chinese currency RMB would appear to most likely to appreciate (taking stated information about fundamentals as given).  But the likelihood that there will be a decent return from the Chinese government?

Don't bank on it.  It is a reflection of the broader alignment of the Australian economy too - and looking at the recent headlines doesn't make good reading:

The economic weakness in China clearly appears to be taking a toll on the Aussie economy.... (here)

The Cyprus connection...

Australia is not Cyprus.  Professor Ross Garnaut said as much during an interview with the ABC's Tony Jones this week (more on that later).  Of course Australia is not a small country tied into an unpalatable and unfunctioning monetary union like a Mediterranean peripheral country.  So why the headline.

Well Australia is tied strongly to China and... is very dependent on offshore financing.  Since the GFC started in 2007 Ozzie banks were exposed for the relatively small deposit bases - something they have been remedying in recent years (though not without using this as an excuse to gouge depositors).  This in itself is not particularly remarkable - the Aussie dollar and bond markets have swelled with surging inflows as worldwide investors have galloped in for healthy returns and interest rates in Australia's booming economy.

But therein lies the risk - should a sudden reversal of sentiment cause a 180 degree turn and a rush of money out of the country, how exposed will #Ozeconomy be? It's hard to say but one tweet by respected economist Stephen Koukoulas raised an eyebrow.  Though justifying the current strong position there does seem to be a hint of possible future vulnerability for Australia:

All is fine for now but worth remembering that confidence is precious...

UPDATE - Bloomberg has an article indicating that foreign interest in Australian bonds is falling:

...Banks held A$76.2 billion ($79.5 billion) of securities issued by regional borrowing authorities, or 37 percent of the outstanding debt, at the end of 2012, according to data from the statistics bureau. That’s up from A$71 billion, or 35 percent, at the end of the third quarter. The share of foreigners’ holdings fell to 32 percent, the lowest level since June 30, 2009....(here)

Credit risk rising

The cost of insuring corporate bonds from non-payment in Australia increased, according to traders of credit-default swaps....The Markit iTraxx Australia index rose 0.5 basis point to 113.5 basis points.....The gauge has fallen 14 basis points since Dec. 31, extending a 53 basis-point drop in 2012, CMA data show....Credit-default swap indexes are benchmarks for insuring bonds against default and traders use them to speculate on credit quality. A drop signals improving perceptions of creditworthiness, while an increase suggests the opposite (here).