The Potential Role of Panda Bonds in Development Finance

By Yan Wang and Zheng Zhai

Over the past two decades, China has become the largest bilateral provider of development finance. At the 2024 Forum on China-Africa Cooperation (FOCAC), China reaffirmed its commitment to further opening its vast financial market to African nations, encouraging them to issue panda bonds. Alongside this, it pledged $51 billion in various forms of financing. This initiative provides an alternative for many African countries that have been borrowing at high interest rates in the Eurobond market, allowing them to access funding at comparatively lower rates through China’s bond market.

Recently, the former governor of the People’s Bank of China (PBOC), Zhou Xiaochuan, delivered a speech at the Caixin Annual Conference in December 2024, proposing seven recommendations for optimizing China’s overseas investment. These include optimizing China’s external financing structure (shifting from debt to equity investment), debt financing models (increasing panda bonds issuance and reducing dependence on bank loans) and institutional structure (including private and multilateral organizations). In light of the current global efforts of enhancing development finance, Zhou’s speech offers new insights for China’s contribution to the global effort as shown by the UN-led preparation for the 4^th International Conference on Financing For Development (FfD4).

Why it is good timing for issuing panda bonds

Panda bonds refer to a renminbi-denominated bond from a non-Chinese issuer. China’s financial market has experienced a notable internationalization in recent years. Over 1,100 institutions from more than 70 countries and regions had invested in China’s interbank bond market, with foreign capital holdings totaling RMB 4.4 trillion ($610 billion) by the end of September 2024. Additionally, the renminbi-denominated panda bond market serves as an important gateway and symbol of opening China’s financial market to the world. The cumulative issuance of panda bonds has surpassed RMB 800 billion, attracting top international issuers and investors.

Since panda bonds are denominated in RMB, the bonds coupon rates are benchmarked to the domestic interest rates of China, such as the Shanghai Interbank Offered Rate (SHIBOR) and the China Government Bond (CGB) Yield. Traditionally, the coupon rates of bonds denominated in currencies of developed countries are lower than those of developing countries due to the better monetary market conditions of the former. However, this situation substantially changed in recent two years. While the base interest rates in Western countries have been rising since the pandemic to combat inflation, China’s RMB benchmark interest rates have been steadily declining. On January 3, 2025, the yield on China’s 10-year government bonds fell to a record low of 1.61 percent. This leads to an inversion of interest rates between China and Western countries. As shown in Figure 1, the yield on China’s 10-year government bonds has been lower than that of the US since 2022, and this yield gap has been widening since then.

Therefore, issuing panda bonds at this time allows developing countries, if they have needs for RMB financing and generating RMB denominated income, to benefit from China’s low-interest-rate market environment, reducing the financing costs and contributing to alleviating the debt distress.

Figure 1: Yield on China and US 10-year government bonds

Panda bonds: win-win for China and other Global South countries

Increasing the issuance of panda bonds could be win-win for China and host countries. Once a host country identifies a development project, it brings another funding option, reducing their financing reliance on dollar-denominated bonds. Additionally, they can diversify their funding channels in China from mainly relying on loans from the China Development Bank (CDB), the Export-Import Bank of China (CHEXIM) or other commercial banks, to directly raising funds in the market by issuing panda bonds.

Second, since panda bonds can be traded in the secondary market, they provide more liquidity to the sovereign bonds of developing countries, helping to attract more market investors to trade this financial asset. With the rapid increase in panda bond issuances in 2024, the liquidity of panda bonds in the secondary market has also shown significant progress, with monthly trading volume increasing from around RMB 30 billion in 2023 to over RMB 50 billion in 2024.

Third, increasing the share of RMB-denominated panda bonds contributes to the diversification of currencies of host countries’ liabilities. This could increase the resilience for host countries to respond to the fluctuations of economic cycle and the divergence of economic policies and economic development trend among different creditor countries. This not only helps developing countries reduce the exchange rate fluctuation risk but also promotes the use of RMB in trade and economic cooperation with China.

For China, there are several benefits. First, it promotes RMB internationalization and further opening-up of the bond market. RMB internationalization can be reflected in various ways, including increasing the volume of RMB-denominated financial assets in global financial markets. By increasing the panda bonds for development financing, China can not only facilitate the opening-up of its bond market but also expand the scale of RMB-denominated financial assets in the global market.

It can also mobilize private financial resources to invest in developing countries. China’s past overseas investments and loans have been primarily led by state-owned banks, such as CDB and CHEXIM, as well as state investment funds like the China Investment Corporation and the Silk Road Fund. The participation of private capital in overseas investments has been relatively limited. Issuing panda bonds by developing countries provides an opportunity for China’s private investors to participate in overseas investments, thereby sharing the financial burden on China’s public institutions. Panda bonds can also offer a new investment opportunity for China’s investors to pursue higher returns, as the yields of panda bonds issued by host countries are typically higher than China’s domestic treasury and corporate bonds.

Lastly, the engagement of private creditors through investment in panda bonds can optimize the structure of China’s overseas investment, which is beneficial to China in debt restructuring negotiations. Given that bonds typically offer better tradability than bank loans, this will contribute to improving the quality of China’s overseas investment portfolio.

In recent years, the Chinese government has actively promoted the development of the panda bond market by improving regulatory frameworks, facilitating the two-way opening of financial markets. For instance, in early 2024, the National Association of Financial Market Institutional Investors (NAFMII) revised the guidelines for bond issuance by international development institutions and foreign government agencies, simplifying the directed issuance process and enhancing the financing efficiency. Regarding the use of raised funds, PBOC and the State Administration of Foreign Exchange (SAFE) issued a notice in December 2022, which removed the mandatory requirement for offshore institutions to retain bond proceeds within China. In addition, to facilitate foreign investment in China’s bond market, the “Swap Connect” was launched in May 2023, enabling foreign investors to hedge interest rate risks through RMB interest rate swaps.

Panda bonds as a part of Shanghai plan for debt restructuring

The debt crisis in developing countries that started during the COVID-19 pandemic has not shown significant abatement, but it rarely causes media attention these days. According to the latest data from Debt Sustainability Analyses (DSAs) conducted by the World Bank and International Monetary Fund (IMF), there are 25 countries which are at high risk and 10 countries are in debt distress for external debt. Though the international community, such as the Group of 20 (G20), has alleviated the short-term debt repayment pressure for debtor countries to bilateral official creditors through the Debt Service Suspension Initiative (DSSI), there seems to be a consensus that the Common Framework, which aims to coordinate debt treatment among G20 official creditors, is not working well, and debt restructuring negotiations for developing countries are still progressing slowly.

The lending from China to developing countries over the last two decades makes China an important creditor in the Global South. According to International Development Statistics (IDS), by the end of 2023, around $190 billion of the public and publicly guaranteed external debt stock in lower- and middle-income countries were owed to China’s official creditors, this represents about 7 percent of their total debt stock. Since the outbreak of the pandemic, China has actively participated in global debt restructuring in developing countries, making significant contributions. Precisely when countries need to ramp up investments in climate adaptation and SDGs, net transfer flows to debtor countries (defined as the difference between gross disbursement flows and debt service) turned negative. While some countries are facing liquidity constraints, other countries need debt relief to enable a path of development and growth. In response to the need for comprehensive debt relief including all creditor classes, China can explore innovative restructuring models, including Brady-like restructuring, and leverage low domestic interest rates to ease developing countries’ debt crises.

Issuing sovereign bonds by debtor countries for debt restructuring

Debt swap refers to the process of replacing existing debt with new debt through negotiation and market refinancing. In an ideal scenario, debtor countries can issue new sovereign bonds (probably with lower-interest or longer-term) to replace their previous debt. However, countries at high debt risk or already in debt distress face limited access to international capital markets. Even if they succeed in issuing the sovereign bonds, the financing costs could be very high, which adversely affect their debt sustainability. Therefore, to facilitate smooth bond issuance for these countries with affordable financing costs, developed countries should enhance debtor countries’ capital markets access and offer credit enhancements, such as guarantees. For China, expanding the panda bond market can be an effective option for supporting debtor countries. 

The issuance of panda bonds can be part of a broader debt restructuring plan as proposed in “the Shanghai Model” in 2021 by PBOC’s Zhou Chengjun. Drawing on the lessons of the Brady Plan in resolving the debt crisis in Latin America during the 1980-1990s, panda bonds can be used in a “debt to bond” conversion to swap the debtor countries’ debt to China’s development and commercial banks, with some additional operations such as reducing the principle or interest rate to original debt based on the negotiation between creditor banks and debtor countries. China’s creditor banks have the flexibility in choosing the debt resolution plans (such as par bonds with lower fixed rate, or discount bonds with floating rate).

To further enhance the creditworthiness of panda bonds, developing countries can use their foreign exchange reserves or concessional finance provided by the World Bank or IMF (such as the additional allocation of Special Drawing Rights, facilities like the IMF’s Poverty Reduction and Growth Trust, and the World Bank’s Disaster Risk Financing and Insurance Program) to purchase government bonds of China or other creditworthy countries as collateral for the principal and/or interest payments of panda bonds. Alternatively, the World Bank and IMF can provide guarantees for panda bonds, thereby reducing the risk and enhancing the market appeal. While creditor banks may need to forgo part of the principal and interest revenues in the short term, this debt swap combined with credit enhancement instruments can effectively help creditor banks revitalize the impaired loans and increase overall liquidity. In the long run, this approach benefits the banks, making them more willing to participate in debt swap.

The Brady Plan turned out to be successful for Latin American countries to escape the debt crisis in the past, improving their fiscal and economic conditions, and promoting market-oriented reforms. Therefore, there is reason to believe that the Shanghai model (with Chinese characteristics) could also make significant contributions to alleviating the current debt crisis. At the same time, China can gain more experience in international debt restructuring through this process, enhancing its debt management capabilities.

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